Ehud Helft - GK Investor Relations Shaike Orbach - Chief Executive Officer Eran Gilad - Chief Financial Officer.

Alex Henderson - Needham and Company Aria Cole - Cole Capital Chip Saye - AWH Capital Ethan Etzioni - Etzioni Portfolio Management David Wilson - UCS Finance Vladimir Galabov - IHS Markets.

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Fourth Quarter and Full Year 2017 Results Conference Call. All participants are at present in listen-only. 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 and Public Relations at 1646-688-3559 or view it in the news section of the Company’s Web site, www.silicom-usa.com. I would now like to hand the call over to Mr.

Ehud Helft of GK Investor Relations. Mr. Helft, would you like to begin..

Thank you, operator. I would like to welcome all of you Silicom's fourth quarter 2017 results conference call. Before we start, I would 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 on a limited number of customers in the evolving cloud-based market.

The speed and extent to which cloud-based and cloud-focused solutions are adopted by the market, the likelihood that you will rely increasingly on customers, which provide cloud-based and cloud-focused solutions in this evolving market, resulting in an increasing dependency on smaller number of larger customers, difficulty in commercializing and marketing Silicom's products and services, maintaining and protecting branded solutions, protection of intellectual property, competition 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 earning 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 core operations 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 in additional information to investors in order to provide them with an alternative method for assessing our financing 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 Web site. With us on the line today are Mr. Shaike Orbach, CEO; and Mr. Eran Gilad, the CFO. Shaike 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 now to hand over the call to Shaike. Shaike, please..

Thank you, Ehud. Good morning, everyone and welcome to our conference call to discuss the fourth quarter and full year results of 2017. As has been the case for many quarters, we are again proud to present a record set of financial results. We are very happy with these results of the full year, as well as with those of the fourth quarter.

We announced our highest ever level of revenues and net profit in both the quarter and the full year period. Our full year 2017 revenues were up 25%, operating income was up 29% and net income up 31%, demonstrating continued and significant growth in all parameters. Eran will provide more color on our financial results in a few minutes.

We continue to see many growth opportunities among both our existing as well as new customers. Above that, there is a strong industry migration to cloud, including both the data center and Edge with SD-WAN and NFV riding on top of the basic infrastructure.

As you know, our products fully addressed the needs of these market segments, and the exploding demand is leading to a trend whereby the potential as a whole as well as from any specific design win, which is within our pipeline, is now significantly larger than what we used to have in the past.

Our design wins from 2017 already demonstrate that trend, as many of the design wins that we have achieved during the year were in fact on a much larger scale than what we have achieved in prior years.

Of the 11 new design wins we announced in the year, we had won* with a full run rate potential of $6 million and additional two with an $8 million and $10 million potential. And of course the largest one that we announced last year with a run rate potential of around $75 million, once our challenges are overcome and we reach a steady state.

This largest ever design win for Silicom progresses very well from our side and we are meeting our ongoing targets. As I mentioned last quarter, there are challenges that remain ahead. In my discussion of last quarter, I divided these challenges into two categories; customer challenges and our cloud deployment challenges.

I am pleased to inform you that we have practically resolved almost all deployment challenges related to our card during the past quarter. The only challenges that remain in terms of the deployment of our cards are now standard operational issues, which do not represent any unique difficulty.

However, I stress that as with all complex projects, there can always be unpredictable operational issues which may result in push out in deliveries, which in turn may lead to significant quarterly fluctuations in revenue. As to the customer challenges, we understand that the customer is progressing in accordance with its plan.

As such, there is still no general availability of the product to end users yet and the customer is still working to meeting certain milestones necessary for getting all the full solution ready for use by end customers. The plan, however, is still to reach general availability by mid-year.

Achieving general availability per the plan as well as understanding the demand once such GA is achieved, are obviously our customers’ challenges, which will have an impact on us.

