Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Third Quarter 2019 Results Conference Call. All participants are at present in listen-only mode. Following management’s formal presentation, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded.

You should have all received by now, the Company’s press release. If you have not received it, please contact Silicom’s Investor Relations team at GK Investor and Public Relations at 1-646-688-3559 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.

Kenny Green of GK Investor Relations. Mr. Green, would you like to begin, please..

Yes. Thank you, operator. I would like to welcome all of you to Silicom’s third quarter 2019 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 dependence for substantial revenue growth on a 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 dependence 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, which are 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 conference call. Such non-GAAP financial 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 are useful to investors’ understanding and assessment of the Company’s ongoing co-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 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 is included in today’s earnings release, which you can find on Silicom’s website. With us on the line today are Mr. Shaike Orbach, CEO; and Mr. Eran Gilad, 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 the call over to Shaike. Shaike, please go ahead..

Thank you, Kenny. I would like to welcome all of you to our conference call to discuss the results of the third quarter of 2019. The results of the quarter were in line with our expectations and we continue to generate ongoing profitability and cash ending Q3 with $89 million in total cash with no debt.

Our shareholders’ equity at the end of the quarter was up over $163 million and this is as a result of our 15 years of ongoing and continued profitability while successfully navigating through the many varied market cycles over the period.

Today’s strongest ever balance sheet in our history, continues to give us significant financial flexibility and enables us to pursue any opportunities that may arise whether through internal R&D investment or through external acquisitions.

In terms of our financial results, we reported revenues of a little over $24 million, which were in line with our expectations and net income of $2.5 million. As you know, we are currently focused on investing in capitalizing on two main growth drivers.

Our uCPE/Edge product targeting primarily SD-WAN, NFV and other Networking and Telco related sectors, as well as our advanced FPGA solutions.

As we discussed earlier this year, because of the emerging nature of these nascent markets, we have seen some visibility and order-timing issues in the past few months, particularly from our newer design wins, which have impacted our short-term top line growth. This short-term impact, as I explained last quarter, is mainly due to two factors.

The first one is the fact that the ramp-up phase and order-timing of our major Telco wins was slower than our original expectations, when we first announced the design wins.

The second is that, one of our major SD-WAN customers build a large level of inventory of our products last year, while they continue to see strong market demand for their products, which use our CPEs, they have paused their ordering of products while supplying market demand from their current excess inventory.

However, as we move ahead in time and from our perspective, now in late 2019, we’re becoming ever more excited and a significant growth ahead that we see in these particular customers in 2020 is much more tangible.

It is becoming clear to us that the market has now reached the early adoption phase of its growth curve, even given the inherent uncertainty and order volatility. And we will start to see the benefit in the year, in the near-term.

Therefore, looking into 2020, we believe that the ramp-up delays with the major Edge design wins, which we faced in 2019 will finally be behind us. In 2020, we will begin to benefit from both the recent wins in the Edge space combined with start of the ramp in our FPGA related wins, which altogether will be translated into very strong revenue growth.

At the moment, based on our customers order forecast, we are comfortable forecasting our revenues at between $120 million and $128 million for 2020, representing solid double-digit growth over 2019. And given the ramp-up expectations, we would expect further accelerated growth in 2021.

As each quarter passes, we are becoming increasingly excited with regard to the potential we see for our Edge business in particular. Our design wins in the Edge segment now amount to over 10 wins, some of which have a long-term revenue potential measured in the 10’s of millions of dollars per year at full deployment.

The shift to white box and SD-WAN/NFV or other third-party based software solutions, looks closer than ever. We’re seeing the market transitioning slowly but surely and ramping from proprietary combined hardware and software solutions to generic hardware white box solutions, of which our products are a critical component.

This is happening in the Telco space, which has been our focus for quite some time, as well as in the enterprise segment, which we believe will also become a significant contributor to our growth in the future.

We also see increased interest in implementing LTE solutions within SD-WAN environments, which is another factor that has been working in our favor. We are already securing relevant design wins and the press release, we announced earlier this week is an example.

This is a major new design win from a leading SD-WAN player, a long-term existing customer of Silicom and a new SD-WAN customer for us. The customer is standardizing on our newest uCPE solutions for use in its next generation portfolio of SD-WAN devices.

