Ladies and gentlemen, thank you for standing by. Welcome to the Silicom's Third Quarter 2020 Results Conference Call. All participants are 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 begin please?

Thank you, operator. I would like to welcome all of you to Silicom's third quarter 2020 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 revenues; maintaining and protecting brand recognition; protection of intellectual property; competition; disruptions to our manufacturing developments, along with general disruptions to the entire world's economy relating to the spread of the novel coronavirus COVID-19; and other factors identified in the documents filed by the company with the SEC. In addition following the company's disclosure of certain non-GAAP financial measures in today's earnings press 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 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 disclosed by management are provided additional information to investors in order to provide them with an alternative method for assessing our financial condition and operating results. These measures are not in accordance with or a substitute for GAAP. A full reconciliation of non-GAAP to GAAP financial measures are included in today's earnings press 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 the call over to the question-and-answer session. And with that I would 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 our third quarter 2020 results. We are very pleased with the solid improvement in both the top and bottom-line. We reported revenue of $28.4 million, an 18% improvement over the third quarter of the past year and also a strong 23% improvement over the prior quarter. Furthermore, we reported our 63rd quarter of profitability with net income of $2.9 million the highest level this year. This represents a 15% increase over Q3 last year and a 59% increase versus the prior quarter. We also ended the quarter with over $86 million in net cash and for the quarter used our strong cash position to further progress our -- on our share buyback with the goal of bringing increased value for shareholders. We achieved all this despite the ongoing impact from the corona pandemic. Like everyone, we continue to experience the unusual working and logistical challenges as well as various levels of economic shutdown and social distancing in the countries in which we operate. Our results demonstrate that not only have we maintained business continuity, but also have returned to growth. This demonstrates the resilience of our business and our ability to plan for and overcome the supply chain interruptions and component shortages which we saw earlier this year. Revenue visibility continues to improve and our expectations are for further revenue growth into the fourth quarter. I will discuss the guidance in a few moments. I would like to discuss some trends we are capitalizing on which has led us to increasingly focus on the telco and mobile markets in recent quarters. I believe these trends are important and significant to Silicom. Over the past few years, as you know, we experienced a decrease…

Thank you, Shaike and hello, everyone. Revenues for the third quarter of 2020 were $28.4 million. This is a year-over-year increase of 18% compared with revenues of $24.1 million as reported in the third quarter of last year and a sequential increase of 23% over the $23 million reported in the prior quarter. Our geographical revenue breakdown over the last 12 months were as follows: North America 68%; Europe and Israel 25%; Far East and Rest of the World 7%. During the last 12 months our top three 10% 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, as well as 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 third quarter of 2020 was $9.4 million, representing a gross margin of 33.3% compared to a gross profit of $8.5 million or gross margin of 35.2% in the third quarter for 2019. The variance in the gross margin is a function of the specific product mix sold during -- in the quarter. Operating expenses in the third quarter of 2020 were $6.3 million compared with $6 million in the third quarter 2019. Operating income for the third quarter of 2020 was $3.2 million, an increase of 26% compared to operating income of $2.5 million reported in the third quarter of 2019. Net income for the quarter was $2.9 million, an increase of 15% compared to $2.5 million in the third quarter of 2019. Earnings per diluted share in the quarter were $0.41. This is a year-over-year increase of 31% compared with EPS of $0.34 as reported in the third quarter of last year and a sequential increase of 58% over the $0.26 reported in the prior quarter. Now turning to the balance sheet. As of September 30, 2020, the company's cash, cash equivalents, bank deposits and multiple securities totaled $86.6 million, with no debt or $12.36 per outstanding share. During the quarter, we executed on our new $16 million share buyback plan, which we started on May 4, 2020. During the third quarter, we purchased approximately 100,000 shares at a total cost of $3.6 million. This means that we are on track to execute the full buyback plan on time. That ends my summary, and we would all be happy to take any questions. Operator?

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

Thank you very much. So, I just wanted to start-off with a little bit of granularity around the contract conversations here. You said, I think, three wins that you've announced are $10 million. And then, you talked about the Tier 1 O-RAN project. I'm assuming that is not included in the $10 million as the O-RAN project is still in testing and it has to go through the rest of the process. So, that's upside to the $10 million, correct?

Well, obviously, I mean, the -- what we announced about the Tier 1 is just that we were selected for field trials. It definitely is not included in the $10 million. Not only that -- I mean the $10 million are SD-WAN wins and they're not O-RAN wins. The Tier 1 that we announced now just last week was about O-RAN and rather than SD-WAN.

Yeah. I understand. I just want to make it clear. Now, we had also talked about two Tier 1s in the U.S. that were expected to ramp fairly large projects with you. I think one has progressed. The other one seems to have stalled a little bit. Can you give us an update on those two?

