Ladies and gentlemen, thank you for standing by. Welcome to the Silicom Second Quarter 2022 Results Conference Call. All particpants’ are present in listen-only mode. [Operator Instructions] 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 EK Global Investor Relations at 1-212-378-8040 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, EK Global Investor Relations. Mr. Green, would you like to begin, please.

Thank you, operator. I would like to welcome all of you to Silicom's Second Quarter 2022 Results Conference Call. Before we start, I would like to draw your attention to the following Safe Harbor statement. This 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 Silicom's 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, marketing and protecting brand recognition, protection of Intellectual Property, competition, shortages of component supply disruptions to our manufacturing and development, along with general disruptions to the entire world economy relating to the spread of the novel coronavirus and other factors identified in the documents filed by the company with the SEC. In addition, following the company's disclosure of certain non-GAAP financial measures in today's earnings release, such non-GAAP financial measures will be discussed during this call. These 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, prospects for the future. Unless otherwise stated, it should be assumed that the financial measures 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 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 GAAP to non-GAAP -- sorry, of non-GAAP to GAAP financial measures are included in today's press release, which you can find on Silicom's website. With us on the line today are Mr. Liron Eizenman, President and CEO; and Mr. Eran Gilad, CFO. Liron will begin with an overview of the financial results, followed by Eran, who will provide the analysis of the financials. We will then turn over the call to the question-and-answer session. And with that, I would now like to hand the call over to Liron. Liron, please go ahead.

Thank you, Kenny. I would like to welcome all of you to our financial results conference call discussing our second quarter 2022 results. This is my first quarter as CEO of Silicom after working for many years as COO of Silicom and CEO of our North American subsidiary. I would like to thank the Board for their confidence in my ability to lead Silicom ahead. Shaike Orbach, our former CEO, still remains involved in Silicom as Executive Vice Chairman. My aim is to continue and build upon the success he has brought to Silicom over the many years. Now to provide a short summary of the results of the quarter. We are very pleased with our continued solid performance for the second quarter of 2022. The second quarter was a period of growth in revenues, margins and EPS, driven by stronger-than-ever demand for our product, coupled with attention to operational efficiency. We demonstrated 13% revenue growth year-over-year to $34 million at the center of our expected guidance range for the second quarter. Furthermore, quarter-end backlog stands at record levels for Silicom. Our revenue growth continues to reflect the accelerating transition of mainstream players from industrial and online retail giants to telcos and service providers to disaggregated and decoupled networks driving demand for Silicom's enabling solutions. With significantly improved gross and operating margins, we are very pleased to report our 70th quarter of continued profitability with net income of $4.7 million, which was up 61% year-over-year. All of that resulted in earnings per share of $0.70, a very significant 67% increase year-over-year. We are all the more pleased with those results despite the continued background of ongoing component shortages and tight supply chains. And had it not been for the shortages, revenues for us would have been strongly higher. We're maintaining…

Thank you, Liron, and hello, everyone. Revenues for the second quarter of 2022 were $34.2 million, 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, 69%; Europe and Israel, 25% for East and rest of the World, 6%. During the last 12-months, our top three customers together accounted for about 25% of our revenue. 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 lease liabilities, financial income. 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 2022 was $12.3 million, representing a gross margin of 36% at the top of the range of our gross margin guidance of 32% to 36%, and compared to a gross profit of $10.8 million or gross margin of 35.8% in the second quarter of 2021. The variance in the gross margin is a function of the specific product mix sold in the quarter. Operating expenses in the second quarter of 2022 were $7.3 million, compared to $7.3 million reported in the second quarter of 2021. Operating income for the second quarter of 2022 was $5 million, representing an operating margin of 14.6% and an increase of 39%, compared to operating income of $3.6 million as reported in the second quarter of 2021. Net income for the second quarter was $4.7 million, representing a net margin of 13.8% and an increase of 61%, compared to net income of $2.9 million in the second quarter of 2021. Earnings per diluted share in the quarter were $0.70, a 67% increase, compared with EPS of $0.42 as reported in the second quarter of last year. Now turning to the balance sheet, as of June 30, 2022, the company's cash, cash equivalents and marketable securities totaled $48.1 million with no debt or $7.17 per outstanding share. That ends my summary. I would like to hand back over to the operator for question-and-answer session. Operator?

