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MLNX > SEC Filings for MLNX > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for MELLANOX TECHNOLOGIES, LTD.

Form 10-Q for MELLANOX TECHNOLOGIES, LTD.


2-May-2014

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition as of March 31, 2014 and results of operations for the three months ended March 31, 2014 and March 31, 2013 should be read together with our financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that involve risks, uncertainties and assumptions. Words such as "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," "predict," "potential" and similar expressions, as they relate to us, our business and our management, are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this report. The identification of certain statements as "forward-looking" is not intended to mean that other statements not specifically identified are not forward-looking. All statements other than statements about historical facts are statements that could be deemed forward-looking statements, including, but not limited to, statements that relate to our future revenues, product development and introductions, customer demand, our dependence on key customers for a substantial portion of our revenue, performance of our subcontractors, our ability to consummate acquisitions and integrate their operations successfully, growth rates, market adoption of InfiniBand, competitive factors, gross margins, levels of research, development and other related costs, expenditures, protection of our proprietary rights and patents, tax expenses and benefits, cash flows, management's plans and objectives for current and future operations, conditions in the Middle East and worldwide economic conditions.

Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under the section entitled "Risk Factors" in Part II, Item 1A of this report and in the section entitled "Risk Factors" in Part 1, Item 1A of our Annual Report on Form 10-K for fiscal year ended December 31, 2013. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. All forward-looking statements included in this report are based on information available to us on the date of this report, and we assume no obligation to update any forward-looking statements contained in this report. Quarterly financial results may not be indicative of the financial results of future periods.

Unless the context requires otherwise, references in this report to the "Company," "we," "us" and "our" refer to Mellanox Technologies, Ltd. and its wholly owned subsidiaries.


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Overview

We are a fabless semiconductor company that designs, manufactures and sells high-performance interconnect products and solutions primarily based on the InfiniBand and Ethernet standards. Our products facilitate efficient data transmission between servers, storage systems, communications infrastructure equipment and other embedded systems. We operate our business globally and offer products to customers at various levels of integration. The products we offer include integrated circuits ("ICs"), adapter cards, switch systems, cables, modules, software, services and accessories, as an integral part of a total end-to-end networking solution focused on computing, storage and communication applications used in multiple markets, including high-performance computing ("HPC"), Web 2.0, storage, financial services, enterprise data center ("EDC"), and cloud. Our adapters and switch ICs provide per port bandwidth up to 10Gb/s, 40Gb/s and 56Gb/s Ethernet, and 10Gb/s (Single Data Rate or SDR), 20Gb/s (Double Data Rate or DDR), 40Gb/s (Quad Data Rate or QDR) and 56Gb/s (Fourteen Data Rate or FDR) InfiniBand. Our switch systems range in port density from 8, 12, 18, 36, 48 and 64 port top-of-rack switches to director-class switches ranging in size from 108 to 648 ports. Connectivity between the adapters and switches is supported with our short reach copper cables and long reach active optical cables, and our management software provides visibility, monitoring and diagnostics for the system.

As a leader in developing multiple generations of high-speed interconnect solutions, we have established strong relationships with our customers. Our products are incorporated in servers and associated networking solutions produced by the four largest server vendors, IBM, HP, Dell and Oracle, which collectively shipped the majority of servers in 2013, according to industry research firm Gartner. We supply our products to leading storage and communications infrastructure equipment vendors such as Data Direct Networks, Fujitsu, Hewlett Packard, IBM, EMC/Isilon, NetApp, Nimbus Data, Oracle, Teradata, Toshiba and Seagate/Xyratex. Additionally, our products are used as embedded solutions by companies such as Fujitsu, GE Fanuc, Mercury, and Toshiba Medical.

We are one of the pioneers of InfiniBand, an industry-standard architecture for high-performance interconnects. We believe InfiniBand interconnect solutions deliver industry-leading performance, efficiency and scalability for clustered computing and storage systems that incorporate our products. In addition to supporting InfiniBand, our products also support industry-standard Ethernet transmission protocols providing unique product differentiation and connectivity flexibility. Our products serve as building blocks for creating reliable and scalable InfiniBand and Ethernet solutions with leading performance. We also believe that we are one of the early suppliers of 40Gb/s Ethernet adapters and switches to the market, and the only end-to-end 40Gb/s and 56Gb/s Ethernet supplier on the market today, which provides us with the opportunity to gain additional share in the Ethernet market as users upgrade from 1Gb/s or 10Gb/s directly to 40Gb/s or 56Gb/s.

