embedded systems. We operate in one reportable segment: the development, manufacturing, marketing and sales of interconnect semiconductor products.
We are a fabless semiconductor company that provides high-performance interconnect products based on semiconductor integrated circuits, or ICs. We design, develop and market adapter and switch ICs, both of which are silicon devices that provide high performance connectivity. We also offer adapter cards that incorporate our ICs. Growth in our target markets is being driven by the need to improve the efficiency and performance of clustered systems, as well as the need to significantly reduce the total cost of ownership.
It is difficult for us to forecast the demand for our products, in part because of the highly complex supply chain between us and the end-user markets that incorporate our products. Demand for new features changes rapidly. Due to our lengthy product development cycle, it is critical for us to anticipate changes in demand for our various product features and the applications they serve to allow sufficient time for product design. Our failure to accurately forecast demand can lead to product shortages that can impede production by our customers and harm our relationships with these customers. Conversely, our failure to forecast declining demand or shifts in product mix can result in excess or obsolete inventory.
Revenues. We derive revenues from sales of our ICs and cards. To date, we have derived a substantial portion of our revenues from a relatively small number of customers. Revenues were approximately $53.4 million for the six months ended June 30, 2008 compared to approximately $36.6 million for the six months ended June 30, 2007, representing an increase of 46%. Total sales to customers representing more than 10% of revenues accounted for 36% and 70% of our total revenues for the six months ended June 30, 2008 and 2007, respectively. The loss of one or more of our principal customers or the reduction or deferral of purchases of our products by one of these customers could cause our revenues to decline materially if we are unable to increase our revenues from other customers.
Cost of revenues and gross profit. The cost of revenues consists primarily of the cost of silicon wafers purchased from our foundry supplier, Taiwan Semiconductor Manufacturing Company, or TSMC, costs associated with the assembly, packaging and production testing of our products by Advanced Semiconductor Engineering, or ASE, outside processing costs associated with the manufacture of our HCA cards by Flextronics, royalties due to third parties, including the Office of the Chief Scientist of Israel's Ministry of Industry, Trade and Labor, or the OCS, the Binational Industrial Research and Development (BIRD) Foundation and a third-party licensor, warranty costs, excess and obsolete inventory costs and costs of personnel associated with production management and quality assurance. In addition, after we purchase wafers from our foundries, we also have the yield risk related with manufacturing these wafers into semiconductor devices. Manufacturing yield is the percentage of acceptable product resulting from the manufacturing process, as identified when the product is tested as a finished IC. If our manufacturing yields decrease, our cost per unit increases, which could have a significant adverse impact on our cost of revenues. We do not have long-term pricing agreements with TSMC and ASE. Accordingly, our costs are subject to price fluctuations based on the cyclical demand for semiconductors.
We purchase our inventory pursuant to standard purchase orders. We estimate that lead times for delivery of our finished semiconductors from our foundry supplier and assembly, packaging and production testing subcontractor are approximately three to four months and that lead times for delivery from our HCA card manufacturing subcontractors are approximately eight to ten weeks. We build inventory based on forecasts of customer orders rather than the actual orders themselves. In addition, as customers are increasingly seeking opportunities to reduce their lead times, we may be required to increase our inventory to meet customer demand.
We expect our cost of revenues to increase over time as a result of the expected increase in our sales volume. Generally, our cost of revenues as a percentage of sales has decreased over time, primarily due to manufacturing cost reductions and economies of scale related to higher unit volumes. This trend may not continue in the future, and will depend on overall customer demand for our products, our product mix, competitive product offerings and related pricing and our ability to reduce manufacturing costs. Operational expenses
Research and development expenses. Our research and development expenses consist primarily of salaries, share-based compensation and associated costs for employees engaged in research and development, costs associated with computer aided design software tools, depreciation expense and tape out costs. Tape out costs are expenses related to the manufacture of new products, including charges for mask sets, prototype wafers, mask set revisions and testing incurred before releasing new products. We anticipate these expenses will increase in future periods based on an increase in personnel to support our product development