This customer will be using a series of off-the-shelf and customized SKUs with varying processing power and configurations, including LTE and Wi-Fi optionality. Based on the customer projections, orders are expected to begin ramping in 2020 and at full run rate will be more than $15 million in revenue per year.

Beyond the significant revenues, this win is strategic for us. It demonstrates our ability to penetrate SD-WAN market segments beyond Telcos and into new adjacent market segments. It also proves the superiority of our latest uCPE innovations to other potential customers. This wins, underscores how we grow and evolve with our customers.

This long-term customer, which has used our traditional product over many years is now again turning to us for our latest solutions for its latest SD-WAN devices. This is another demonstration of the value contained within our large and loyal customer base.

We invest in nurturing this base and as demonstrated in this case, the customer appreciates the high level cooperation and superb support that has characterized the relationship over the many years, and selected our solution to enable the latest product.

The win is a confirmation of how the power of our traditional connectivity markets continue to support and drive long-term growth at Silicom. Looking ahead, our pipeline in this market is broad, deep, and growing consistently and includes further such potential wins with significant long-term revenue potential for Silicom.

And now to our FPGA-based solutions, we continue to invest significantly in developing and advancing our FPGA technology and this market is a key element in our long-term growth strategy. Momentum and interest from customers and potential customers for our new FPGA based offerings continues to build.

We are seeing strong interest and a trend away from basic network interface cards, towards those including offload and acceleration built on programmable FPGA based SmartNIC’s. We see very segment growth in the market for SmartNIC’s, with the market expected to grow from $1.1 billion in 2019 to $2.6 billion, more than doubling by 2022.

In fact, in recent months, we announced several important FPGA wins that we expect will translate into strongly growing revenues next year. A global ISP selected our FPGA based SmartNIC for its data centers throughout the world and we see orders ramping up to $4 million per year at the peak.

A leading cloud player selected our FPGA based SmartNIC solutions, which will become part of the customer virtualized cloud. We expect that orders from this client will be at the multi-million dollar level during each of the next few years.

And one of the world’s largest companies commissioned us to design and build a task-specific FPGA based card for its autonomous vehicles.

We’re designing the car and we’ll manufacture a pilot batch for a set fee, after which the manufacturer will -- the manufacturing will move to the customers’ manufacturer and we will receive a license fee for each car deployed. Revenues from the projects are expected to reach approximately $2 million. The majority of which will be licensing fees.

The agreed upon license fee structure enables going -- ongoing revenues flow if the client decides to utilize our FPGA technology in a wide deployment of autonomous vehicles offering at a later date. Given the high growth projections for the autonomous vehicle market, it is hard to overstate the boost that this market could offer us.

And we all know that, we are working to transform a significant portion of our strong FPGA pipeline into new wins and associated ramp-ups in 2020. At the same time, we continue to invest in expanding our technological lead in the space.

Our technology bridges the gap between bare FPGA chips and cards to fully functional FPGA based integrated solutions, allowing our customers to tailor solutions to their exact needs.

One of the major selling point is, that our SmartNIC uses a unique Packet mover technology, a feature enabling both us and our customers to easily integrate their own specific or generic IP into our core FPGA framework.

Our unique Packet mover technology and FPGA design expertise, are emerging as important enablers for all these industries as well as our ability to integrate third party IP such as AI, Artificial Intelligence, Encryption, Deep Packet Inspection, Compression, 5G and others into their functionality.

While our end markets transitions to these more advanced technologies, we ourselves are also undergoing a transition as part of this ecosystem. All these changes represent a very large opportunity for Silicom over the coming years.

The bottom line is that we expect the ramp to start during 2020 and we believe it will provide us very nice accelerated growth in the second half of the year. With regard to our specific guidance for the fourth quarter.

As I mentioned earlier, short-term visibility in the Edge spaces -- in the Edge space remains unclear, while the FPGA ramp is yet to really stop. With that in mind, we are providing guidance for the fourth quarter and project revenues between $25 million and $26 million.

In summary, our focus continues to build our business for the longer term and we look forward to strong double-digit growth in 2020 and beyond. We are becoming increasingly bullish with regard to the long-term prospects of our Edge related business.