While our customer continues to finalize various aspects of the new cloud infrastructure it is establishing, sufficient infrastructure needs to be ready for initial user demand before rolling out the service throughout its full user base, which represents the current demand against which we are currently delivering our cards.

During the current stage, our customers’ assessment as to its own success may cause outside or downside fluctuations in its short-term demand of our cards. Our customer believes the risk of not reaching the general availability milestone is negligible.

We understand that there remain standard engineering work and debugging rather than any issues which threatens visibility. However, only when all such debugging is complete and the infrastructure is fully functional, will general availability we reached.

Following this, user response will be validated and only then will we truly understand the actual level of demand.

While our customer may experience delays in meeting the GA date and it does not yet have a full handle on the exact demands that will be placed on the infrastructure, the expectations of the customer based on its current existing cloud deployments are huge.

In fact, the customer is describing potential scenarios with which even our current estimates are conservative.

To demonstrate how confident our customer is and its success, I am pleased to update you that just recently we were selected by the customer to develop and deliver a new version of the card, which includes additional functionality supporting a different deployment scenario on top of everything that the current solution does.

We believe that the customers’ willingness to invest in such additional scenarios is a clear indication as to its view of the low level of rates within the solution.

Coming back now from the specific win to the broader cloud picture, this design win as well as many of our recent of our other recent wins, reflect the fruits of our successful cloud and cloud related strategy, which leverages the ongoing industry transition towards cloud technologies at both the data center and Edge.

While we have had significant success, I know that our cloud journey is still in its early stages. And as each quarter passes, we become ever more optimistic with regard to its power to drive our business to a whole new level.

The recognition that we continue to receive from this market for our technologies and solutions, coupled with strong and growing market demand, is empowering us to build our business to a new level. Looking at our business from an even broader perspective, while cloud is indeed a very strong growth engine for us, Silicom is much more than just cloud.

We continue to invest in and convert the strong and growing pipeline into design wins in some of the hottest networking segments, including cyber security, SD-WAN and NFV in addition to cloud. All these markets depend on flawless connectivity, and our product innovations are tweaked towards exactly meeting our customers’ need.

We have cemented ourselves and we are increasingly seen by many existing and potential customers in our target industries as the connectivity partner of choice. We specifically see a growing interest in our SD-WAN and NFV related offering where we now have a thick and long pipeline, which we hope will soon turn into wins.

This pipeline includes a few potential design wins for our Edge devices with a few of the leading U.S. telcos. That being said, I know that often wins in this environment can take a long time to translate into significant revenue as that, which is compensated by the significant size of such wins, once they reach the steady state.

I would like to spend a few moments discussing our short and longer-term operating model and the recent strategic changes we have chosen to make to capitalize on the market opportunities or opportunities we currently see. As I often mentioned, our end markets continue to grow strongly and demonstrate very strong potential for Silicom.

As a company, we aim to take every advantage of the significant increased revenue potential and opportunities we anticipate from all the major players in a variety of targeted market segments in the coming quarters and the years. On previous calls, I have spoken about the gross margin levels we expect to see in the quarters ahead.

To reiterate this, earlier this year, we adjusted our gross margins in such a way that we believe will bring us a step up in revenue and the corresponding step-up in operating and net income.

It is also important to reiterate that we strongly believe that this change serves as a significant competitive advantage for Silicom, which has been able to long demonstrate its unique capability to generate high net profit, while offering customers attractive and innovative products with low gross margins.

We believe that such a capability presents a significant barrier for competitors and will allow us to better capitalize on the many opportunities in the market, and the overall effect to our bottom line will be very positive. In fact, we can already show this effect comparing our 2017 results to those of 2016.

While our gross margin trended down 220 basis points to 36.8% for the year, our operating margin still increased 70 basis points to 20% and our net margin also increased 70 basis points to 17.3%.

This is a very impressive leverage, and more important the improve margins together with the increase of 25% in revenues, further increased our net profit by the impressive 30% from $16.6 million to $21.7 million and from EPS of $2.24 to EPS of $2.85.