activities and the introduction of new products. We anticipate that our research and development expenses may fluctuate over the course of a year based on the timing of our product tape outs.
We received grants from the OCS for several projects. Under the terms of these grants, if products developed from an OCS-funded project generate revenue, we are required to pay a royalty of 4-4.5% of the net sales as soon as we begin to sell such products until 120% of the dollar value of the grant plus interest at LIBOR is repaid. All of the grants we have received from the OCS have resulted in IC products sold by us. We received no grants from the OCS during the year ended December 31, 2007 or the six months ended June 30, 2008. In total we have received grants from OCS in amount of $2.8 million. As of June 30, 2008, our obligation in respect of royalties accrued and payable to the OCS totaled approximately $261,000.
The terms of OCS grants generally prohibit the manufacture of products developed with OCS funding outside of Israel without the prior consent of the OCS. The OCS has approved the manufacture outside of Israel of our IC products, subject to an undertaking by us to pay the OCS royalties on the sales of our OCS-supported products until such time as the total royalties paid equal 120% of the amount of OCS grants.
Under applicable Israeli law, OCS consent is also required to transfer technologies developed with OCS funding to third parties in Israel. Transfer of OCS-funded technologies outside of Israel is permitted with the approval of the OCS and in accordance with the restrictions and payment obligations set forth under Israeli law. Israeli law further specifies that both the transfer of know-how as well as the transfer of intellectual property rights in such know-how are subject to the same restrictions. These restrictions do not apply to exports of products from Israel or the sale of products developed with these technologies.
Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries, share-based compensation and associated costs for employees engaged in sales, marketing and customer support, commission payments to external, third party sales representatives, sales-related legal costs for contract reviews, and charges for trade shows, promotions and travel. We expect these expenses will increase in absolute dollars in future periods based on an increase in sales and marketing personnel and increased commission payments on higher sales volumes.
General and administrative expenses. General and administrative expenses consist primarily of salaries, share-based compensation and associated costs for employees engaged in finance, human resources and administrative activities and charges for accounting and corporate legal fees. We expect these expenses will increase in absolute dollars in future periods based on an increase in personnel to meet the requirements associated with our anticipated growth and costs associated with being a public company.
Taxes on Income. Our operations in Israel have been granted "Approved Enterprise" status by the Investment Center of the Israeli Ministry of Industry, Trade and Labor, which makes us eligible for tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959. Under the terms of the Approved Enterprise program, income that is attributable to our operations in Yokneam, Israel will be exempt from income tax for a period of ten years commencing when we first generate taxable income (after setting off our losses from prior years). Income that is attributable to our operations in Tel Aviv, Israel will be exempt from income tax for a period of two years commencing when we first generate taxable income (after setting off our losses from prior years), and will be subject to a reduced income tax rate (generally 10-25%, depending on the percentage of foreign investment in our company) for the following five to eight years.
The change in our effective income tax rate in 2008 reflects the impact of releasing the valuation allowance in Israel as of December 31, 2007. The 35% effective tax rate is the blend of geographic income in the U.S. and Israel at their respective statutory rates, adjusted for permanent differences. Management currently expects the Israeli Approved Enterprise Tax Holiday will begin in 2009 and our effective tax rate will be materially reduced as a result. Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

We believe that the assumptions and estimates associated with revenue recognition, allowance for doubtful accounts, inventory valuation, warranty provision, income taxes and share-based compensation have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, please see Note 1 of the accompanying notes to our consolidated financial statements.
See our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the SEC on March 24, 2008, for a discussion of additional critical accounting policies and estimates. We believe there have been no significant changes in our critical accounting policies as compared to what was previously disclosed in the Form 10-K for the year ended December 31, 2007. Results of Operations
The following table sets forth our consolidated statements of operations as a percentage of revenues for the periods indicated:

                                          Three Months Ended          Six Months Ended
                                               June 30,                   June 30,
                                          2008           2007         2008         2007
       Total Revenues                       100 %          100 %        100 %       100 %
       Cost of revenues                     (20 )          (25 )        (22 )       (25 )

       Gross profit                          80             75           78          75

       Operating expenses:
       Research and development              36             28           34          31
       Sales and marketing                   14             15           14          16
       General and administrative             7              8            7           8

       Total operating expenses              57             51           55          55

       Income from operations                23             24           23          20
       Other income, net                      3              9            3           7
       Provision for taxes on income        (10 )           (5 )         (9 )        (3 )