Revenues. We derive revenues from sales of our ICs, boards, switch systems, cables, modules, software, accessories and other product groups. Our sales have historically been made on the basis of purchase orders rather than long-term agreements. Revenues for the three months ended March 31, 2014 were $98.7 million compared to $83.1 million for the three months ended March 31, 2013, representing an increase of approximately 19%. Our fiscal first quarter 2014 revenues are not necessarily indicative of future results.

Our products have broad adoption with multiple end customers across HPC, Web 2.0, cloud, EDC, financial services and storage markets; however, these markets are mainly served by leading server, storage and communications infrastructure OEMs. Therefore, we have derived a substantial portion of our revenues from a relatively small number of OEM customers. Sales to our top ten customers represented 61% and 74% of our total revenues for the three months ended March 31, 2014 and 2013, respectively. Sales to customers representing 10% or more of revenues accounted for 13% and 35% of our total revenues for the three months ended March 31, 2014 and 2013, respectively. The loss of one or more of our principal customers, the reduction or deferral of purchases, or changes in the mix of our products ordered by any one of these customers could cause our revenues to decline materially if we are unable to increase our revenues from other customers. Our customers, including our most significant customers, are not obligated by long-term contracts to purchase our products and may cancel orders with limited potential penalties. If any of our large customers reduces or cancels its purchases from us for any reason, it could have an adverse effect on our revenues and results of operations.

Cost of revenues and gross profit. The cost of revenues consists primarily of the cost of silicon wafers purchased from our foundry supplier, costs associated with the assembly, packaging and production testing of our ICs, outside processing costs associated with the manufacture of our products, royalties due to third parties, warranty costs, excess and obsolete inventory costs, depreciation and amortization, and costs of personnel associated with production management, quality assurance and services. In addition, after we purchase wafers from our foundries, we also face yield risk related to 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 foundry suppliers and contract manufacturers. Accordingly, our costs are subject to price fluctuations based on the overall 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, lead times for delivery from our adapter card manufacturing subcontractor are approximately eight to ten weeks, and lead times for delivery from our switch systems manufacturing subcontractors are approximately twelve weeks. We build inventory based on forecasts of customer orders rather than the actual orders themselves.


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We expect our cost of revenues as a percentage of sales to increase in the future as a result of a reduction in the average sale price of our products and a lower percentage of revenue deriving from sales of ICs and boards, which generally yield higher gross margins. This trend 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, amortization of intangibles, allocable facilities related and administrative expenses and tape-out costs. Tape-out costs are expenses related to the manufacture of new ICs, including charges for mask sets, prototype wafers, mask set revisions and testing incurred before releasing new ICs into production. 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.

Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries, incentive compensation, share-based compensation and associated costs for employees engaged in sales, marketing and customer support, commission payments to third party sales representatives, advertising, trade shows and promotions, travel, amortization of intangibles, and allocable facilities related and administrative expenses. We expect these expenses will increase in absolute dollars in future periods based on an increase in sales and marketing personnel and increased marketing activities.

General and Administrative Expenses. General and administrative expenses consist primarily of salaries, share-based compensation and associated costs for employees engaged in finance, legal, human resources and administrative activities, professional service expenses for accounting, corporate legal fees and allocable facilities related expenses. We expect these expenses will increase in absolute dollars in future periods based on an increase in personnel and professional services required to support our business activities.

Amortization of Intangible Assets. Amortization of intangible assets relates to intangible assets resulting from our acquisitions of businesses and purchases of patents and other license rights, which will be amortized over their estimated useful lives. Amortization is included in cost of revenues, research and development, sales and marketing or general and administrative expenses based upon the nature of the intangible asset.

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 and "Beneficiary Enterprise" status by the Israeli Income Tax Authority, which makes us eligible for tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959. Under the terms of the Beneficiary 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 fiscal year 2011. Income that is attributable to our operations in Tel Aviv, Israel is subject to a reduced income tax rate (generally between 10% and the current corporate tax rate, depending on the percentage of foreign investment in the Company) for five to eight years beginning fiscal year 2013. The Yokneam tax holiday is expected to expire in 2020 and the Tel Aviv tax holiday is expected to expire between 2017 and 2020. The corporate tax rate in Israel was 25% in 2013 and is 26.5% in 2014.

