Ehud Helft – GK Investor & Public Relations Shaike Orbach – Chief Executive Officer Eran Gilad – Chief Financial Officer.

Alex Henderson – Needham and Company Vladimir Galabov – IHS Markit.

Ladies and gentlemen, thank you for standing by. Welcome to the Silicom's Second Quarter 2018 Results Conference Call. All participants are at present in a 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 & Public Relations at 1-646-688-3559 or view it in the News section of the company's website at www.silicom-usa.com. I would now like to hand over the call to Mr.

Ehud Helft of GK Investor Relations. Mr.

Helft, would you like to begin?.

Yes, thank you, operator. I would like to welcome all of you to Silicom's second quarter 2018 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 passed. 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 we will rely increasingly on customers which provide cloud-based and cloud-focused solutions in this evolving market, resulting in an increasing dependency on a smaller number of larger customers; difficulty in commercializing and marketing Silicom's products and services; maintaining and protecting brand recognition; protection of intellectual property, competition and other factors identified in documents filed by the company with the SEC.

In addition, following the company's disclosures of certain non-GAAP financial measures in today's earnings release, such non-GAAP 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 investor understanding and assessment of the company's ongoing collaborations and prospect 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 measures discussed by management are provided as an 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 call are Mr. Shaike Orbach, the 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 now like to hand over the call to Shaike. Shaike, please..

Thank you. I would like to welcome all of you to our conference call to discuss the results of the second quarter of 2018. For the quarter, our revenues reached $27.6 million and represented net income of $3.4 million. We showed significant operating cash flow generating $12.1 million in the quarter.

Overall we are pleased with the result which were in line with our expectations for the quarter, demonstrating that we are on track with our planning and confirms the underlying strength of our business. Moreover, our successes in achieving new design wins in key markets, demonstrate that we continue to make progress on our ongoing strategic plans.

This plan has been in place for sometime now targeting cloud, SD-WAN and NFV segments specifically as well as the cyber security space, all of which are strongly growing markets.

I would like to focus today in particular on our uCPE offering which we target towards the SD-WAN and NFV market segments, both exponentially growing markets which consequently represents key growth drivers for Silicom. These segments demonstrate much potential for us ahead and we expect will drive our business forward in the coming quarters.

We had continuously been investing in developing the right products and in building relationships with new and potential customers in all these areas. In 2018, our win so far demonstrates the truth of these strategies.

The major top tier telco deal that we closed at the end of April, as well as the major internet and content provider that we announced in June where indeed the result of lengthy penetration efforts.

Although, on top of being successful with CPEs in these markets, our existing SD-WAN engagements are enabling us to advance from the CPE up to the hub and consequently up to the data center and vice versa. We think that these only represent the very initial successes of a series.

There are many more opportunities inside our growth pipeline, representing significant revenue potential much larger than what we have achieved in the past. For example, each telco-related deal in the pipeline and we have quite a few there represents revenue potential in the double-digit millions of dollars per year.

So winning any combination will have a significant positive impact on our revenues and profit. Again as I mentioned last year, there is at least one such shorter additional and major potential design win in the pipeline, which we believe will be awarded during 2018.

I would like to spend some time talking about the two initial but important and strategic deals that we won, demonstrating the unique fit of our product so the connectivity needs of SD-WAN and SD-WAN-related markets both at the CPE and at the hub level. Last month, we announced that a U.S.

based top tier internet and content provider choose our Switch-on-a-NIC solution for a SD-WAN related distribution hub infrastructure. To-date, the Tier 1 customer has placed approximately $1 million in purchase orders. In parallel, we're talking to these customers with regard to providing additional product for its upcoming edge device needs.

This first win with major communications giant is a strategic achievement for us on many levels.

The fact that our cloud Switch-on-a-NIC solution has been adopted to use in an SD-WAN related hub architecture is important because it allows us to capitalize on the relationships that we have built through sales of SD-WAN edge devices proposing solutions that will allow us to penetrate more deeply into our customers infrastructure.

In parallel, this new solution enables us to approach other service providers looking for a hub infrastructure solution and from there to propose solutions for their edge requirements. At the end of April, we announced a selection of our solution by a top tier telco and its edge devices for its upcoming SD-WAN based small business deployment.

We have so far received $1 million in preliminary purchase orders and expected to run gradually to a steady run rate of between $15 million and $20 million per year. We are also engaged with this customer in an evaluation process regarding another huge uCPE program for its NFV deployment and our edge devices to reach the final shortly stage.