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

Well, let me start off not with a question, but rather with a statement. Liron, I understand you've been a major driver of the company's development of the newer products and direction of the company that has been so successful. And it certainly seems like a clear correct move to bring you up to the CEO job, and congratulations on that. It's clearly well deserved.

Thank you very much, Alex.

Hey more than welcome. So I wanted to just talk a little bit about the cost side of the equation a little bit. Obviously, the strong dollar is a major challenge to international revenues based in dollars, because of the price increase it implies to customers. But you also benefit tremendously from the weak shekel and other currencies where your OpEx are. So I'm looking at the numbers for the June quarter, and they're actually down $370,000 on OpEx, which we had not really expected that kind of decline. So I was wondering if you could talk about whether that's a temporary blip and that it will be up again as we go into the second half of the year. How should we think about the declines in all three items, R&D, sales and marketing and G&A?

Yes, absolutely. So I mean the impact here really is the dollar. And since it's hard for us to predict what would be with the dollar in the future, we don't know to answer that right now, but I can say our structure remains pretty much the same. We're not increasing too much or definitely not decreasing, if we'll have significant design we may increase more. But right now the structure is pretty much the same and the impact is the dollar itself.

So we should be using about the same level of spending in the back half of the year is in the front half of the year or in the June quarter?

Yes, I would expect that. Again, the function would be the dollar itself, but from a level of investment in Silicom, yes, the answer is it's going to be the same.

So assuming a flat dollar, it should be sequentially fairly stable. Okay, going back to the gross margins. Obviously, you had a nice pop, 36%. Obviously, that's driven by -- predominantly by mix. Should we be assuming it returns back towards that 34.5% level that you've been doing the last four, five quarters and normalizes in the back half?

So we still expect to be in the same range. We've always been in 32% to 36%. This quarter specifically, was -- there was a mix of products that caused it to go a little bit higher, but we still believe we're in the same range of 32% to 36%.

All right. Broadly speaking, macro headwinds are the primary issue that people are dealing with in a lot of the networking companies from Cisco and Juniper, Extreme, just as an example. So they're running backlogs that were in from 40% to 100% of annual product revenues and that gives them a lot of insulation. I know you guys have had a lot of wins, but it really isn't a hard backlog in the same way that it is for the systems companies as components driven by projects and programs that could easily be deferred, delayed or stretched. Can you talk a little bit about the implications of the macro versus the projects that you have? How firm are they? What are the major project leaders has been telling you about their intention to continue to deploy on schedule or maybe slow down those deployments because of the macro environment. And specifically, how much of that's U.S.-centric projects versus international?

So at the moment, we do not see any immediate impact for one. I mean, specifically on Q3 and even more than that, we don't see an immediate impact, but we are feeling the hard bit and monitoring the status all the time. We're discussing with our customers very openly on that. We're hearing what they see. And at the moment, at least what we see is we don't see any impact at the moment. And we think that our highest ever backlog also shows that the demand and the fact that last quarter, we said it's the highest quarter, and now we say again that we have the highest ever backlog again. So that means that the orders that came in are continuing to come in. And from what we see and what we talk with our customers today, they continue and -- their plan is to continue with the plans that we have with them.

Just to clarify on the backlog. A lot of companies are providing the backlog numbers in order to get a sense of how large it is relative to the scope of their business. Is it plausible to think that you're looking at seeing 20% to 50% of product -- annual product sales in backlog?

While we don't provide the exact numbers, I can tell you that the growth from previous quarter was quite significant, but we're not providing those exact numbers.

All right. One more question on the shekel and exchange rates. Can you just talk about how you're hedged both in terms of your operating costs as well as receivables?

The answer is very simple. We did -- we do not hedge anything.

Right. So you're immediately benefit from the sharp decline in the shekel and that's why your OpEx has come down.

Exactly.

Any thoughts on change in the tax rate or interest income line share count as we move forward?

No, no change. Indeed, the tax percentage in the quarter was somewhat lower, compared to the average, but we still believe in the around 15% range.

All right. Great. I'll see the floor at this point, but I will come back into the queue. So if there's additional opportunity to talk.

Operator, let’s move onto the next question.

The next question is from Jeff Meyers from Cobia Capital. Please go ahead.

