Silicom Ltd. (NASDAQ:SILC) Q4 2022 Earnings Call Transcript

Silicom Ltd. (NASDAQ:SILC) Q4 2022 Earnings Call Transcript January 30, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Fourth Quarter 2022 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 Global Investor Relations 1-212-378-8040, or view it in the News section of the company’s Web site www.silicom-usa.com. I would now like to hand over the call to Mr. Kenny Green of GK Global Investor Relations. Mr. Green, would you like to begin, please?

Kenny Green: Thank you, Operator. I would like to welcome all of you to Silicom’s fourth quarter and full year 2022 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 that information. Actual events or results may differ materially from those projected, including as a result of our increasing dependency for substantial revenue growth and the limited number of customers in the evolving cloud-based SD-WAN, NFV and Edge markets, the speed and extent to which solutions are adopted by these markets, the likelihood that we 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 Silicom’s products and services, maintaining, protecting brand recognition, protection of intellectual property, competition, disruptions to our manufacturing and development along with general disruptions to the entire world economy related to the spread of the novel coronavirus COVID-19 and other factors 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 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 operations and prospects for the future. Unless otherwise stated, it should be assumed that financials discussed today in this conference call will be on a non-GAAP basis. Non-GAAP financial measures are — disclosed by management are provided as additional information to investors in order to provide them with an alternative method for assessing our financial condition 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 are included in today’s earnings release, which you can find on Silicom’s Website. With us on the line today are Mr. Liron Eizenman, President and CEO, and Mr. Eran Gilad, 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 now like to hand the call over to Liron. Liron, please go ahead.

Liron Eizenman: Thank you, Kenny. I would like to welcome all of you to our financial results conference call discussing our fourth quarter and full year 2022 results. We are very pleased to report another solid quarter capping a strong year of revenues, margins, and EPS growth for Silicom. In particular, this is all the more impressive against the background of what has been a continued challenging and complex environment with significant component shortages and a lot of supply chain issues. We are very happy with our performance, growing our fourth quarter revenue to $45.2 million, which is up 24% over last year. For the full year of 2022, our growth was 17% year-over-year to $151 million in revenue, a record year for Silicom.

Furthermore, the strong operating leverage within our business model allow the revenue growth to translate into accelerated profit growth. This is demonstrated by our operating margin expanding to 15.6% for 2022 versus 12.4% last year, and our net margin growing to 14.1% for 2022 versus 10.9% last year. The continued success led to our 72nd quarter of uninterrupted profitability, and we reported 2022 earnings per share up 55% year-over-year to $3.12 per diluted share, double that from only 2 years ago. It all highlights the strong and broad demand for more end markets, especially the edge products, and the markets understanding of our unique value proposition that we have built over the years, including high performance products, reliable delivery, quick customization, and unmatched support capabilities.

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Our success demonstrate the markets clear need for our groundbreaking products, while underscoring the benefit of the leverage inherent in our business model. 2022 is taken up a step towards meeting our long-term target financial model that we shared with you a few years ago. Back in 2020, our target was 18% operating margin and 15% net margin when we reach full year revenue of approximately $250 million. At that time, our respective operating and net margin were about 10%. And this was an aggressive target. The results in 2022 demonstrate that in only 2 years, we are well on the way, thanks to the impressive leverage we demonstrated in our business model throughout the year. Our cash position currently stands at $50 million, up by approximately $7 million since last quarters.

As I explained last quarter, our working assumption is that the component shortages will continue to improve during 2023, in fact we have decided to actively and gradually reduce our inventory levels. Peak inventory levels are therefore now behind us. And as inventory has decreased during the past two quarters and is expected to continue to gradually decrease in the quarters ahead, it is and will directly translate to an increase in the cash level. Our continued strong cash position remains a key strategic asset and significant competitive advantage, especially in today’s market. It allows us to serve our existing customers better, maintain a high-level of critical inventory allowing us to deliver products which are not readily available. This in turn enables us to attract new customers and new businesses, which have difficulty finding product elsewhere.