We are proud of the fact that these two major customers came to us, it shows that our edge networking products are at the focal point of the exploiting SD-WAN and NFV market, which are highly strategic for all major telcos and connectivity service providers today.

We also demonstrate how deeply we are associated with the SD-WAN space and just how powerful our technology and solutions approach is. Our wins in this space are increasing our market share of the uCPE edge segment, as well as the heart and center of infrastructure markets including data center and cloud segment.

We demonstrate the inherence and growth synergies within our solution portfolio. Our cloud-based SD-WAN solutions prove their value at the hub level and provide a comprehensive networking solution from the data center all the way through the edge.

We see these and other similar telcos and service providers struggling with a daunting challenge of handling the massive volumes of data that are now coming to the edge. They have a clear need for edge devices like ours to help them integrate a variety of technologies has debated for a new business volume.

The response that you are receiving from these global giants confirmed that the U.S. has a strategic performance partner that brings the products development capabilities and supply they need to cope with today's challenges for high speed and high volume connectivity demands.

That is what underlined my confidence that Silicom will continue to be choosing to deliver what telcos needed edge and why I see our edge offering as a major growth driver ahead.

We are also increasingly seeing our FPGA technology based acceleration adapters being evaluated to improve performance by allowing the offloading of processing having functionality such as security related loads into the adaptor.

We can see a potential for this type of offloading being recently utilized in major cloud deployments and believe our FPGA strategy represents another growth market for Silicom. With regards to the major cloud project that was canceled by our post customer last quarter, discussions to a closure our progressing positively.

This is a long and somewhat complex process which will take time to resolve, but we are having open and constructive discussions with all the parties.

Importantly, our relationship with the customer and the two other server manufacturers remain strong and we do hope that our close working relationship over the past few years as well as into current closing process will lead to a future engagements with them. And now for the guidance, for Q3 we expect revenues of $30 million to $31 million.

In summary, while the organic growth within our financial result is not afferent this year because of the significant discontinued project, it does indeed continue across the rest of our customers and our strategy is successfully moving forward, move us forward.

As I mentioned earlier, the key growth driver for us today are the SD-WAN and NFV-related markets, new clients including major telcos and ISPs such as those we want this quarter, are increasingly choosing our products as the critical building blocks they need to maximize the performance of their SD-WAN and NFV-related infrastructures.

Our concepts are proving to be powerful for the CPE’s parts and the data centers. Our portfolio of product is up to the challenge. We can handle massive volumes of data reliably at top speeds giving our customers’ product a clear performance edge.

Silicom does not only offer a market-leading technology, but also exceptional development capabilities and commitment to close our customer support.

Our technology lead is due to a long-term investment in our product, forecasting and building our today's leading technology and strongly differentiating ourselves to create market leading solutions for our customers' needs.

We have more than 400 active design wins with over 150 customers, many of which are in the ramping stage and some of which are the top tier of networking players globally. This roster provides us with both short- and medium-term revenue visibility as well as a runway for long-term growth.

With products that are important at every segment of the communications network, all communication providers, including service providers and telcos represent an opportunity for an almost unlimited serious of design wins.

Our growth strategy is designed to lead new engagement, while delivering on an increasing number of double-digit design wins for a growing roster of top tier customers. Combined with a strongly supportive market environment, my confidence in our ability to regain our footing and represents strong growth over the many years ahead remains.

With that, I will now hand over the floor to Eran for a detailed review of the quarter's result. Eran, please go ahead..

Thank you, Shaike, and hello, everyone. Revenues for the second quarter of 2018 were $27.6 million, a decrease of 9% compared with revenues of $30.3 million as reported in the second quarter of last year.

Our geographical revenue breakdown over the last 12 months were as follows; North America, 80%; Europe and Israel, 15%; Far East and rest of the world, 5%. During the last 12 months period, we have three 10% plus customers. All three customers together accounted for about 45% of our revenues.

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 second quarter of 2018 was $9 million, representing a gross margin of 32.5%.

Operating expenses in the second quarter of 2018 were $5.5 million or 19.8% of revenues compared with $5 million or 16.6% of revenues in the second quarter of last year. Operating income for the second quarter of 2018 was $3.5 million compared to $6.2 million as reported in the second quarter of last year.

Net income for the quarter was $3.4 million or 12.2% of revenues, compared to $5.2 million or 17.3% of revenues in the second quarter of last year. Earnings per diluted share in the quarter were $0.44, compared with $0.69 in the second quarter of last year.