As always, our success will be built on the ramp of our already existing design wins, which include wins with major Telcos, service providers and leading SD-WAN players as well as further design wins in that space.

Beyond that, we are optimistic about the potential of our other growth engine, our FPGA technology, which has the potential to become a significant growth driver over the long term for our business. We expect to see a solid ramp and real contribution from our FPGA business accelerating significantly in the second half of 2020.

With superior products and technologies, design wins with larger and larger companies, a strong base of loyal customer, a strong balance sheet and an excellent cash position, we are ideally positioned to benefit from the long-term development of the industry’s strongest trends and remain strongly confident about our prospects.

The opportunities ahead for Silicom remain huge and are much greater than what we have achieved in past years. We look forward to reaping those rewards in the coming years. With that, I will now hand over the call to Eran for a detailed review of the quarter’s results. Eran. Please go ahead..

North America 77%, Europe and Israel 18%, Far East and Rest of the World 5%. During the last 12 months, our top three, 10% plus customers together accounted for about 35% 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, acquisition related adjustments, as well as discontinued project related write-offs.

For the full reconciliation from GAAP to non-GAAP numbers, please refer to the press release we issued earlier today. Gross profit for the third quarter of 2019 was $8.5 million, representing a gross margin of 35.2% compared to a gross margin of 34.1% in the third quarter of last year.

Operating expenses in the third quarter of 2019 were $6 million or 24.8% of revenues compared with $5.4 million or 17.2% of revenues in the second -- in the third quarter of last year.

Operating income for the third quarter of 2019 was $2.5 million or 10.4% of revenues, compared to operating income of $5.3 million or 16.9% of revenues as reported in the third quarter of last year. Net income for the quarter was $2.5 million or 10.5% of revenues compared to $4.7 million or 15.2% of revenues in the third quarter of last year.

Earnings per diluted share in the quarter were $0.34 compared with $0.62 as reported in the third quarter of last year. Now turning to the balance sheet, as of September 30, 2019, the company’s cash, cash equivalents, bank deposits and marketable securities totaled $89 million with no debt or $11.94 per outstanding share.

This is up $1.6 million compared with $87.4 million at the end of the second quarter, and up $15 million compared with $74 million at the end of 2018. That ends my summary. And we would all be happy to take any questions.

Operator?.

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

Thank you very much. So I’ve got a couple of questions, I’d love to ask, I hope I’m able to -- that you’re able to hear me. The first one is, clearly the service providers are much later than we had expected, you sound a little bit more optimistic that there are set to start to ramp.

Do you have any improved clarity on the timeline when that’s going to happen? And what is giving you the improved since that that’s going to happen sometime more imminently?.

Okay. So yes, I mean we have somewhat better clarity. I would not say that everything is clear right now to us. It is far from being like that. But we have some better clarity, at least with some of the accounts. And this clarity is achieved through, I would say everything that is happening on a day-to-day basis, with these customers.

And that includes a variety of factors and I could give you several examples. I mean we are getting some POs. So we’re seeing the beginning of that. That did not happen in the past. They are asking us questions about building materials and being ready and things like that.

They are telling us that they are done with their testing and just I mean and just waiting for some formalities before they launch. They are beginning to provide forecast, which they have not done in quite recently. So all these are very good signs for us. While not necessarily being a commitment because sometimes you know they’re just getting ready.

And then something else happens or whatever, but we are getting quite some positive indications, which is the result for this increased level of optimism..

So if I could follow-up on that.

So it seems pretty clear that there was a, one service provider that was well ahead of the other service provider, has the timing of those two changed in terms of relative timing? Or do you expect them to still be staged with a three months to six months gap between the first and then the, a little bit of a [indiscernible] to the second? Are they becoming -- coming together as a result of the slow deployment of the first?.

Well, I mean, indeed, there was a gap of six months, more or less between the time that we announced the wins, but not necessarily this gap is maintained throughout the whole process. They were having different issues and because I mean there are even some, I would say guesses as to the identity of these customers.

I’d like to be careful and not really say who is first and who is second right now. I’ll say that it is not exactly the same situation with both of these. The signs that we’re getting that I was talking about earlier were -- are much more evident from one of them than the other..

