Silicom Ltd. 2019 Form 20-F Summary
Business context and reporting period
Silicom Ltd. is an Israeli provider of high-performance networking and data-infrastructure solutions, including server adapters, programmable Smart Cards, FPGA-based products, CPE and edge-networking devices, bypass switches and related appliances. Its customers include OEMs, cloud providers, telecommunications companies and service providers. The filing is an annual report for the fiscal year ended December 31, 2019, prepared under U.S. GAAP. The filing does not provide separate fourth-quarter 2019 financial statements; the requested “2019 Q4” period is therefore addressed using full-year 2019 results and year-end data.
Key financial metrics
| US$ thousands, except per-share data | 2018 | 2019 | Change |
|---|---|---|---|
| Sales | 133,753 | 105,240 | Down 21.3% |
| Gross profit | 42,056 | 36,094 | Down 14.2% |
| Gross margin | 31.4% | 34.3% | Up 2.9 percentage points |
| Operating income | 16,651 | 10,213 | Down 38.7% |
| Operating margin | 12.4% | 9.7% | Down 2.7 percentage points |
| Income before taxes | 17,574 | 11,859 | Down 32.5% |
| Net income | 14,637 | 10,236 | Down 30.1% |
| Diluted earnings per share | $1.912 | $1.352 | Down 29.3% |
| Cash flow from operations | 45,678 | 26,726 | Down 41.5% |
Research and development expense increased to $15.075 million from $14.820 million, or 14.3% of sales. Sales and marketing expense was essentially unchanged at $6.647 million, while general and administrative expense increased 5.5% to $4.159 million. Financial income, net increased to $1.646 million from $0.923 million, primarily because of higher interest and investment income.
At December 31, 2019, total assets were $195.063 million and shareholders’ equity was $162.923 million. Current assets were $110.447 million versus current liabilities of $26.332 million, producing reported working capital of $84.115 million and a current ratio of 4.19. Cash and cash equivalents were $16.469 million; short-term bank deposits were $13.542 million; and held-to-maturity marketable securities totaled approximately $61.1 million at amortized cost. Management stated that available cash resources were sufficient to fund operations for at least the next twelve months.
The company reported no short- or long-term interest-bearing loans or debt. Lease liabilities recognized under ASC 842 totaled $3.783 million at year-end. Capital expenditures were $1.635 million, including approximately $1.234 million for machinery and equipment. The company repurchased 252,388 shares during 2019 for approximately $7.971 million; 7,351,317 shares were outstanding at year-end, including treasury shares and shares held by a subsidiary as described in the filing.
Material changes versus the prior comparable period
- Revenue declined primarily because the company generated no revenue in 2019 from its largest-ever cloud-related Design Win, which the customer canceled in March 2018 for strategic and business reasons unrelated to Silicom’s product or support.
- Gross margin improved to 34.3% from 31.4%, mainly because 2018 included a $3.2 million write-off associated with the canceled Design Win and because of product-mix changes. Inventory write-downs declined to 2.0% of sales from 2.9%.
- Operating income and net income fell substantially because the revenue decline reduced gross profit while operating expenses remained broadly stable. Unlike 2017, neither 2018 nor 2019 included a contingent-consideration benefit.
- Operating cash flow decreased to $26.726 million from $45.678 million, although lower inventories and other working-capital changes provided support.
- Cash and cash equivalents declined by $10.339 million, but the company increased short-term deposits and marketable securities. The combined balance of cash, short-term deposits and marketable securities increased by approximately $16.578 million.
- The company adopted ASC 842 for leases on January 1, 2019, recognizing operating lease right-of-use assets and liabilities. The adoption did not materially affect reported operations but increased recognized assets and liabilities.
- The company’s dividend policy remained suspended. The board suspended the policy in March 2018 to preserve funds for long-term growth.
Outlook, management commentary, risks and unusual items
Management identified cloud infrastructure, virtualization, NFV, SD-WAN, edge networking, cybersecurity and FPGA-based solutions as important growth opportunities. During 2019, Silicom announced several Design Wins involving FPGA Smart NICs, customized 400G products, autonomous-vehicle applications and next-generation uCPE solutions. However, Design Wins generally require lengthy evaluation and qualification periods and do not represent firm purchase commitments or guaranteed revenue.
The filing was signed April 27, 2020 and includes extensive disclosure regarding COVID-19. At the time of the financial statements, the company had not experienced a material adverse effect, but warned of possible workforce restrictions, factory closures, supplier and shipping disruptions, delayed Design Wins, customer-credit issues, reduced demand and cybersecurity exposure from remote work.
- Customer concentration is significant: the top three customers represented approximately 35% of 2019 revenue, and the largest customer represented approximately 16%.
- The company relies on certain single-source or limited-source components, including components manufactured by Intel and silicon supplied by Intel or Xilinx. Supply interruptions could cause production delays, redesign costs or inventory write-downs.
- Rapid technology changes and competitive pressure may reduce demand, pricing and gross margins. The company competes with larger companies including Intel, Broadcom and Mellanox, as well as specialized networking and appliance vendors.
- Long sales cycles, short customer order lead times and long supplier lead times create forecasting and inventory risks. Canceled or delayed Design Wins could produce excess or obsolete inventory.
- Approximately 96% of international sales are denominated in U.S. dollars, while a material portion of costs is incurred in Israeli shekels and Danish kroner. The company does not hedge foreign-currency or interest-rate exposure.
- The company held approximately $60.6 million of corporate and government debt securities at year-end, generally rated at least A-. No other-than-temporary impairments were recorded, but the portfolio remains exposed to credit, liquidity and interest-rate risk.
- The company benefits from Israeli Preferred Enterprise tax treatment. Loss or reduction of the benefit could increase future tax expense. The filing also reports approximately $50.516 million of tax-exempt retained earnings that could create additional tax if distributed.
- Outstanding OCS or IIA royalty-bearing contingencies totaled approximately $2.960 million, relating to discontinued products. Management does not anticipate future sales from the associated programs.
- No material litigation was pending or threatened as of the filing date, and management reported effective disclosure controls and internal control over financial reporting.
Important facts for investors to verify
- Whether new cloud, Telco, edge and FPGA Design Wins are converting into recurring revenue and whether customer concentration has changed.
- The effect of COVID-19 and subsequent supply-chain, production, shipping and customer-credit developments on revenue, margins and backlog.
- Whether gross-margin improvement is sustainable after the absence of the 2018 Design Win write-off and amid potentially lower-margin cloud and service-provider business.
- The composition, maturity profile and credit quality of the approximately $61.1 million held-to-maturity securities portfolio.
- Inventory aging and future write-down exposure, particularly for products tied to canceled, delayed or technologically obsolete Design Wins.
- The status of the $15 million share-repurchase authorization, including purchases after year-end and the impact on shares outstanding and liquidity.
- Continued eligibility for Israeli Preferred Enterprise tax benefits and the potential tax cost of distributing tax-exempt retained earnings.
- Future dividend policy, which remained suspended as of the filing.