Now, turning to the balance sheet, as of June 30, 2018, the company's cash, cash equivalents and marketable securities strengthened significantly and totaled $52.6 million with no debt, compared with $30.7 million at the end of 2017. That ends my summary. And we would be happy to take any questions.

Operator?.

Thank you. Ladies and gentlemen, at this time we'll begin the question-and-answer session. [Operator Instructions] The first question is from Alex Henderson of Needham and Company. Please go ahead..

Thanks. Nice quarter, guys. Thanks. Let me start off with something easy.

Given the move in the exchange rate dollar-versus-shekel, could you just remind us what’s your hedging policy is and how you are positioned through the quarter into the back half?.

Okay. First of all, we usually do not hedge our currencies. Secondly, we have positive – not significant, but positive effects both on our operating expenses and on our financial income. I would say, the impact on our operating expenses was positive and the amount of more or less $100,000 to $160,000..

Great. Second question, on the run-off of the last customer. Obviously, you’re doing lots of things to maintain that relationship, but hard for us externally to kind of gauge what the impact is in both the top line and particularly on the gross margin.

Can you give us some sense of what that impact was in the quarter and what you think we should be thinking about into the back half for those two – for revenue and margins?.

Well, in general, I’d say that in terms of gross margin we would be within the limits. As like we said, which means that overall there is no significant impact from that respect, because, I mean, the close project is obviously a cloud project on the other side.

The edge devices that are increasing now are also belonging to the same kind of environment, I would say. So overall you can still continue and expect that our margins would be between 32% to 36%, just like we said.

Obviously, just like we were always saying, I mean, in general the trend would be for revenues from this last project to diminish gradually. And by the end of the year we believe that everything will be done, while at the same time revenues from the edge devices will grow up.

But that only means that overall the margins with more or less stay within the limits that we provided..

All right.

So just in general, in the second quarter and in the second half, what kind of portion of revenue do we think is coming from thesis in run-off mode? Is this bigger than a breadbox or smaller?.

I mean, we obviously do not provide that specific data about this specific project. So other than telling you that it is going down while the others go up, I cannot tell you too much about that. The only thing I can add to that is that in the second quarter the revenues from this customer were not significant..

The other development, I think wanted to see if you few had some comments on was the Intel 100-gig NIC products coming out. I know Intel has been pretty late on that. You're very tight – closely tied to them.

Can you talk a little bit about how that program ramps, and how you benefit from that, and when that should start to kick in?.

Okay. So we are still within the development of the program so obviously there are no revenues yet from this upcoming Silicom. I do not expect that there would be revenues not in the third quarter, and maybe very little insignificant in terms of revenues in the fourth quarter. I believe that it will begin to ramp up next year.

On paper I mean it seems to be an extremely important, what I mean by saying on paper, I mean people are telling us that they’re waiting for this for devices using this piece of silicon, and actually that would become – everyone is telling us that there is a chance that this new solution or solutions, which abates that into new silicon, it would be a significant element in terms of how the 100-gig cloud deployments are going to be like.

But I would like to have a word of caution here, because these are all words to the moment. We would need to come out with their cards. We would need to test it internally to see that it really performs as advertised. and then we’ll go through that to some customers and there are definitely customers, who are waiting to receive it.

So, I believe that there is a significant potential for that, but it’s still under potential, which is not approved. We need to see that everything works probably, first of all from an engineering, from a technical perspective, and then we would have the marketing and sales challenge going to customers and getting them to use that.

I would say that, I believe, we would have a significant penetration rate with customers that are not yet using 100-gig, because for them, it would be an easy decision to move towards an Intel-based solution. But on the other side, these customers would just be ramping up, and it would take some time before the quantities are significant.

It would take more time to get customers, who are using other technologies right now to switch to our cards. but the benefits could be more immediate, because one thing besides like that has already have been – if they already have 100-gig deployments, that can such a switch could result in significant revenues almost from day one.

But all of that would happen next year, it’s not going to – it will begin happening next year, hardly this year, but we consider that to be extremely important..

So just a point, make a point on that. So you are more deeply in line with that development program than typical companies having been brought in with Intel in that design and work-in phase.

So does that give you an advantage getting out to the market in that?.

I believe we do, but once again, I do not know everything that Intel is doing. What I can tell you is that we’re considered to be what Intel defines as early adopters.

And as adopters, we’re giving all the information about Silicom even before the Silicom is out, even before the form of data, because typically Intel releases the data and it puts it on their website, and we received the information before that.

Now, if Intel decides to do exactly the same thing with many others, then we would not have that peak of an advantage. I don’t think that you would add. but I don’t know for sure as to who exactly they provide these early access just like they do with us.