Furthermore, it enabled us to capitalize quickly as opportunities present themselves. I would like to discuss our recent edge networking design win from Fortune-500 SD-WAN F. This networking leader serves customers across the Americas, APAC and EMEA, and is a new important edge customer roster. The win was for a customized version of one of our 5G integrated edge networking products. And the win was due to our unique feature set, flexible connectivity options and offering differentiation in the market. We expect orders to ramp up through 2023 with deployment levels reaching a steady state beginning in 2024. This win is another clear demonstration of the depth and quality of the potential opportunities in our pipeline, as well as the compelling value proposition that we offer for next generation edge networking use cases.

We can now point to a record pipeline of opportunities for our edge products in multiple varied markets as well as significant interest from potential new customers for our product. Wins such as those have established us as an industry edge platform provider of choice with a product rapid customization capability, delivery capabilities and ongoing support that many customers need. We expect to continue benefiting strongly as the market transitions to the edge platform paradigm, driving multiyear growth for our company. Telcos, service providers, enterprises, network vendors, cyber vendors as well as cloud players, all are seeing the need for edge products for various applications, such as SD-WAN, virtual CPE, telco dedicated routing and SASE and more.

As our edge products, which are initially target to the SD-WAN market became a clear growth driver for us, we realized that those same products are highly attractive for significant broader applications and varied markets, thus making our total addressable market potential even bigger than what we had initially thought. Finally, in terms of our guidance ahead, while we move into 2023 with all-time record, year-start backlog, our visibility is limited due to a challenging mixed-signal environment that is impacted both by the global economic slowdown and the expected loosening of the supply chain after a long period of component shortages. We therefore project that our revenue for the first quarter of 2023 will range between $37 million and $38 million.

The midpoint of this range represents 17% year-over-year revenue growth over the first quarter of 2022. In summary, we remain very pleased with our performance throughout 2022 with strong year-over-year growth in revenue and a significant acceleration in our profit growth, proving the operation leverage inherent in our business. We have strong tailwinds in the form of our highest-ever level of year-start backlog and a strong roster of leading customers in design wins, many of which are in the early ramp up stage. Furthermore, we maintain a healthy and quality pipeline of future design wins. Finally, we see that the company shortage is easing up. And over the coming year, we expect to put this issue behind us. On the other end, there are headwinds emerging in the form of global economic slowdown, which is starting to impact our visibility.

We are being cautious as there is increased potential for longer decision making processes and delayed ramp up by customers, as well as the potential for cancellations or push outs of the high-level of orders that were issued during the very long component shortage period. All in all, looking at the coming years, we remain optimistic that are double-digit compound annual revenue growth will continue. As we enter into 2023 with a total addressable market larger than ever, our highest-ever year-start backlog and a healthy quality pipeline, we have never been better positioned. With that. I will now hand over the call to Eran, for a detailed review of the quarter results. Eran, please go ahead.

Eran Gilad: Thank you, Liron, and hello, everyone. Revenues for the fourth quarter of 2022 were $45.2 million, up 24% compared with revenues of $36.3 million as reported in the fourth quarter of last year. Our geographical revenue breakdown over the last 12 months were as follows: North America 72%; Europe and Israel 23%; Far East and rest of the world 5%. During the last 12 months, we had only one over 10% customer and our top three customers together accounted for about 27% of our revenues. I will be presenting the rest of the financial results on a non-GAAP basis, which excludes the noncash compensation expenses in respect of options and RSUs granted to directors, officers and employees, acquisition related adjustments as well as lease liabilities, financial expenses.

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 2022 was $15.1 million, representing a gross margin of 33.5% within the range of our gross margin guidance of 22% to 26% and compared to a gross profit of $12.7 million, or gross margin of 34.9% in the fourth quarter of 2021. The variance in the gross margin is a function of the specific product mix sold in the quarter. Operating expenses in the fourth quarter of 2022 were $7.2 million, below the $7.5 million reported in the fourth quarter of 2021. Operating income for the fourth quarter of 2022 was $7.9 million, an increase of 55% compared to operating income of $5.1 million as reported in the fourth quarter of 2021.