With regard to guidance for the first quarter, we expect revenues of between $30 million to $31 million, representing year-over-year growth of 20% at the midpoint. In summary, we are increasingly excited with regard to our prospects.

While 2018 is very much a transition year for us as we continue our evolution into a company delivering on an increasing number of double-digit design wins for a growing roaster of top tier customers, we are now far better positioned than ever to achieve accelerated strong growth on the top line with the corresponding increase on the bottom line for the years to come.

With clouds’ tailwinds driving demand for our product, additional expected growth in cyber security, SD-WAN, NFV and other related markets at the start of 2018, our business is at a financial inflection point in our growth trajectory with the potential to significantly accelerate ahead moving forward.

The success we have experienced in recent years demonstrates our ability in predicting currently investing in and ultimately capitalizing on the upcoming market trends. Our design wins represent the ongoing fruits of significant fast R&D investments made at the right time.

There are also a clear indication of the superiority of our overall technical and solution capabilities. They are very much aligned with the critical performance needs of both existing and new potential top tier customers addressing all the high growth markets which we target.

We look forward to reporting on our continued progress over the coming quarters. With that, I'll will now hand over the call to Eran for a detailed review of the quarters’ result. Eran, please go ahead..

Thank you Shaike and hello everyone. Revenues for the fourth quarter of 2017 were a record $37.8 million, an increase of 33% compared with revenues of $28.3 million as reported in the fourth quarter of last year.

Revenues for the full year of 2017 were also at a record reaching $125.7 million, representing year-over-year growth of 25% compared with $100.3 million reported last year. Our geographical revenue breakdown for 2017 were as follows; North America 80%, Europe and Israel 16%, Far East and rest of the world 4%.

During 2017, we had two customers with over 10% of revenues, one is about 20% and the other above 10%. We also had two other large customers both where below 10% of full year revenues and combined they reached about 15%.

In this context, I would like to point out that a large customer and the large design win are not necessarily the same with many of our customers, including the larger ones, revenues from a specific customer are the result of more than one design win.

Also, as discussed earlier by Shaike, our recent design wins and those in the pipeline are getting bigger in size. As such, some of these design wins result in revenues attributed to more than one customer.

I will be representing the rest of the financial results on a non-GAAP basis, which excludes the non-cash compensation expenses in respect of auctions and RSUs granted to directors, officers and employees, and acquisition related adjustments.

I should note that the larger than usual difference between the GAAP and non-GAAP numbers this quarter is due to the effect that the maximum amount in connection with our latest acquisition, which was closed in 2015, will be lower than the amount we originally incorporated in our GAAP financial reports at the time of the acquisition.

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 2017 was $13.6 million, representing a gross margin of 36%. This is compared with $11.3 million or gross margin of 39.8% in the fourth quarter of last year.

As Shaike mentioned earlier, this lower gross margin is mainly a result of our margins strategy and long-term model. Looking ahead and given the very strong growth opportunities in our end markets, we reiterate that our expected gross margin in 2018 will be in the 32% to 36% range.

Operating expenses in the fourth quarter of 2017 were $5.8 million or 15.3% of revenues compared with $5.4 million or 19.2% of revenues in the fourth quarter of last year.

While the operating expenses as a percentage of revenues were significantly lower than in the fourth quarter of 2016, the increase in the absolute level of operating expenses was mostly due to the strength of the Israeli shakel in which we generate a large portion of our operating expenses versus the U.S. dollar, our reporting currency.

Operating income for the fourth quarter of 2017 was $7.8 million, a significant growth of 34% compared to $5.8 million as reported in the fourth quarter of 2016. Net income for the quarter was $6.9 million or 18.2% of revenues, an exceptional growth of 39% compared to $4.9 million or 17.4% of revenues in the fourth quarter of last year.