I do know for sure that they do that with us and I believe it’s going to give us an edge at least over some of the competition. And by the way, I mean in the past week, sometimes we were able to come out with solutions even before Intel itself come outs and with that, we even helped them sometimes.

So, I hope that it’s going to give us an edge, but as you can imagine, I am not familiar with, or exactly or even not exactly with what exactly Intel is doing with other potential competitors..

And one last question to just leave the floor.

Could you just give us the headcount at the end of quarter?.

The headcount in the quarter is quite similar to the previous two quarters approximately 265 increased..

Great. Thank you..

[Operator Instructions]. We have a follow-up question from Alex Henderson. Please go ahead..

Well, great. So, let me add a couple of more questions, because I certainly have plenty more to talk to.

So, the first one I wanted to get a little bit more granularity on is kind of the timeline around the second Tier-1, has there been any change in your thinking on the timing is it a little earlier or exactly on track in terms of timing little later, any change in the rate of movement there?.

Let me put it this way. First of all, we still see confident that this is going to happen within the second half of the year. No later than that.

I would say that when we – I think we’ve said that in the past, I’m not sure, but we’ve said that in the past, why we were heading loads that it would close even earlier, but things with these giants is taking time. Now, nothing negative, I mean we’re moving forward, but it takes more time that was – I would have hoped that it would.

and so we’re not changing what we think about that, which means that it would happen during the first half – the second half of the year. Taking a little bit slowly on then what I hope for, but on the other side, not slowly as an expected because that’s the way that these giants work..

Yeah, no doubt. So, if I were to look out say a year to the back half of 2019. And I – would it take the Tier-1 that you’ve already contracted with the Tier-1 year hoping to close by the end of the period. The ICP and I assume substantial amount of business with the other SD-WAN, how would the mix of SD-WAN related businesses shake out.

Is that the large Tier-1 that’s already announced half of the business or quarter of the business or do the other three venues match that scale in terms of opportunity, how do we think about the aggregate of the SD-WANopportunity across those four alternative vehicles?.

Well, I don’t have an accurate number right now to give you. I think that, if we’re looking second half of the next year, then first of all, it’s going to be significant. Second half of next year, well, just out of my head and please don’t take that as an accurate number, I think it’s going to be more than 25% of our revenues..

Okay. That’s helpful.

So, if I were to look at that, it sounds like just sort of splaying that out, that you would be – maybe you’re third of it coming from the turn Tier-1 a little less than that for the second Tier-1, and then the rest coming in from the other SD-WAN with some portion from the ISP being the smallest of the bunch, is that’s kind of the right rank ordering?.

Yes. I believe that, I mean, I can’t say accurate, because we’re talking about a year ahead, but it seems reasonable..

Okay. I get it.

And in terms of FPGA offload applications, could you talk a little bit about where you think that that will hit most, is it going to be in – after my type, end marketer is going to be more in the application enterprise type end-market is it – what type of cloud architecture pushes out to the edge the most to take advantage of those application growths?.

Well, I see – I would say two main areas in general. and then within the second one, I could be a little bit specific – no, well, it’s not specific as the business something, which is happening right now. but rather what I see is different. So one area is security.

I think that almost all the cloud guys, which we are talking to about FPGAs, that’s the main thing that had in mind right now, security and that would indeed involve FPGAs, which are the basic – the basis of our expertise, because that involves connectivity, networking, which requires security.

So that would be the main area in applications, which is why I mean when we are other than just building FPGA card through investing in developing solutions within the security space, which is a part of that and which would expand or increase, I would say our value add, when we speak to these cloud vendors. That’s one area.

the other area is machine learning. So, machine learning could be in a variety of spaces.

I could say that I’m seeing some – I would say aggregation or accumulation of interest, the needs coming from the automobile industry with the data centers that many of the giants of this industry are beginning to build in order to collect all the data, which would be coming from the autonomous cars, et cetera, and so on and so forth, which would need to be analyzed, so it includes areas, which has to do with machine learning and Big Data to analyze all that stuff and that’s another area, where we see a lot of interest in..

So, the trend in technology seems to be pushing from large public cloud scaled out of data center environments pushing closer to the edge, where people are calling it edge computing in the like.

it seems that edge computing would fit your business model very well, particularly as content delivery networks start pushing more and more content further and further out.

when you talk about security, are you talking about security in that context in that you’re doing cloud hub and cloud edge for a content delivery network security, is that what we should be thinking about?.

that’s a part of that, and it’s not only that, it’s not only for; I would say the private clouds and things like that. it is also for the public clouds as well.