Okay, that’s helpful. Thank you. A separate line of thought, we spent a bunch of time with the number of the SD-WAN companies and you’re obviously very well positioned against the vast majority of the companies we talked to out in the West Coast.

However, it does sound like there was two generations of SD-WAN, the first generation being predominantly focused on what I would describe as Layer 2, 3, 4 kind of skills, whereas the newer generation is much more application aware.

And that seems to be causing a shift between what I would describe as the early winners and the smaller start-up companies. Has that had an impact on your business, one way or another, is it -- are you more represented at the larger companies and the smaller companies, does it matter to you.

Which winner take share and then along that same lines, one of those companies appears to be embedding their product predominantly into their router as opposed to selling it in the uCPE product.

Is that a drag on your business nasty win that has to be overcome by the smaller players taking share?.

So I would say that in general we don’t see the impact directly. I mean, of course, we have customers. And if a certain customer has been working only in the first generation, and then the market is shifting to the second generation, then this customer would take less than our boxes. So we might be able to see that through that.

However, the customers that we’re pursuing in general, are -- I would say are spread across generations. So generally speaking I would say responding to your first question, no impact.

Now as to the second question, I think, well once again I don’t want to speak about other companies, but it seems to me, and it’s only my own impression that this, I would say big effort of incorporating SD-WAN within the general routers that whatever is some sort of an effort to compensate for something, which was not very successful to start with.

So let’s say, if a certain company wanted or started to work with SD-WAN selling appliances and it didn’t meet their expectations. So they may be trying a different strategy, which would include selling that through their routers or something like that and hopefully being more successful than what they were before.

So I mean it all goes to this, overall this company market share.

Right now this company or at least some -- let me be general, I mean some of these companies or mostly these companies that are moving into routers are not our customers, then I would say that as long as their overall market share is not increasing it would not – it would definitely not have a negative impact on us.

If at all, it would have a positive impact on us, as long as their market share is not growing. If they are going to become 100% successful and take the full market selling through their routers, then of course, it would impact us, but I don’t think that’s going to happen..

Okay, thank you. One more different subject again, so if you look at the SD-WAN market, you look at the EDC market. Those markets are under enormous stress that those are your historical base customers in many instances.

For instance, F5 indicated that their systems business declined 15% year-over-year as they are shifting more and more and more to what I would describe is a pure software play.

Is your legacy or your older product that go into what I would describe is enterprise on premise products that are more hardware based? Are you seeing an acceleration in the declines in that is an offset to the growth in SD-WAN and some of these other projects?.

Okay, first of all, I would say no. But I need to explain that. And my explanation would be that, I mean we believe that there is a decline in the market for these type of products. And the reason that I said no, is not to contradict the decline in the market of these solutions.

It is simply because we have such, I would say powerful, historical connections with these customers whether they are already customers or even potential customers that we continue to get new wins within these customers, when there are some new areas for them because they’re still selling. I mean there is a decline in their overall business.

But they’re going to a new card with us here and there. And even more than that some new customers in that space, which is new customers for us, it’s not a start-up doing appliances, but customers that have been there all along and suddenly they found Silicom and they’re starting to buy cards from us.

So this is happening as well, which is why the bottom line for our business in terms of these traditional business is not very significant..

Alex, does that answer all your questions?.

Seems like we lost the connection..

Hello, operator?.

We’ll continue to the next question. [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..

Yes. Thank you, operator. Thank you, everybody for joining the call....

Mr. Orbach, Alex Henderson is on the line.

Would you like to take further questions from him?.

Sure. Alex, you are with us? You could continue with your questions..

Yes, one more question if I could. So it seems like there is clearly a fairly significant mix shift going on here between the newer FPGA between the SD-WAN and some of the older products. How do you see your margin structure on the growth side? No changing over time as a result of those.

Is it a positive? Are we still in that historical range that you’ve guided to about a year or two ago? How should we think about gross margins here?.

Yes. I mean, I think we are going to stay within this margin range. We’re still within the – I believe it was 32% to 36%. I think we’re still there. I mean, generally speaking, I would say that – well, the mix that you just was talking about is the reason why I would say that we continue with that.

The mix and the balance that we see between the various products. Yes. At this time, we continue with that..

Okay, great. Thank you very much for the questions..

[Operator Instructions] The next question is from Harris Leviton of PI. Please go ahead..