Yeah. This has not changed from last quarter, and your description is pretty accurate. One of them has ramped up and is contributing quite significantly to our revenues. We're even hoping that in the future it would be more. The other one -- yeah, the other one actually didn't ramp up. And they're still in the mode of changing their decision as to where to take their strategy towards and didn't ramp up for us yet. We're still hoping, but nothing is happening, right now.

There's been some consolidation of some of the players in the SD-WAN space. Is that for several acquisitions? Has that changed or altered your trajectory with any of those OEMs?

Let me put it this way. I mean, typically, when customers -- or when let's say partners of ours or customers of ours are acquired by bigger companies that has, in most cases, short term the impact is positive, because they are getting prepared for more and they're buying more. Sometimes over time it seems that they prepared for too much. That happened to us in the past as well. And for the longer term, it is not clear. We can see different types of impact, because on the one side sometimes when something like that happens, sometimes the buying company -- organization which is a big one would like to use its own hardware. But on the other side if it decides not to do that and rather continue and use our hardware with the higher or bigger footprint that it has in the market, it may end up positively for us. So, all-in-all, it's difficult to say what would be the impact. Let me say that in general as we're talking to these companies, I lean to say that it would have a positive impact, but I cannot guarantee that, of course, because it could turn out to be not impacted at all or even to a certain extent negative in the longer term. I don't see any short-term negative impact for sure.

I see. And so, just to round that out. If you look at the rest of the appliance, legacy product lines, the more traditional business, have you seen any change in the rate of decline in that business as a result of COVID shifting spending within the enterprise, or alternatively, is it still relatively stable to declining slightly?

Well, I would say that in server adapters, which is the most significant part of our legacy products, I wouldn't say accelerating decline. Accelerating maybe too, I would say, powerful or strong words to say on that. But if you look over time then it is not also exactly a steady decline in demand. So, it's -- the decline -- I mean I'm not -- I've not done accurate statistics model specifically for this quarter. So, I cannot tell you for sure if the decline in demand is accelerating or not. There is definitely a decline in demand. This is for sure.

I see. And as you're looking forward, are you anticipating any change in the trajectory of that? I assume that from your answer that that's kind of steady.

Yes. I mean, server adapters to the appliance customers that we used to have would definitely -- I mean the demand would continue to get lower -- to become -- to reduce -- to get reduced. Sure.

And then, one other question. You mentioned growing the market changing. And I noticed the Intel announcements very visibly talking about the interchangeability of their products with your products. It seems like you've gotten significantly more important to Intel. Can you talk about how that relationship is blossoming? Is it -- this press release is glowing and very prominent.

You were cut in the middle of -- for some reason. Can you please repeat that?

Sure. I'm sorry, headset, sometimes don't broadcast very well. The Intel announcements that you guys, jointly put out are glowing.

Okay, Intel.

Yes, Intel. They're glowing, I mean it's -- your prominence in these releases and the way they talk about their product with your product is pretty unusual. And so could you talk a little bit more about how big an impact this is going to have how the go-to-market with Intel is changing your presence in some of the larger cloud companies, and how long it takes for this to metastasize do you think?

Yeah. Okay. So indeed, I mean, I think that the cooperation that we're having with Intel is growing in scope. And I do think that this is indeed something, which is extremely important for us. This cooperation, I would say, is now -- counting in my head, I would say that it is now around -- it is happening around three major areas where Intel -- where we have developed things in cooperation with Intel and where Intel is supporting us, recommending us, even providing leads for us and introducing us to customers in many of these cases. And the three areas are: the first one is the area of actually the platforms, which we're building with them. And this Tier 1 announcement that we have made last week, include such a platform and such a recommendation from Intel about the platform even though it was not only the platform. I would come to the other aspect of that. So platform-wise is one thing. The other thing is -- and I think we have -- I've been talking about that is the development, the mutual development of the eASIC cards. Now, I'm not sure if everyone is familiar, but I would say that eASIC is a technology, which allows you to produce an ASIC in a relatively quick time. Intel has developed an eASIC such as this, which means an ASIC but developed in a quick technology to offload some sort of a 5G technology. We developed the card, which includes this ASIC for them. This card is currently, to the best of my knowledge, the only one in the market which is doing such kind of an offload on an ASIC. Now there would be competition to that card in the future. But right now there isn't. So we…

So if I look at the press release that they put out, it talks about penetration and a variety of different major players, including SK telecom, Twitter like these labs and some other stuff. And it's tied into the Barefoot Networks acquisition that they did. So it sounds like they're putting a lot of emphasis on this. So how do we see this program and projects ramping beyond what we've already heard?