I mean we see that the need for security solutions is across the board and even in terms, I mean, so we could see at the even public data center within a public cloud or even at some solutions, which are required not only at edge computing, but rather at a very edge itself – some edges of course, not every, consumer would need FPGA, but in terms of securities, we see that across the board, and what you have mentioned is a part of that, obviously..

If I were to step back to your historical roots and look at the non-cloud business, the more traditional on-prem customers that have made up of your roots.

Is that area benefiting from enough from macro conditions that it’s able to actually hold up and maybe even produce a little bit of growth or is it – is that more traditional customer base, a shrinkage at this point, because their on-prem business is moving more to the cloud.

Therefore, undermining the growth, and if you take a look at like, something like in F5 talking about the decline in the ADC market as an example as a result of that type of stuff.

Can you give us some sense of how the more traditional portion to your business is looking?.

Well, first of all in terms of what is happening right now, so I would say that yes, I mean here and there, we see more or less flat, I would say here and there, even some areas of growth. Now as through the future, so we also think that eventually, this business will not grow.

but I mean, I can – I’m still seeing that actually all these customers in the areas are working – they understand this situation, and they’re trying to find solutions for themselves in order to maintain this business, when it’s sometimes changing what they’re doing, they’re changing their definitions, some of their ADC companies are going into SD-WAN, be frank to become some sort of an OEM to telcos or to other service providers et cetera.

And if they’re successful with that, then we – you may still call it our traditional business, but in that case, if they’re successful and maybe able to grow to a business stand..

So, we have to look at 2018 and going into 2019 and trying to back out the impact of the run-off of the lost customer. Is it reasonable to think that roughly 10% of the 2018 revenue that falls out as a result of that going away by the end of the year.

and therefore, I need to start off with a lower base to put the growth rates from these other areas on it.

is that kind of the right mechanic?.

it’s a little bit still difficult to say, because we’re still in discussions with this customer about this closure of the project, also I don’t want to – I cannot as a matter of fact to provide accurate numbers as to what would be the size in this year, even if I knew of this project.

But definitely this one would have closed degrees, the SD-WAN related will increase. and overall, I think 2019 will demonstrate a significant increase..

So can you give me even the sense of that, if that’s in the general ballpark when we’re just from a line….

I don’t want – I think I cannot give you a ballpark with the percentage of last project in this year. This is not something I can do..

Okay. One last question and then I’ll see the floor again. This tax rate came in at a little lower than we’ve expected in the quarter.

So using 15% in the back half, is that going to in 15% in 2019?.

We still believe in the range of 14% to 15%. In other words, we believe that the future effectively, will be at the same range of previous years, which means 14% to 15%.

What happens is that during the first half of 2018, we have several positive tax considerations such as one-time settling of the accounts with these value tax authorities, which resulted in lower tax position, during that period. But again, generally speaking, we keep our range of approximately 14% to 15%..

Okay, great. Thank you..

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

Hi guys. thank you for taking my question.

When I look at your long-term growth strategy and execution presentation, the one that was published in April, the product discussion tends to be split into data center and edge, where the data center looks – I don’t know adapters offloading a picture while edge looks at CPE appliances, wireless connectivity et cetera.

And I was just wondering if you could give us some color on how is the revenue that you reported this quarter; split between these two segments and do you expect that to change and yeah….

So you have data about the general market trends. Eran, you could – you may want to do that. but in general, I believe that, what you see in there, I mean the market is still moving forward for both cloud and SD-WAN, I mean exactly the percentage as how it’s going to be, I do not have, but let me give you some data.

Eran, can you do?.

First of all, the data can be seen on our quarterly presentation, which will be uploaded to the website today – later today.

The numbers, which will be shown there that’s a place for infrastructure, market segment is about 35%, the private security is about 26%, network appliances about 25%, storage about 10% and about 4% for other type of market segments..

That’s the current situation..

Correct..

And what we expect is that the platform infrastructure will grow and the Cyber Security would also grow while the others either they’d say flat or grow a level base and maybe, even shrink a little bit, just like my earlier discussions..

Thank you..

[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 website, www.silicom-usa.com. Mr.

Orbach, would you like to make your concluding statement?.

Yeah. Thank you, operator. Thank you, everybody, for joining the call. We look forward to hosting you in our next goal in three months’ time. Good day..

Thank you. This concludes Silicom’s second quarter 2018 results conference call. Thank you for your participation. You may go ahead and disconnect..