Hi guys. I’m a Private Investor. Just in terms of your cash you’re up to almost $12 a share as you pointed out and your free cash flow generation continues to be pretty great.

Can you give us any kind of update as to how you might consider deploying some of that either by buyback or a dividend or further acquisitions? And if you’re looking at acquisitions, maybe you can give us some sense of what the pipeline is out there and what areas you might be interested in? Thanks..

As we announced few months ago, in May, we are currently in the process of buyback program and we progress as planned and intend to meet the target set by our Board, which is the total amount of up to $15 million..

Okay.

How much have you bought back so far?.

So far we bought for almost – by the end of the third quarter, we bought back about $4.5 million..

And how much of that was in the third quarter?.

About $3.5 million..

Okay. Okay.

And how about acquisitions, are you still looking at those or is there, I mean, is there a pipeline out there?.

We’re always looking, but it’s not as if we must do an acquisition. We’re always looking at them market always trying to see if there is an opportunity if there is one we’ll move ahead, always looking..

Okay, all right, thank you..

[Operator Instructions] The next question is a further question from Alex Henderson. Please go ahead..

Thanks. So, clearly, there is a number of projects that are in the headlights that are set to ramp, both on the SD-WAN side, the service provider side as well as on the FPGA side. The timing of those ramps have some variance to them, but it does sound like it should start off modestly in 2020 and then start to accelerate.

So should we be looking at the growth year-over-year much more heavily weighted to the back half of the year, but start to show year-over-year growth in the second quarter, is that kind of the cadence of the ramp that you’re looking at ?.

Yes.

Well, that was a fast answer.

Any sense of the timing of when, if you were to pause between them, which one is likely to kick in first, any grading between those three categories?.

Once again, I mean I don’t want to provide information, which is related to the big wins in the service providers between themselves. But I would say that the Edge would begin its ramp up first, the FPGAs would be somewhat later..

I see, okay.

Is there any difference in margin between those projects? Is FPGA, because it’s got programmability and more software involvement, a little bit higher on the margin side or is?.

Yes. That’s what we’re looking at. There would be price pressures on the FPGAs as well, especially as the quantities ramp up. But still we consider the FPGA market to be somewhat of a higher margin than the Edge market..

Okay, that’s great. Just on the modeling side of the equation.

Any sense of intention around your spending levels as we look into 2020 should we, what kind of growth in OpEx, should we be thinking about?.

Well, I mean, I’m assuming there would be a very modest growth, because as we see the business development – developing, we are increasing our investment. But I don’t see anything dramatic happening..

Anything on the tax rate side that we should be aware of?.

The tax rate in 2019 is somewhat below 15%. However, in the short term, which means in 2020 and perhaps beyond that we expect a tax – effective tax rate of approximately 15%..

So consistent with what’s modeled. That’s great, thank you very much..

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

Yes. Thank you. My question is about the dollar amount of all the design wins and SD-WAN you had one this week with $15 million sort of that would be the run rate, if you added up all the ones you’ve announced, I mean I can go do it over the press releases that you’ve announced, but got to be over $50 million or $60 million now, annual run rate.

Correct?.

If it’s all of them reach their peak as forecasted by the customers and time wise, they’re going to happen really together, then yes..

Okay. And of course you have many more that you have not announced that are probably not….

But they are much, much smaller. When we have a very significant design win, we do announce it. Yes, I mean, well, – you’re right..

How about on the FPGA side? What would be that number there?.

While we have announced several wins is there and I would say that the major ones were – they were, one of them where we did not specify how many millions of dollars per year, it’s going to be, because we’re not – we do not have this accurate information from the customer.

But based on the intentions of this customer, it is supposed to be multi million dollars per year. I don’t know, I don’t want to say any information that we have not heard directly from the customer. But it’s supposed to be relatively big.

I think that the other one which was relatively big that we announced was supposed to ramp up to $4 million per year..

Yes. All right, well, substantial numbers. So thank you, good luck..

Thank you..

There are no further questions at this time, Mr. Orbach, would you like to make your concluding statement? Mr.

Orbach?.

Operator, let’s – statement..

Yes. 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 third quarter 2019 results conference call. Thank you for your participation. You may go ahead and disconnect..