Well, actually this is a part of what I said, because we mentioned telco and telco cloud and cloud. And for many of these we were indeed using again in cooperation with Intel IP that was developed by Intel and it's now being integrated with our cards in order to be presented to all these customers. So this is a reason for our optimism. However, as we cautioned in what I've said earlier, the processes, the decision and the decision, the evaluation and all these parts of the equation with telcos and telco clouds are long. So – and that's why unlike the SD-WAN, where we're seeing the fruit, even of this cooperation in – even in this year compensating for the decline in demand of the server adapters. And definitely in next year, all these things I believe they would have an impact on revenues in 2021 as well. But really I think the more significant contribution to revenues would happen later on 2022 or later. So some impact in 2021 but not that significant. And then in the most part there is a significant part of that later on.

So one last question on this front. Is the margin gross margin you're expecting from these cards similar to your current gross margins around 33% higher lower? What are your thoughts in terms of where this plays out?

I think it would be – I think that more or less it would be on the same kind of gross margin. I would like to – what I'm telling you is about the average in this case, because I think that the pricing of these components would be very much dependent on the quantities. I think that for the low qualities opportunities the prices – the margins may be somewhat higher. But on the other side, going to the really very significant quantities on these. The margins may even be lower but still I mean in terms of overall profitability for the company it would be justified. Because if we do win one of these huge opportunities that are in the pipeline right now, I'm assuming that our manufacturing and all that would be very effective as well as the relation between the level of R&D and the quantities. So overall even if margins are somewhat lower with these opportunities, overall it's going to have quite a significant contribution bottom line.

So if I look at it from that perspective, your margins have come down a little bit over time if you go back to 2018 – 17%, 18% on the 2018 time frame. And prior to that actually it was above 20%. Can you talk to us a little bit about whether you think you can bring those margins back up into the 15% plus range over the next two or three years? Is that a viable expectation?

I think that at the bottom line that could happen. I'm not sure yet. I mean there are some unknowns because we're moving into an entirely different era with quantities per product, which might be much bigger on the one side. And if you take any of these deals on a P&L basic by itself, it may definitely demonstrate higher margins at the bottom line. But on the other side, I mean on the operating, if you just are – is calculating gross margins it may be even lower. But the quantities may become much bigger.

All right. And then just one last question a little bit more minor. Any change in the tax rate thinking as we go forward here?

Eran?

No. There is no change during quarter one to quarter three. The average tax rate – effective tax rate as can be seen is around 15%. And currently we believe that this is the range that we should expect in the short and medium term 15%.

Perfect. Let me give the floor to anybody else who’s got question. Thanks.

[Operator Instructions] The next question is from Sergey Mascaro [ph] from – of Wall Street. Please go ahead.

Good morning. Congratulations for the results. We have been waiting a long time for this. Hello?

Yes. Thank you.

Thank you.

Okay. My first question is about the FPGA segment. Some of your competitors like Napatech and Eternity have a constant gross margin between 70% and 50%. Silicom has a 32% gross margin. As you said, we could expect pressure in the gross margin as revenues ramp up. Can you give us more color on what do you do differently versus your competitors?

Yes. I mean, I can definitely explain that, or at least trying to explain that. I wouldn't like to talk too much about our competitors. But let me say a few words. First of all, I mean you mentioned two competitors one of them – I mean one of them I don't think that we need to really address the gross margin because due to the safe level. I mean they're selling less than $2 million per year or something like that. So with that – with this kind of sales, I do not think that the comparison of gross margins could be too meaningful. The other one is definitely a significant and important company. However, I mean I would like to say that most of these sales that you see indeed in the FPGA market is in the capture market. We are selling some costs in the capture market. And in this market our margins are very similar to these companies but this is not our strategic markets. Our strategic markets are as we mentioned before the cloud and the telco cloud and the telco in general and the SD-WAN. These are entirely different markets, where we are trying to achieve much higher level of revenues. And that's why the business model is different. We're not approaching the same markets. If we were to approach just these markets, we would have been able to maintain the same level of gross margin that these companies do. But this is not our strategy. Our strategy is to go back. As you can tell obviously, we're – our revenues per quarter are much higher than these companies each of them. This is an indication to the fact that we are addressing different markets with also different products. And yes, the margins in the markets that we're targeting are lower but the potential for revenues is much higher and that's what we're trying to achieve. These are lower in terms of gross margins of course.

Yes, yes, perfect. Thank you. So, can you speak about FPGA on where we are? I think that we have not had FPGA design wins for a while and these other competitions are growing 20% plus. So, can you explain us where we are in FPGA terms?