Earnings per diluted share in the quarter were $0.89, a significant growth of 35% compared with $0.66 in the fourth quarter of last year. Now turning to the balance sheet. As of December 31, 2017, the Company's cash, cash equivalents and marketable securities totaled $30.7 million with no debt. That ends my summary.

And we would be happy to take any questions.

Operator?.

[Operator Instructions] The first question is from Alex Henderson of Needham and Company. Please go ahead..

First question is, can you give us some guidance on your tax rate for 2018? Obviously, it’s something we can't forecast independently..

We can estimate a range of 14% to 15%..

And can you remind us your approach to hedging. There's been a pretty good move in the exchange rate over the last year. Were you hedged during that period? And are you now hedging at a lower rate, or did you not hedge at all? Can you just remind as what your approach is to that..

Currently, our approach is not to hedge anything..

So you fully absorbed the decline from 372 down into 332 range at this point, and that’s -- so we shouldn't expect that to be a variable?.

Exactly..

On the customer commentary, you made the comment that you've been updated -- you're updating the customer and selected for a new version and a new deployment. I assume that that's in addition to that $75 million number.

So could you give us any sizing around that? Is that bigger than bread box, what should we be thinking?.

Right now, I don't want to say that it’s on top of the $75 million. It is just -- it describe -- the reasons that I brought that up at this moment to demonstrate how confident the customer feels about the low level of risk, because he is adding some more features into the offering.

I believe that the intention moving forward would be that both versions of the card would be used..

So does the addition of additional features mean that there is additional software work that….

There would also be additional software coming from the customer for that card. And also, as I said I mean this, they are thinking about the growth model of their cloud and they're having several deployment scenarios, and this card would be used in some of them and facilitating.

Well I mean, obviously, they are hoping that with that card maybe the potential for their cloud would even be higher. But at this moment, I'm not ready to say that it increases our focus..

One last question then I'll cede the floor. So historically, you've seen a pretty significant drop from 4Q to 1Q. 4Q tends to spike up and then 1Q is obviously seasonally much weaker.

Is that pattern starting to stabilize as you've grown scale? And could you give us any sense of the variability parameters as you're looking from 4Q to 1Q? My bias is always try to keep 1Q very conservative..

Well, I mean, first of all, indeed. I mean, the fourth quarter has always been quite significantly stronger than the first quarter. And we expect that to continue. How much stronger that could deviate from one year to the other, but it definitely is going to be like that, moving forward.

As we move, because -- I mean we are moving into more market segments that we haven't been playing with before. Overtime, there may be some changes in that model, but we are just at the beginning of this process. So if we’re looking let’s say 2018 as a whole, I think that the pattern is going to be very much like we had in the past..

And when you’re looking at that first quarter, does the mix shift to some of these newer cloud products, because of the seasonality and therefore, we should anticipate the gross margins will reflect that, that mix shift to more cloud, which is lower margin?.

No, I think that Q1, in terms of the -- well, let me put it this way, because I would like to be careful. Right now, I don't see any significant change in terms of the margins between Q1 and Q4. That may change, because obviously we don't have all the revenues for Q1 at hands right now.

But in -- if you’re talking about my guts feeling, it’s going to be more or less the same..

The next question is from Aria Cole of Cole Capital. Please go ahead..

Two quick questions regarding your largest customer and the rollout you're having. My understanding is they were trying to have a second source, and they are having difficulty bringing on a second source and it’s signed now a new one.

Can you give us a status update for if the second supplier has completed a design of a similar card? And when that card might be shipping and what relative revenue share it might get relative to you?.

I can tell you what I know -- what we know, here in Silicom, which is what we are hearing. So first of all, at a moment, there is no second source. So right now, there's no second source available at all. Seems like second source will not be available during 2018 and if at all it will, it’s going to be towards the end, but even that is not for sure.

I would like to noting here that this is not only a decision issue of whether or not which second source to be used, et cetera, this is a very complex card. And just concluding the development and making sure that everything works as it should, is not a simple task.