       Net income                            16             28           17          24

Comparison of the Three Months Ended June 30, 2008 to the Three Months Ended June 30, 2007
Revenues. Revenues were approximately $28.2 million for the three months ended June 30, 2008 compared to approximately $19.8 million for the three months ended June 30, 2007, representing an increase of 43%. This increase in revenues resulted from increased unit sales of approximately 14% and an increase in average sales prices of 25% primarily due to changes in product mix. The increase in unit sales was primarily due to increased purchases by Sun Microsystems, QLogic and Supermicro Computer, which accounted for 18%, 14% and 11%, respectively, of our revenues for the three months ended June 30, 2008 and increased purchases by SGI and Network Appliance, each of which accounted for less than 10%, of our revenue for the three months ended June 30, 2008. These increases in unit sales were partially offset partially by reduced purchases by Cisco and Voltaire. Current quarter revenues are not necessarily indicative of the results to be anticipated for the entire year ending December 31, 2008 or thereafter.
Gross Profit and Margin. Gross profit was approximately $22.5 million for the three months ended June 30, 2008 compared to $14.9 million for the three months ended June 30, 2007, representing an increase of 51%. As a percentage of revenues, gross margin increased to 79.8% in the three months ended June 30, 2008 from 75.1% in the three months ended June 30, 2007. This increase in gross margin was due to higher mix of ICs versus HCA cards, increased sales of double-data rate, or DDR, products and the introduction of our next generation quadruple-data rate, or QDR, products for which we receive higher margins, partially offset by costs related to the in-house manufacturing of newly introduced products. Revenues attributable to DDR products were 84% and 57% of total revenues for the three months ended June 30, 2008 and 2007, respectively. Revenues attributable to QDR products were 4% of total revenues in the three months ended June 30, 2008. In addition, part of the gross margin improvement was due to a reduction in production costs associated with outsourced labor, raw materials and volume discounts, and the conclusion of our OCS obligation. This trend may or may not continue in the near term.
Research and Development. Research and development expenses were approximately $10.0 million in the three months ended June 30, 2008 compared to approximately $5.6 million in the three months ended June 30, 2007, representing an increase of 79%. The

increase consisted of approximately $2.2 million in higher employee related expenses associated with increased headcount and merit-based salary increases, an increase in share based compensation of $844,000 primarily due to new option grants, an increase in new product introduction expenses of $830,000, and higher depreciation and amortization expenses of approximately $272,000 related to purchases of equipment and technology licenses. We expect that research and development expense will increase in absolute dollars in future periods as we continue to devote resources to develop new products, meet the changing requirements of our customers, expand into new markets and technologies, and hire additional personnel.
For a further discussion of share-based compensation included in research and development expense, see "Share-based compensation expense" below.
Sales and Marketing. Sales and marketing expenses were approximately $4.0 million for the three months ended June 30, 2008 compared to approximately $3.0 million for the three months ended June 30, 2007, representing an approximate increase of 33%. The increase was attributable to higher employee related expenses of $353,000 associated with increased headcount and merit-based salary merit, an increase in external sales commissions of $208,000 due to the increase in sales, an increase in share based compensation of $186,000 primarily due to new option grants, and increases in advertising and public relations expenses of $156,000 due to increased tradeshow participation.
For a further discussion of share-based compensation included in sales and marketing expense, see "Share-based compensation expense" below.
General and Administrative. General and administrative expenses were approximately $2.1 million for the three months ended June 30, 2008 compared to approximately $1.5 million for the three months ended June 30, 2007, representing an increase of 37%. The increase was due to an increase in employee related expenses of $187,000 associated with increased headcount and merit-based salary increases, an increase of $175,000 in accounting and audit fees, an increase of $160,000 in facilities and maintenance expenses, higher share based compensation of $150,000 due to new option grants, and an increase in other expenses of $118,000, partially offset by a decrease in legal expenses of $100,000.
For a further discussion of share-based compensation included in sales and marketing expense, see "Share-based compensation expense" below.
Other Income, net. Other income, net consists of interest earned on cash and cash equivalents and short-term investments, and foreign currency exchange gains and losses. Other income, net was approximately $941,000 for the three months ended June 30, 2008 compared to approximately $1.8 million for the three months ended June 30, 2007. The decrease consisted of approximately $750,000 of lower interest income associated with lower average interest rates paid on investments and lower foreign currency exchange gains of approximately $129,000.
Provision for Taxes on Income. Provision for taxes on income was approximately $2.8 million for the three months ended June 30, 2008 compared to approximately $0.9 million for the three months ended June 30, 2007. The increase was primarily a result of utilization of certain deferred tax assets related to net operating losses in Israel that are currently expected to be utilized before the Approved Enterprise Tax Holiday begins in 2009. Comparison of the Six Months Ended June 30, 2008 to the Six Months Ended June 30, 2007
Revenues. Revenues were approximately $53.4 million for the six months ended June 30, 2008 compared to approximately $36.6 million for the six months ended June 30, 2007, representing an increase of 46%. This increase in revenues resulted from increased unit sales of approximately 19% and an increase in average sales prices of 22%. The increase in unit sales was primarily due to increased purchases by Sun Microsystems, which accounted for 11% of our revenues for the six months ended June 30, 2008 and increased purchases by Supermicro Computer, IBM, Network Appliance and Dell, each of which accounted for less than 10%, of our revenue for the six months ended June 30, 2008. These increases in unit sales were partially offset by reduced purchases by Cisco and Voltaire. Year-to-date revenues are not necessarily indicative of the results to be anticipated for the entire year ending December 31, 2008 or thereafter.

