Silicom Ltd. — 2018 Form 20-F Summary
Reporting period: Fiscal year ended December 31, 2018. The filing is an annual Form 20-F, not a standalone fourth-quarter filing. Financial statements are prepared in U.S. dollars under U.S. GAAP and cover Silicom Ltd. and its wholly owned subsidiaries.
Business context
Silicom designs, manufactures, markets and supports high-performance networking and data-infrastructure solutions, including server adapters, programmable and intelligent cards, hardware acceleration products, bypass switches and customer-premises equipment for Cloud, data-center, SD-WAN, NFV, cybersecurity, storage, Telco and OEM applications. Approximately 80% of 2018 sales were in North America, 16% in Europe and 4% in Asia-Pacific.
Key financial metrics
| US$ thousands, except per-share data | 2018 | 2017 | Change |
|---|---|---|---|
| Sales | 133,753 | 125,690 | 6.4% |
| Gross profit | 42,056 | 45,928 | (8.4%) |
| Gross margin | 31.4% | 36.5% | Down 5.1 points |
| Operating income | 16,651 | 25,426 | (34.5%) |
| Operating margin | 12.4% | 20.2% | Down 7.8 points |
| Net income | 14,637 | 21,714 | (32.6%) |
| Net margin | 10.9% | 17.3% | Down 6.4 points |
| Basic EPS | $1.938 | $2.912 | (33.5%) |
| Diluted EPS | $1.912 | $2.856 | (33.0%) |
| Cash flow from operations | 45,678 | 1,408 | Significant increase |
Balance sheet and liquidity
- Total assets increased to $182.3 million from $162.6 million; shareholders’ equity increased to $158.1 million from $140.8 million.
- Cash and cash equivalents increased to $26.8 million from $17.0 million.
- Marketable securities totaled approximately $47.2 million at year-end, principally held-to-maturity corporate and government debt securities. No other-than-temporary impairment was recorded.
- Working capital was $82.5 million and the current ratio was 4.83.
- The company reported no short- or long-term interest-bearing debt.
- Trade receivables declined to $23.8 million from $41.4 million, while inventories declined to $42.4 million from $51.5 million.
- Capital expenditures were approximately $1.7 million, funded from internal resources. Contractual obligations totaled $27.8 million, including $24.0 million of purchase obligations and $3.9 million of operating leases.
Material changes versus 2017
- Sales grew modestly, driven principally by customer and product expansion, particularly in CPE/Edge products supporting NFV, SD-WAN and cybersecurity.
- Profitability declined materially. Gross profit fell by $3.9 million and gross margin contracted to 31.4%.
- Gross profit was adversely affected by a $3.2 million inventory write-off associated with the cancellation of the company’s largest-ever Cloud-related Design Win, product-mix changes and higher inventory write-downs. Total obsolete-inventory write-downs were $6.2 million in 2018 versus $2.9 million in 2017.
- The cancelled Cloud Design Win was abandoned by the customer for technical and business-strategy reasons unrelated to Silicom’s product or support, according to management.
- Operating expenses increased to $25.4 million from $20.5 million. The 2017 figure included a $4.6 million contingent-consideration benefit; no such benefit was recorded in 2018.
- Research and development expense increased 6.5% to $14.8 million, or 11.1% of sales. Silicom capitalized $928,000 of internal software-development costs in 2018.
- Net financial income increased to $923,000 from $156,000, primarily due to higher investment income and favorable currency effects.
- Operating cash flow increased sharply, largely because of collections of receivables and reductions in inventory, rather than because of corresponding net-income growth.
- The board suspended the company’s dividend policy on March 15, 2018. No dividend was paid in 2018, compared with $7.4 million paid in 2017.
- Silicom adopted ASC 606 at the beginning of 2018; management reported no impact on revenue recognition.
Guidance, outlook, commentary and risks
Management views Cloud, data-center, Telco, service-provider, NFV and SD-WAN deployments as important long-term growth opportunities. The company announced several 2018 Design Wins, including CPE products for Telco and service-provider deployments and a 100G bypass switch. However, the filing does not provide quantified 2019 revenue, earnings or margin guidance.
- Design Wins generally involve long qualification and sales cycles, often twelve months or more, while firm customer orders may have short lead times. Timing and ramp-up are therefore difficult to forecast.
- Cloud and Telco growth may require higher inventory, longer customer payment terms and additional working capital. Design Wins may be cancelled or fail to convert into recurring sales, creating excess inventory and write-off risk.
- The top three customers represented approximately 36% of 2018 revenue; the largest customer represented approximately 14%. Three customers represented approximately 50% of accounts receivable at year-end.
- Rapid technology changes, including integrated server functionality, new interfaces, virtualization, Cloud architectures and competing solutions, could reduce demand for Silicom’s add-on products.
- Key components are available from limited or single sources, including components manufactured by Intel. Supply interruptions, component price increases or redesign requirements could affect production and margins.
- Competition includes larger or better-resourced companies such as Mellanox, Broadcom, Intel, Xilinx, Cavium, Netronome, Keysight and Gigamon, depending on the product category.
- Approximately 97% of international sales are denominated in U.S. dollars, while significant expenses are incurred in Israeli shekels and Danish kroner. The company does not currently hedge foreign-currency or interest-rate exposure.
- Tax benefits from the Israeli Preferred Enterprise regime reduced 2018 tax expense by approximately $1.4 million. Loss or reduction of these benefits could increase future taxes.
- Government-funded research and development programs impose restrictions on the transfer of know-how and manufacturing activities outside Israel. Outstanding potential royalty-related contingencies were approximately $3.0 million, principally associated with discontinued products.
- The company identifies geopolitical and security risks in Israel, military reserve duty, export-license requirements, cybersecurity and data-privacy regulation, intellectual-property claims, customer credit concentration and potential PFIC status for U.S. shareholders.
- Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2018. The independent auditor issued an unqualified opinion on the financial statements and internal control.
Most important facts to verify
- Whether 2019 and subsequent-period results demonstrate a recovery in gross margin after the 2018 Cloud Design Win cancellation and inventory write-offs.
- The conversion, timing and expected revenue contribution of announced Cloud, Telco, NFV, SD-WAN and CPE Design Wins.
- Customer concentration, receivable collectability and the effect of changes in payment terms on operating cash flow.
- Inventory aging, additional write-down exposure and the extent to which inventory reductions in 2018 were sustainable.
- The company’s ongoing dividend policy, capital-allocation plans and use of its approximately $74 million of cash and marketable securities.
- Future eligibility for Israeli Preferred Enterprise tax benefits and any potential tax liability on distribution of tax-exempt retained earnings.
- Exposure to component shortages, supplier concentration, foreign-currency movements and geopolitical disruptions.
- The effect of lease capitalization and other new accounting standards adopted after December 31, 2018; management anticipated approximately $3.4 million of lease assets and $3.3 million of lease liabilities upon adoption of the new lease standard.