Hi, guys. Thank you. Congratulations on a nice quarter. Just had a quick question. Did you guys buy back any stock during the quarter? And if so, how much?

Yes, the buyback plan ended in April this quarter. How much in total the third buyback plan, it was about $12.5 million.

I see. And is there a thought to renew that, I guess, going forward?

So when we look at our cash and what's the best use for that cash, at the moment, we feel that the best thing to do with that is to build it into our inventory, so we can be in the best position we can in order to build products and provide them to our customers.So that is our plan at the moment.

Got it, okay. Thank you, guys.

Operator, let’s move to the next questions.

Yes, the next question is from Shawn Boyd of Next Mark Capital. Please go ahead.

Good morning. Can you hear me, okay.

Yes.

Great. I understand we're not giving exact numbers here on the backlog, but perhaps you can help us with bookings. Given what's going on in the macro over the past couple of quarters here. Are your bookings and your excitement in your pipeline continuing to be as strong as they were? Or is that ebbed at all? And how do you think that rolls out into Q3?

So yes, I mean, we -- as I said before, we discuss with our customers consistently. We're very obsessed with speaking with our customers to feel what they're doing and now especially that we're traveling a lot again and meeting our customers face-to-face, we even feel it more. And we see that, yes, we see the pipeline. We believe it's very strong. And we believe that all the design wins that we collected over the last few quarters, which are starting to ramp up some more and some less will continue to ramp up. So we believe very strongly in our pipeline and in our backlog.

Okay. Very good, very good. So taking that kind of to the next level and thinking about that product going to the P&L and starting to see shipments there. On the component constraints, you mentioned that the situation has stabilized, no longer worsening. Now maybe we're just kind of at a bad level, but not getting better. Can you give us more color on that? What exactly are you seeing that tells you that? What gives you the confidence that we'll start to see those constraints ease? I guess if I heard it right, you think they're easing later in Q3 and Q4, but any more color you can give us specifically on that would be helpful.

So first of all, we don't see that easing yet. We see that it's not getting worse, and our assumption is that it will remain until the end of the year at least, it will remain as it is right now. We hope that we'll start seeing improvement in 2023, but at least for 2022, our assumption and what we see right now is that it's going to be hopefully flat and not worse. So the -- and the way that we understand the market is, again, is a lot of work talking with suppliers, talking with suppliers' suppliers, talking with Silicom's vendors, talking with other manufacturers in the market, talking with distributors, just trying to understand what they see in their backlog. Do they see push outs still? Are they seeing the lead times of the covenants going down or up or flat? And based on all of that, we kind of get an understanding of what we believe is going to happen in the component market. And our assumption, as I said for now is 2022 will not get worse and that we are now going to be, let's say, about flat with the lead times and the availability of the product. And in 2023, we hope to see improvement.

Okay. And just last question along this line is so far, have you had any cancellations? Have you had any customers where you have major wins where they've given the weaker macro and just time delays that are caused by these component constraints where they've basically pulled off and they said, okay, we're going to revamp these plans. We're going to go elsewhere where we're just not going to do this program.

Definitely not for the big programs. You may have some insignificance here and there, but none of our major design wins is nowhere near the situation.

Very good. And thank you for the additional color, guys.

Thank you, Shawn.

Thank you.

Next question is a follow-up question from Alex Henderson of Needham & Company. Please go ahead.

Great. I was hoping to talk a little bit about employment environment that you're in, to what extent you're seeing churn and staffing, I assume that it's very stable, because that's the history of the company. And I know people tend to be there a long time. But have you seen any acceleration in churn? And when do you have annual bonus increases when? What are you doing on the compensation side? Obviously, the strong dollars also creating inflation in various geographies that leads to offset with compensation. So how should we think about the compensation going up given the backdrop?

We are very pleased with the situation. I mean we do not see significant churn even at all, I would say, I mean, compared to what we see from around us and certain companies, we're very pleased with that. And from a bonus perspective, compensation perspective, we continue with the policy that pretty much we always had and continuing to understand where we are compared to the market, but we don't expect to see any significant impact on that or on the P&L or anything of that sort.

The annual compensation reviews and escalation generally is in the March quarter, is that correct?

Usually, we do it at year-end, but it depends on the -- I mean, we definitely do it at year-end, but it changes from year to year sometimes.