Yes. I can explain where we are in the FPGA. And this is -- in a way, this is related to my previous answer. I mean, we have not announced FPGA wins. I mean obviously, there is one reason to that. It doesn't mean that we didn't have any FPGA win, but we're not announcing every win that we have. But you're right in one thing. We have not announced anything, which is really significant win with FPGAs. And the reason is exactly the reason that I explained before because, we have taken our FPGA strategy to a different direction. I mean, we have taken it into development of new cards, which are addressing the other markets that we are targeting, which are mostly the -- as I mentioned before, the telco O-RAN infrastructure. This is where we have taken this development and we've done that together with Intel as has been announced. And this is a process which takes time. So while we still have design win here and there in our traditional markets, which were mostly the capturing cards as well as the high-frequency trading market, we have decided to focus on a market which is synergetic to any other -- to all our other activities which is the O-RAN area as I've described. This is taking time. You could see with the announcements that we had with Intel that we're making progress in this direction and we expect that the FPGAs would be a significant part in what I've described before as the emerging market for us within the mobile infrastructure. This is where we expect our big wins to be.

Okay. I see. So, 128 Technology was bought by Juniper earlier this month.

What? Okay 128 yes. Go ahead, please.

So does it have an impact on you since you are partners and you reported some design wins in collaboration with that company?

Can you run the question again? What did you ask?

Yes, 128 Technology, the software partner was bought by Juniper earlier this month.

Yes.

My question is, does it have an impact on you since you are partners and you reported some design wins in collaboration with that company?

Well, first of all, I think, I'm not 100% sure that while the fact that we are partners with 128 is public information, but specifically about design wins, I'm not sure that there is any information. So, I cannot refer specifically to any design wins. However, I can repeat the general answer that I provided before about impact of consolidation within the SD-WAN industry, where we definitely do not see any negative impact short term, probably a positive impact on the short term and as for the longer term, cannot tell yet. It may be positive, may also be negative in some cases. We hope based on discussions that we have with 128 that it's going to be positive, but we cannot be sure about that.

Okay. Do you know anything about the Silicom Telefónica flexiWAN project posted by Intel? Any progress on that that you can share with us?

I cannot share. I mean, we have been in the conversation that we are involved in discussions with many of the world's leading telcos. And unfortunately, I cannot provide any specific information more than that right now.

Yes, I understand. Do you have any visibility into the next year 2021?

Well, I believe that 2021 will be a growth year. There are still many unknowns including the impact of COVID-19 or -- on the business, which could have still an impact from a variety of perspectives, not only in disruptions of supply chain, but rather on the rate at which evals are being performed or even deployments are being performed in certain places. So, we cannot be sure of that as of now. There is unclarity, but we consider it to be a year of growth.

Great. The Federal Reserve is saying that, interest rates are going to stay at 0% level for a long time for some years. You have a net cash position of one-third of your market capitalization. In my opinion, you are not going to need around $30 million of this cash for working capital needs. Do you have any plans with this extra cash? I think, it would be a really nice opportunity for you to do a tender offer increase or accelerate the share buyback program.

As we said over the call, we are in the middle of the second buyback plan. We progress as planned and intend to meet on the targets set by our Board, which means the buyback of $15 million. This is currently our plan.

Okay. And anything from M&A?

Well, just like we always say, M&A, there’s nothing specific on the table right now. But we are always looking. Our strategy is not to go for an M&A just because we have the cash. But definitely having this cash encourages us and makes us look around, look for synergies. And if we find something, we would go for it.

Yes, I understand. And now about the COVID pandemic. Did you have any COVID cases at Silicom? How did you deal with them?

Yes. First of all, we did. I mean, we had, I think, two employees that were hit by COVID-19. But, I mean, we're taking measures which allow us to operate properly, by splitting the companies into capsules, in a way. As a part of that, it may even be that you're not hearing me as good as you would have heard me or as you might have heard me in previous calls, because we -- the meeting room that we typically use for the conference call is now a lab, because we decided to divide the labs into several capsules. So that if someone is indeed being infected by COVID, it does not mean that everyone else needs to go home, because we do have labs. And as a hardware company, we cannot allow everyone to work from home. So we're taking the right measures and I think that the result is some sort of a demonstration to that. I mean, even though two of our employees, separately, were infected by COVID, the number of employees which had to be quarantined due to that was minimum. Maybe two, three in each case. And the company could continue as usual.

Amazing. Perfect. And my final question, do you expect the lockdowns in Europe have an impact on you?

Lockdowns may cause an impact. I don't think that the lockdowns in Europe, specifically, would have a dramatic impact, but they may cause an impact. I mean, we have, as you know, a subsidiary company in Denmark. I mean, right now, they're not impacted, of course, but we have customers in other territories which could be significant for us. So it may have an impact. That's a part of what I said before, that in 2021 there is still definitely some areas which are not clear as to how and what would develop and that's definitely a part of that.

Thank you. Perfect. That’s all. Thank you for you time.

Thank you.

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 tomorrow on Silicom's website 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 wish you all health and we look forward to hosting you on our next call in three months' time. Good day.

Thank you. This concludes Silicom's third quarter 2020 results conference call. Thank you for your participation. You may go ahead and disconnect.