Gross Profit and Margin. Gross profit was approximately $41.7 million for the six months ended June 30, 2008 compared to $27.4 million for the six months ended June 30, 2007, representing an increase of 52%. As a percentage of revenues, gross margin increased to 78.2% in the six months ended June 30, 2008 from 74.9% in the six months ended June 30, 2007. This increase in gross margin was due to a reduction in production costs associated with outsourced labor, raw materials and volume discounts and increased sales of our next generation double data rate, or DDR, products for which we receive higher margins. Revenues attributable to DDR products were 84% and 51% of total revenues for the six months ended June 30, 2008 and 2007, respectively.
Research and Development. Research and development expenses were approximately $18.3 million in the six months ended June 30, 2008 compared to approximately $11.5 million in the six months ended June 30, 2007, representing an increase of 58%. The increase consisted of higher employee related expenses of $4.1 million associated with increased headcount, approximately $1.8 million of increased share base compensation, higher depreciation and amortization expenses of approximately $659,000, an increase in facilities related expenses of $319,000, and an increase in equipment expenses of $106,000 partially offset by a decrease in new product introduction expenses of $300,000 associated with introduction of our Connect X product in the prior year.
For a further discussion of share-based compensation included in sales and marketing expense, see "Share-based compensation expense" below.
Sales and Marketing. Sales and marketing expenses were approximately $7.4 million for the six months ended June 30, 2008 compared to approximately $5.8 million for the six months ended June 30, 2007, representing an increase of approximately 27%. The increase was attributable to higher salary related expenses of $580,000 associated with increased headcount, an increase in external commissions of $353,000 due to higher sales, an increase in share based compensation of $353,000 and higher tradeshow and marketing related expenses of approximately $189,000.
For a further discussion of share-based compensation included in sales and marketing expense, see "Share-based compensation expense" below General and Administrative. General and administrative expenses were approximately $3.9 million for the six months ended June 30, 2008 compared to approximately $2.9 million for the six months ended June 30, 2007, representing an increase of 36%. The increase was due to higher salary related expenses of $366,000 associated with increase headcount, higher share based compensation of $314,000, an increase in accounting fees of approximately $257,000, and an increase in other professional services of $193,000 associated with consulting and listing fees partially offset by a decrease in legal expenses of $160,000.
Share-based compensation expense. The following table presents details of total share-based compensation expense that is included in each functional line item in our consolidated statements of operations:

                                             Three months ended          Six months ended
                                                  June 30,                   June 30,
                                              2008           2007        2008         2007
                                                            (In thousands)
  Cost of goods sold                       $        49       $  18     $      97     $    33
  Research and development                       1,259         415         2,446         690
  Sales and marketing                              457         271           835         482
  General and administrative                       272         123           533         220

  Total share-based compensation expense   $     2,037       $ 827     $   3,911     $ 1,425

At June 30, 2008, there was $24.2 million of total unrecognized share-based compensation costs related to non-vested share-based compensation arrangements. The costs are expected to be recognized over a weighted average period of 2.96 years.
Other Income, net. Other income, net consists of interest earned on cash and cash equivalents and foreign currency exchange gains and losses. Other income, net was approximately $2.0 million for the six months ended June 30, 2008 compared to approximately $2.7 million for the six months ended June 30, 2007. The decrease consisted of approximately $328,000 of lower interest income associated with lower average interest rates paid on investments and higher foreign exchange losses of approximately $439,000.
Provision for Taxes on Income. Provision for taxes on income was approximately $4.9 million for the six months ended June 30, 2008 compared to approximately $1.1 million for the six months ended June 30, 2007. The increase was primarily a result of

utilization of certain deferred tax assets related to net operating losses in Israel that are currently expected to be utilized before the Approved Enterprise Tax Holiday begins in 2009.
Liquidity and Capital Resources
From our inception until our initial public offering in February 2007, we financed our operations primarily through private placements of our convertible preferred shares totaling approximately $89.3 million. We incurred net losses from operations since inception until the second quarter of 2005. On February 13, 2007, we closed the initial public offering of our ordinary shares. We sold 6,900,000 ordinary shares in the offering, which number of shares included the underwriters' exercise in full of their option to purchase up to 900,000 shares to cover over-allotments, at an offering price of $17.00 per share. Net proceeds generated by the offering, after adjusting for offering costs, totaled approximately $106 million.
As of June 30, 2008, our principal source of liquidity consisted of cash and cash equivalents of approximately $73.8 million and short-term investments of approximately $90.4 million. We currently anticipate that our existing cash and cash equivalents and short-term investments and our cash flows from operating activities will be sufficient to fund our operations over the next 12 months . . .