As a result of realigning some of our business activities, we may start utilizing carryforward net operating losses in one of our subsidiaries in the future. The valuation allowance established for deferred tax assets will be released if it becomes more likely than not that we will generate sufficient future taxable income in that subsidiary.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. 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.


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We believe that the assumptions and estimates associated with revenue recognition, allowance for doubtful accounts, fair value of financial instruments, short-term investments, inventory valuation, valuation and impairment of goodwill and acquired intangibles, warranty provision, share-based compensation and income taxes 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, 2013, filed with the SEC on February 28, 2014, for a discussion of additional critical accounting policies and estimates. There have been no changes in our critical accounting policies as compared to what was disclosed in the Form 10-K for the year ended December 31, 2013.

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
                                       March 31,
                                  2014          2013
Total revenues                       100 %         100 %
Cost of revenues                      34            35
Gross profit                          66            65
Operating expenses:
Research and development              49            46
Sales and marketing                   20            20
General and administrative             8             9
Total operating expenses              77            75
Loss from operations                 (11 )         (10 )
Other income, net                      -             1
Provision for taxes on income         (1 )          (1 )
Net loss                             (12 )%        (10 )%

Comparison of the Three Months Ended March 31, 2014 to the Three Months Ended March 31, 2013

The following table represents our total revenues for the three months ended March 31, 2014 and 2013 by product category, interconnect protocol and data rate.

                                             Three Months Ended March 31,
                                                    % of                         % of
Product category:                    2014         Revenues        2013         Revenues
                                (in thousands)               (in thousands)
ICs                             $        12,687       12.8 % $        11,098       13.4 %
Boards                                   31,188       31.6 %          23,668       28.5 %
Switch and gateway systems               32,343       32.8 %          35,558       42.8 %
Cables, accessories and other            22,487       22.8 %          12,756       15.3 %
Total revenue                   $        98,705      100.0 % $        83,080      100.0 %




                                                    Three Months Ended March 31,
                                                           % of                         % of
Interconnect protocol and data rate:        2014         Revenues        2013         Revenues
                                       (in thousands)               (in thousands)

InfiniBand:
FDR                                    $        51,432       52.1 % $        41,832       50.4 %
QDR                                             14,058       14.2 %          24,962       30.0 %
DDR/SDR                                          3,683        3.8 %           4,146        5.0 %
Total                                           69,173       70.1 %          70,940       85.4 %
Ethernet                                        18,997       19.2 %           7,840        9.4 %
Other                                           10,535       10.7 %           4,300        5.2 %
Total revenue                          $        98,705      100.0 % $        83,080      100.0 %


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Revenues. Revenues were $98.7 million for the three months ended March 31, 2014 compared to $83.1 million for the three months ended March 31, 2013, representing an increase of 18.8%. The year-over-year revenue increase was primarily due to higher sales of 10Gb/s and 40Gb/s Ethernet products into Web 2.0 and Cloud markets slightly offset by a decrease in revenue from sales of InfiniBand products. The increase in FDR revenues in the three months ended March 31, 2014 was primarily due to the decreased revenues in the three months ended March 31, 2013 related to depletion of inventory accumulated at an OEM customer during the second half of 2012. The decrease in QDR revenues was primarily due to customers transitioning to FDR generation of products. Revenues for the three months ended March 31, 2014 are not necessarily indicative of future results.

Gross Profit and Margin. Gross profit was $64.9 million for the three months ended March 31, 2014 compared to $54.1 million for the three months ended March 31, 2013, representing an increase of 19.9%. As a percentage of revenues, gross margin increased to 65.7% in the three months ended March 31, 2014 from 65.2% in the three months ended March 31, 2013. The gross margin percentage increase was primarily a result of improvement in gross margin on our cable product family mainly due to lower warranty expenses. This improvement was partially offset by changes in the product mix where revenue attributed to lower margin products such as 10Gb/s Ethernet NICs and cables increased. Generally, we derive higher gross margin on sales of ICs and boards than on the sales of switches, gateways, cables and 10Gb/s Ethernet products. Gross margin for the three months ended March 31, 2014 is not necessarily indicative of future results.

Research and Development.