So obviously, as you can imagine, I mean we’re not being informed about all the difficulties and everything that is happening with the second source, but we do know that right now there isn't one..

And just the follow up with your intentional lower gross margins here.

What sort of price advantage would you expect versus the competitor? Is it 10% 20%, or different amounts in terms of having a lower price available to the customer?.

No, I would say that the brands’ advantage that we would get over the competitors is low in terms of percentage.

What I am saying is that the customers like us better than the competition, because of that technology, because of that depth of knowledge, because of the way that we handle our customers, because of all these reasons that had been the reason for our success until now.

However, I mean no matter how much they liked us if we were, I would say, significantly more expensive than our competitors they wouldn't have been able to select us.

So we have come to the -- I would say to the area of our competitors or at least some of them and maybe a little less than some others, and then it seems to us and this is also why I mentioned that we are having a thick pipeline and not only a long pipeline, seems like that once we’re doing that, the customer is -- its becoming a much simpler decision to the customer to select us..

And then just a final question, I understand that design wins you're working on with potential existing and future customers are not guaranteed. But in 2017, correct me if I'm wrong, but you seem to have signed four new and/or larger customers with annual revenue expectations, as said earlier, of $6 million eighth ten and your number one customer.

Can you give us a sense in your pipeline of how many large contracts like this call it $6 million per year or greater you're working on? Obviously, you might win none of them but can you give us a sense for how full the pipeline is?.

Well, I can tell you that right now we’re having discussions with three major potential customers. The potential of each design win with each of them is a double-digit..

So 10 million or more per year, if you win?.

But once again, I mean just one word to be cautious as I've said, typically with these customers once you have the win, it doesn’t mean that immediately the revenues are ramping up to this number. It takes some time to ramp-up, but once in steady state, that's what we’re expecting..

The next question is from Chip Saye of AWH Capital. Please go ahead..

As you referenced your Switch-Fabric-on-a-NIC product for the large customer.

Can you discuss what are some products that you’re delivering for some of the other markets like the SD-WAN market, which I've heard more and more deployments recently and then maybe, what kind of security markets security products you are offering for cyber security? If you can discuss those, I would appreciate it..

So for the SD-WAN, we are I would say that we’re delivering few types of product. One type of product is the virtual CPEO, the virtual customer premise equipment platforms that we’re delivering.

And with these customers that I mentioned before, this seems to be a very hot area whereas some customers are interested in utilizing or using this type of virtual CPEs coming from us. So this is definitely a major, I would say, strategic leg for our products going forward into that market.

But not only that, I mean we still continue to deliver even to the SD-WAN and mostly, well as a matter of fact these two product lines are playing in both the cyber security and the SD-WAN, because in both of these we see the need for the virtual CPE on the one side and the need of our traditional cost, including and maybe mostly and more so than before, the smart adapters that we’re having which goes into a higher end appliances, which are typically not at a branch.

So what I'm saying is that when you look at SD-WAN and cyber security, so you have the brand side and you have the datacenter or the main office if you want if you are out of the cloud space. So in the branch, we’re talking about the VCP in the main office or into datacenter, we’re talking about card solutions mostly smartcards..

I was just going to ask you on some of those competitive wins, who are you seeing mostly as competition there. I know you don’t have -- you mentioned there is no second source yet for the big customer order.

But who are you seeing competitively in some of the other categories?.

Well, it's a little bit difficult to answer, because the way that we define our business is different from the way that some other companies define their own business, which is why providing you with any names or so would actually be misleading. So we have a variety of competitors, each of which in a different area.

I think that just giving names would be misleading..

Could you maybe step back then, and on the second source of the Switch-Fabric-on-a-NIC product? Who are some of those that are trying to deliver a second source, can you share that information?.

Well, there aren't too many we’re trying. At this moment, there is one company which is let me take one step back. There was one company that's tried and failed. There is another company that we know about right now. I cannot provide any names..