Before moving to the net income data, I would like to mention the relatively high effective tax rate we had in the quarter. The higher the normal tax rate is mainly due to one-time FX in the fourth quarter. Please note that our full year tax rate is 15.2% in line with our 15% expected tax rate. Net income for the quarter was $6.6 million, an increase of 48% compared to $4.5 million in the fourth quarter of 2021. The earnings per diluted share in the quarter were $0.98. This is a year-over-year increase of 51% compared with EPS of $0.65 as reported in the fourth quarter of last year. Now turning to the balance sheet. As of December 31, 2022, the company’s cash, cash equivalents and marketable securities totaled $49.9 million with no debt, or $7.41 per outstanding share.

That ends my summary. I would like to hand back over to the operator for question-and-answer session. Operator?

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Q&A Session

Operator: The first question is from Alex Henderson of Needham & Company. Please go ahead.

Alex Henderson: Great. Thanks so much, and super job against a challenging environment on the print as well as the conservative guide. So the obvious first question here is, you’ve cautioned on concerns about the macro environment, potentially resulting in some of the backlog potentially being either pushed out or diminished as a result of macro conditions. But you also have a significant number of new projects that are in the early phases of ramp, which, obviously they could ramp a little slower given the environment. So have you actually seen any of the backlog be committed to? And second, how do we balance those two as we’re thinking about the progress through the year?

Liron Eizenman: So first of all, thank you, Alex. First of all, we did not see any significant cancellations or push out yet. But it’s definitely something we’re monitoring and wanting requires us to speak with our customers every day to understand their plans, and how they see 2023. As we look into 2023, as we said, we have limited visibility. That’s part of the big question. I mean, how really those new design wins will ramp up? Will there be significant push outs? Will customers ask to cancel orders? Those are the big questions. So it’s hard for us to give a definitive answer, because our visibility is limited for 2023.

Alex Henderson: If we will look at the supply chain side of the equation, you said in the December quarter that you’re starting to see some improvement in availability. Can you talk to what degree that is factoring into your thinking at this point? And how much further do you expect that to improve over the course of the year?

Liron Eizenman: So right now we see the improvement continuous. Things are improving, more vendors are able to support shorter lead time and have better availability, but not all of them and in some cases, certain vendor will have certain parts more available and other parts less available. So the work that we are continuing to do with the finding alternatives and finding solutions continues all the time. But the number of parts that we need to focus on is decreasing all the time. And our assumption is that during 2023, it will, at some point, I don’t know exactly when in 2023, it will be almost back to normal. But hard for us to say exactly when. We do not expect it to be Q1 for sure, but later in the year, we think it will become better and better.

Alex Henderson: And then looking at the OpEx side of your equation here, obviously, the Shekel have bounced around a little bit, but it’s still pretty low relative to historical ranges. And you’ve managed to do a fabulous job of essentially flat costs at the OpEx level in ’22. Should we be thinking about ’23 OpEx in investment mode, in containment mode. How do we think about it? How do we — how should we be modeling it?

Liron Eizenman: I think we should definitely maintain it. I mean, assuming those significant exchanges — exchange rate changes, we expect it to be the same.

Alex Henderson: Great. That’s good news. And then on the interest line does cash

Liron Eizenman: Just to clarify, Alex — Alex, just to clarify, we expect it to be around $33 million, not the same, sorry. I was thinking about the model, not about 2022.

Alex Henderson: Right. I see. And then on the interest line, given your cash balances going up and the benefit of higher interest rates on cash balances, should we be seeing an increase from the 524k that you posted in the December quarter, each quarter? Is that — that’s below the watermark for the year?

Eran Gilad: Not necessarily. On top of the income from investing activities, with its higher yield, the financial income presented in our P&L is largely dependent or impacted by exchange rate differences. In other words, indeed, the yields right now are better than the yields a year ago, no question about it. However, exchange rate is a big factor in the financial income number. Therefore it is hard to predict right now.