The following table presents details of our research and development expenses
for the periods indicated:



                                              Three Months Ended March 31,
                                                     % of                         % of
                                      2014         Revenues        2013         Revenues
                                 (in thousands)               (in thousands)
Salaries and benefits            $        24,356       24.7 % $        18,549       22.3 %
Share-based compensation                   6,678        6.8 %           5,808        7.0 %
Development and tape-out costs             7,039        7.1 %           5,366        6.5 %
Other                                     10,264       10.4 %           8,426       10.1 %
Total Research and development   $        48,337       49.0 % $        38,149       45.9 %

Research and development expenses were $48.3 million in the three months ended March 31, 2014 compared to $38.1 million in the three months ended March 31, 2013, representing an increase of 26.7%. The increase in salaries and benefits was attributable to headcount additions, including those associated with the Kotura and IPtronics acquisitions, partially offset by lower accrued bonuses. The increase in share-based compensation was attributable to RSU grants to new hires during fiscal year 2013 and assumed RSUs and stock options from the Kotura and IPtronics acquisitions. The increase in development and tape-out costs was attributable to higher non-recurring engineering expenses, higher equipment expense, higher software expenses and increased outsourcing expenses, partially offset by a decrease in tape-out costs. The increase in other research and development costs was primarily attributable to higher depreciation and amortization expenses due to amortization of acquired intangibles, as well as increased facilities and maintenance expenses and acquisition-related charges. We expect that research and development expenses will increase in absolute dollars in future periods as we continue to devote more resources to develop new products, meet the changing requirements of our customers, develop new 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.



The following table presents details of our sales and marketing expenses for the
periods indicated:



                                          Three Months Ended March 31,
                                                 % of                         % of
                                  2014         Revenues        2013         Revenues
                             (in thousands)               (in thousands)
Salaries and benefits        $        10,936       11.1 % $         9,314       11.2 %
Share-based compensation               2,433        2.5 %           2,124        2.6 %
Trade shows and promotions             2,620        2.6 %           2,502        3.0 %
Other                                  3,290        3.3 %           2,474        3.0 %
Total Sales and marketing    $        19,279       19.5 % $        16,414       19.8 %


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Sales and marketing expenses were $19.3 million for the three months ended March 31, 2014 compared to $16.4 million for the three months ended March 31, 2013, representing an increase of 17.5%. The increase in salaries and benefits was attributable to headcount additions, including those associated with the Kotura and IPtronics acquisitions, partially offset by lower accrued bonuses. The increase in share-based compensation was attributable to RSU grants to new hires during fiscal year 2013 and assumed RSUs and stock options from the Kotura and IPtronics acquisitions. The increase in other sales and marketing costs was primarily attributable to higher amortization expenses due to acquired intangible assets, as well as increased facilities and maintenance expenses and acquisition-related charges.

For a further discussion of share-based compensation included in sales and marketing expense, see "Share-based Compensation Expense" below.

General and Administrative.



The following table presents details of our general and administrative expenses
for the periods indicated:



                                                     Three Months Ended March 31,
                                                          % of                             % of
                                          2014          Revenues           2013          Revenues
                                     (in thousands)                   (in thousands)
Salaries and benefits               $          3,126          3.2 %  $          2,537          3.1 %
Share-based compensation                       2,005          2.0 %             1,979          2.4 %
Professional services                          1,821          1.8 %             1,769          2.1 %
Other                                          1,263          1.3 %             1,200          1.4 %
Total General and administrative    $          8,215          8.3 %  $          7,485          9.0 %

General and administrative expenses were $8.2 million for the three months ended March 31, 2014 compared to $7.5 million for the three months ended March 31, 2013, representing an increase of 9.8%. The increase in salaries and benefits was attributable to headcount additions, including those associated with the Kotura and IPtronics acquisitions, partially offset by lower accrued bonuses. The increase in share-based compensation was attributable to RSUs granted to existing employees in the first quarter of fiscal 2014, RSU grants to new hires and assumed RSUs and stock options from the Kotura and IPtronics acquisitions.

For a further discussion of share-based compensation included in general and administrative expense, see "Share-based Compensation Expense" below.

Share-based Compensation Expense.



The following table summarizes the distribution of total share-based
compensation expense in the consolidated statements of operations:



                                           Three Months Ended
                                               March 31,
                                            2014         2013
                                             (in thousands)
Cost of goods sold                       $       522   $    464
Research and development                       6,678      5,808
Sales and marketing                            2,433      2,124
General and administrative                     2,005      1,979
Total share-based compensation expense   $    11,638   $ 10,375

Share-based compensation expenses were $11.6 million for the three months ended March 31, 2014, compared to $10.4 million for the three months ended March 31, 2013, representing an increase of 12.2%. The increase in share-based . . .

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