The next question is from of Ethan Etzioni of Etzioni Portfolio Management. Please go ahead..

I wanted to ask, a $75 million customer, you previously updated us that he provided a $10 million order.

Is that above the amount of revenues that came in '17 or was there additional orders from that customer?.

The $75 million, we talked about the potential in steady state. These were not purchase orders..

You said that it gave you $10 million order, so....

Definitely, we received more purchase orders after* the $10 million, I think, that I’ve even mentioned that in one of the conference calls..

Can you give us what number did came-in in ’17 from the $75 million customer….

No, we cannot. I mean, unfortunately, we cannot. This is very sensitive business information and we cannot do that..

But you’re saying more than $10 million?.

Yes..

[Operator Instructions] The next question is from David Wilson of UCS Finance. Please go ahead..

My question has to do with your capital, because you’re growing so quickly.

Have you given any thought to changing your dividend policy and/or capital raise? Any thoughts on that?.

Well, we’re thinking about all these things..

The next question is from Vladimir Galabov of IHS Markets. Please go ahead..

Congratulations on the amazing quarter, and it’s been very nice to see Silicom do very well every quarter last year, so kudos on the great execution. My question is about contributors to the success and specifically if we look at the $125.7 million revenue for the year.

What percentage of that was driven by server adaptors?.

I don’t think this is information that we provide..

I’ll rephrase.

In terms of the server adaptor business, is it growing in line with the revenue of the total company, or is it going ahead or behind?.

In general, I would say that all parts of our business are growing..

And as a follow up question, just in terms of the geo-splits, normally we get a spilt between North America, Europe and Israel and Far East and rest of the world?.

Eran mentioned that....

I mentioned that North America about....

80%, 16% and 4%....

The next question is from [Don Mckernan of Landmark Securities]. Please go ahead..

Can you give us an update on what’s going on with FPGA, feel, programmable?.

So in general, just like I've said, previous times we considered the FPGA business as an strategic extremely important leg within our strategy, and we are moving forward with these solutions as well. It takes more time need to understand that these solutions amongst all the solutions that we provide, these are the most complex.

Typically, customers will buy into anything like that after a series of POCs and then you need to go into these POC with some IP that you get into the FPGA, all of which is happening as we’re talking. So we are definitely making progress with potential customers.

However, this is a longer sales period compared to some of our other product, which are becoming a design win much more quickly..

And then can you give us an idea of how many prospects are in the pipeline for SD-WAN and for your data center NIC card?.

Well, I guess that in general, there are tens* of prospects..

I think on one call you said maybe 5 to 10 on SD-WAN and maybe....

No, these were five to 10, which are plus -- I mean if you take five to 10, so five are the bigger ones and then 10 are taking them all together. But overall this is in line with what I’ve said right now. So if you take the SD-WAN prospect and you add to these the FPGA prospect and you add to these the standard cards then we’re talking about tens.

We are obviously talking about tens of millions of dollars or even more that that we are pursuing right now, and some of these potential design wins that we're pursuing each of them could be even tens of millions of dollars..

And in SD-WAN, has there been any design wins by any of your competitors in the VCPE, the virtual edge routers?.

Can you run that again by me, I didn't hear the first part of the question?.

Yes, in SD-WAN have your competitors for the virtual CPE the routers, has there been design wins by any of your competitors with any of the telcos?.

Well, could be. Well, not because of not necessarily we are aware that -- of everything that is happening in that space, at least recently and talking just out of my head I mean trying to remember. I do not remember anywhere that they've won against us.

But possibly there could be some wins so there could be some areas or some bids we really did not even participate. So that could have been..

Okay, thanks..

[Operator Instructions]There are no further questions at this time. Before I ask Mr. Orbach 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 Web site at www.silicom-usa.com. Mr. Orbach, would you like to make your concluding statement..

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..

Thank you. This concludes Silicom's fourth quarter 2017 results conference call. Thank you for your participation. You may go ahead and disconnect..