Alex Henderson: Assuming the exchange rates stay flat, that would be I think the assumption most people work off of. Would that then be fair to say that the interest line ought to be higher over the course of the ’23 timeframe?

Eran Gilad: That’s correct. That’s correct.

Alex Henderson: Okay. Right. And one last question. And then I’ll cede the floor. The pipeline, these projects are longer term in nature, most companies even in a macro environment are still going to be looking at the projects that they need coming out of a recession in 18 months or whatever the timeline is, how does your pipeline look in terms of larger contracts? And what is the kind of the timing of the next contract wins? Do you expect to see meaningful wins in the first half of the year against this environment? Or does that slow those down to the point where we shouldn’t be anticipating them?

Liron Eizenman: From a pipeline perspective, we have a very good pipeline. I think I said it a few minutes ago in our opening words. Yes, we see a very good pipeline, very fast pipeline, especially for our edge products. We — all the time, we see more and more need. I don’t know exactly how those will ramp up eventually, that will definitely depends on the global economy. But I think from companies pushing more and more network equipment towards the edge, or still needing our equipment in data centers or in enterprises, we still see that and we still see a very set pipeline and our sales team is very, very busy in addressing all those opportunities.

Alex Henderson: addressing new wins as opposed to existing pipeline of business, that’s — how to say it, already in hand. Obviously, the timing of ramping specific projects that have already been won can have a different curve to it. But what about news flow of large new wins?

Liron Eizenman: Definitely working on that. I mean, the — we don’t see a slowdown necessarily in closing the deals, we will see it. Each project has its own nature of how the company is working, and how quickly or slowly they’re moving. But from the point of getting wins, I don’t necessarily see that we’ll see a slowdown. The actual ramp up and deployment of those projects, that will be a big question. But getting the wins, I’m sure, we will get more wins and we’ll see them. Deployment, that’s a big question.

Alex Henderson: One last question. If I look at the geographic display of your customers, is there any difference in the behavior of customers that are located? Obviously, it doesn’t translate into where the products going, but located in different geographies, or are they all behaving pretty similarly at this time?

Liron Eizenman: I think it’s mainly a function of culture, not more than that. I mean — but we don’t see specific markets behaving economically, I would say, differently than other markets right now. Obviously, each geographic with its own culture and the way they are used to doing business, but nothing special beyond that.

Alex Henderson: Right, thanks. I’ll cede the floor.

Operator: The next question is from Alex Anderson of Needham & Company. Please go ahead.

Alex Henderson: I was hoping somebody else was going to queue, but nobody else is queuing, myself continue. Given the improvement in cash flow, given the volatility in the stock market, do you anticipate utilizing the cash in terms of buybacks or any other activity that — how should we think about use of cash in this environment?

Liron Eizenman: Still, right now, we feel that the best use for our cash, given the uncertainty still to be able to use it for inventories if we would need to do so. And for components, we don’t have any other plans at the moment for that.

Alex Henderson: All right. That was our last question. Thanks.

Operator: The next question is from Shawn Boyd of Next Mark Capital. Please go ahead.

Shawn Boyd: Thanks for taking the question. Can you hear me okay?

Liron Eizenman: Yes, we can.

Shawn Boyd: Just one for me. I want to get back to the gross margin and this quarter. I think you call that product mix, but can you elaborate just a bit on that? And also, is that something that continues into the first half of this coming year? Or do we kind of move back to that 35%, 36% level that we saw in the previous two quarters? Thank you.

Eran Gilad: So we still see that we’re going to be in the same range. We don’t see any reason to change the range right now. We still believe will be in the 32 to 36.

Liron Eizenman: Shawn, does that answer your question?

Shawn Boyd: I got it. I got it. Yes. Thank you.

Liron Eizenman: Thank you.

Operator: 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 replay of this call will be available 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 3 months time. Good day.

Operator: Thank you. This concludes Silicom’s fourth quarter 2022 results conference call. Thank you for your participation. You may go ahead and disconnect.