Okay. And going back to the components side of it. Can you talk a little bit about what's going on with your FGA PGA products? Are you seeing any traction with those -- I know that the semi market has been complicated, but it's hard for us to put that into context with your FPGAs. Has there been any improvement there?

Yes. I mean there's definitely a few developments there. We continue our very close work with Intel on that. We have some opportunities that came maybe as part of COVID some -- as we mentioned, some other suppliers are unable to provide products to their customers, so they're turning to us. Definitely, there some opportunities here, some wins we've managed to do over the last few months. And we expect there to be growth, but the growth should be smaller than some other areas of our business, but we definitely see growth there as well.

Another question around the trajectory of the top line. Historically, you've had a pretty nice pop into the fourth quarter and then a seasonal much softer March quarter. Clearly the supply constraints make that seasonal pattern a little bit less likely. Should we be thinking about the fourth quarter as being more of a continuation of the sequential pattern over the course of the year and maybe not as much of a pop in the fourth quarter or as much as the decline in the first quarter. How should we be thinking about that piece of the equation, which is, I think, more supply chain driven than demand driven?

We expect it to continue, I would say, pretty much at the same rate. We do not see a huge pop coming in. As I said, that we do not expect the supply chain situation to ease completely in Q4 and suddenly, we'll have all the components that we need to build all the products that we want. So we think it's going to be -- there's going to be growth. It's going to be pretty much at the same level that we've seen so far. Significant is in supply chain. We do not expect before 2023. So I expect this trend to continue of growth as pretty much similar to what we've seen so far.

So that seasonality into the first quarter, the sequential decline that you've historically seen, which has been relatively steep. Is that something that we should anticipate again? Or is that the lack of full availability of parts make that smoother into the first quarter?

I think it's too early for us to say at the moment about Q1, what our expectations are.

Right, [indiscernible]. Thanks.

The next question is from Robert Johnston from Herald Investment. Please go ahead.

Good morning. Would you want to talk a little bit more about the two product areas and what you're seeing there demand-wise. And also, could you talk a bit more about the competitive landscape and what you're seeing there?

Sure. Yes. So first of all, I'll talk about the Edge. So the Edge is probably one of the highest or fastest-growing domains that we have. We've seen it growing quite significantly over the last few years, and we think that's going to be one of our main drivers to -- for growth in the next few years as well. And there, we see that we definitely have an advantage, our close relationship with the Silicom vendors, our very professional team, our ability to supply products in this very crazy environment of supply issues, which forces us to solve problems all the time, including engineering problems. We're doing redesigns as we go. All of that has put us in a very good position to continue our growth. We believe we also have a lot of innovation in that area, which makes customers want to work with us. And we see that with more and more design wins in this area, and we definitely believe this will continue. As for the other area, I'm assuming that you're referring to the 5G O-RAN, that market is developing. It's really in the early stages, as everyone knows what everything or the reports in the media, et cetera, that many telcos are now in the phase of POCs or initial deployment. So we're definitely part of a lot of those, and we think it will also grow over the next few years. But for that market, it's a little bit earlier even than the edge market that I discussed a little -- a few minutes before.

Terrific. And competitively in the two markets, anything incremental or?

I mean definitely, we see the advantage. I mean, we mid -- I mean, I think in the Edge market specifically, we have become a very known name. Everyone knows Silicom in that domain whenever there's, I mean, an RFP or anything of that sort that are bidding, we are there. We have a broad range of products. We have a strong roadmap.Same goes for the 5G and O-RAN market. So we feel very strong about it.

And so your customers are looking for a single source multiple sources and how are they doing Silicom versus other providers in terms of having a consistent supply?

Well, definitely, we're not the only one in the market, and there is competition there, but our close relationship with the Silicom vendors and the fact that in many cases, we are the first to the market and that we are very innovative in our products that we come with gives us an advantage. And obviously, our obsession with making our customers happy and the fact that we are able to supply and go a long way in order to provide our customers with products are positioning us well. But definitely, there is competition there.

Okay. Pricing, it's stable or going up with a shortage of components or?

So we -- I mean, we're not making significant changes to that. But as you can see from our margins, we are still in the same range. We think we would remain in the same range, so no significant impact due to that.

Yes. You can see that, but you competitively -- I was wondering what you're seeing there?

It's a challenging environment, definitely. And we're not the only ones suffering from that. Our competition is in a similar situation, so all of us are trying to do the best. And I think -- that is also a situation right now where the customers are measuring, who are those customers or suppliers who are able to deliver and they can trust in the long-term. But yes, it's a very challenging environment from a price perspective, from a supply perspective, yes. And I think it will remain so at least until the end of the year and later on as well.

Great. Last question, just on the 5G O-RAN. I mean, so just starting to hit mainstream, but early, I mean, what is your thought in terms of when it starts to ramp up? Is there -- is it component availability? Is it just timing? Or is it -- what do you think is going to be the milestone to really enable this market to start to ramp up a bit more?

I think it's a combination. I mean, on the one side, it's components. But it's not -- I wouldn't say this is the limiting factor. It's a technology that is ramping up. There's the CapEx versus OpEx approach here that many telcos are very interested in and want to adopt. And I don't think there's a single telco in the world, who is not looking into 5G and O-RAN. Some of them in more advanced stages, some less, some are looking at a very big guys to see what they're doing and try to follow them later on. But it's still, as I said, it's still a little bit early days for that. 2023 will be bigger, but I think we will start seeing more and more deployments to 2023, 2024 and beyond.

Thank you very much.

Thank you.

[Operator Instructions] The next question is a follow-up question from Shawn Boyd of Next Mark Capital. Please go ahead.

Thanks for the follow-up. I'll keep it brief. Real quick on the inventory build. Can you just talk a little bit about what's in there? And the trajectory of that? I think you had indicated we should start to see that drop by the end of the year. But what exactly have you built up in there? And how is that helping in terms of kind of deep working through these component constraints?

Sure. So most of it is electronic components, because that's where we've been struggling the most. It's not parts which have short lead time that we can build quickly and metal parts or other things that are easy to get. It's the electronic parts that the entire industry is fighting to get. Some of those parts have a lead time of 60 weeks and more and our strategy has been to build this inventory so we can react and support our customers. So that's mainly what you’ll find in the inventory. And we think that we are now around the peak, I would say, of the inventory and depending on how the market will evolve, but if it will continue as we expect it right now to be kind of flat until the end of the year and then ease towards 2023, we think that towards the end of the year, we will start seeing a dropping and at some point, we're probably going to go back to normal levels. But right now, we are -- we think it's still going to be a little high for a while longer and then go down.

Got it. And we'll certainly help build working capital. Last question for me is your incremental operating margins. Just rough math has been at about 25% incremental operating margins last year. And then it certainly bounces around quarter-to-quarter, but for the first half of this year versus first half of last year, about the same. Is that a good number to think about going forward? Or can we think about something even higher? Because if these component constraints and design wins start to go ramp, it seems like scale would help. So just talk about the 25% operating -- incremental operating margin.

We have some leverage in the model, but we need to look at the dollar and other factors in order to really understand where it's going.

Okay. Good enough. Thanks so much gentlemen.

Thank you. Operator?

The next question is from Alex Henderson of Needham & Company. Please go ahead.

Yes. Just one more quick one. So one of the key metrics is decommits from supply chain. Have you seen any over the last quarter and have you seen any during the current quarter? What's the situation relative to supplier decommits?

Yes. Those still exist definitely. I mean when we are -- we're saying that the situation is flat with supply chain, it does not mean that we're not getting push out. It just means that the number of push outs we're getting is not higher than what we got in previous quarters. But still, I mean, we're in situations that from time-to-time, we get decommit on a certain component and now we not start to find a solution for that, either by an alternative or redesign or proposing a different product for the customer. And yes, it still happens from time-to-time, and we still expect it to continue to happen until the end of the year and maybe even a little bit towards 2023, but maybe at lower rates at that point. But still, this is a reality, and it's an uphill battle every day to deliver the products to our customers.

Right. So at this point in time, in the third quarter, decommits have been as expected. No surprises there so far?

Well, every decommit is a surprise, probably, but it's not a surprise as to how many decommits we get, I would say.

Thank you.

There are no further questions at this time. Before I ask Mr. Eizenman to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available by tomorrow on Silicom's website, www.silicom-usa.com. Mr. Eizenman, would you like to make your concluding statement?

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 second quarter 2022 results conference call. Thank you for your participation. You may go ahead and disconnect.