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Executives

Jacob Shulman - Chief Financial Officer

Analysts

Andrew Nowinski - Piper Jaffray

Mellanox Technologies, Ltd. (MLNX) Piper Jaffray TMT Conference Transcript March 13, 2013 9:30 AM ET

Andrew Nowinski - Piper Jaffray

All right. Well, thank you for joining us today. So my name is Andrew Nowinski. I’m the Storage Analyst at Piper Jaffray. It’s my pleasure today to introduce you to Jacob Shulman from Mellanox. He is the CFO. For those that are not familiar, Michael Gray was the former CFO at Mellanox, and Jacob has recently taken over within the last six months.

So, maybe why don’t we start, Jacob, just give our investors that, you are new to the story or just your background perhaps?

Jacob Shulman

Absolutely. First of all thank you for having me at this conference. So what is Mellanox? Mellanox is a fabless semiconductor company. We design, manufacture and sell high performance interconnect products that help to facility data transmission within servers, storage and embedded systems.

We are an Israeli company. We’re dually headquartered. Our R&D and operations located in Israel, in Yokneam, and our business headquarters in Sunnyvale, California. I work out at the Sunnyvale office.

So each compute and storage systems consist of three major blocks, CPU, memory and interconnect. So, with the time CPU and memory vendors introduced more powerful, more efficient systems that put bottleneck on I/O, on interconnect. That’s why we are so very strategic to each system. We basically help to improve efficiency of each computing storage system.

We play in multiple markets today. Historically, we’ve been viewed as a HPC player, but things certainly changed in the past. Today we play in Web 2.0, data center, cloud, storage and financial services market.

Andrew Nowinski - Piper Jaffray

Great, and thank you. So this is a very timely presentation today. Yesterday, we just hosted big software by networking panel that was attract to lot of investor interest, and I know, just recently Mellanox initiated the, what you call the open Ethernet initiative?

Jacob Shulman

Correct.

Andrew Nowinski - Piper Jaffray

Which I think is revolved around SDN and OpenFlow concept? So, maybe if you could just give investors sort of assessing on what your open Ethernet initiative is?

Jacob Shulman

Of course, so open Ethernet initiative is initiative that we launch just few weeks ago. Basically it came as a demand from our largest customer who build data center, huge data center, and want to have the secrete source to how to design their systems.

Ethernet switch band yesterday sell very close switches, close system that do not allow lot of flexibility to some of the big players in the Web 2.0 and cloud market. That’s why we are coming with our initiative basically we will provide as the case to these customers and they will be able to design their own switch and routing within data center, and as their value the secrete source to the system.

Basically what we are trying to do here is that what we like to do in the operating system world. If you know, Linux become an open source and then with the time commercial vendors came and offered commercial system base in open source. We believe that if this initiative successful, this will also beat and see trend and also it will allow us to increase our ASP per end point in the Ethernet market that we are targeting today.

So far we’ve been selling all the unique, which is adapter products to this market, that market today represent approximately 10% of our revenue with 90% being InfiniBand and if this initiative is successful, our ASP per end point will increase and our revenue from Ethernet market will increase accordingly.

Andrew Nowinski - Piper Jaffray

Okay. So just on clear, so not only are you separating the software, the network operating system from the hardware but you are also making an open first, so that developers can contribute to the future sales. Okay. So the customers that you are referring to, is this specifically the cloud providers and the Web 2.0?

Jacob Shulman

It’s primarily enterprise. Primarily those -- initially those would be Web 2.0 and cloud providers. Big guys who have in-house designing capabilities and with the time when that trends continues, there will be some commercial vendors who will provide that to the enterprise. Okay.

Andrew Nowinski - Piper Jaffray

And then -- I understand, I mean this would certainly seem like it would monetize the hardware aspect of network switch. But given that, I think you currently only have 10% of revenue from the mix that anyway is all essentially, I would say largely incremental to your business. You really have nothing to lose on the Ethernet side, but your only concern is how you see the benefit?

Jacob Shulman

Absolutely correct. So, today, we do not have material switch -- Ethernet switch revenues at all. And therefore, it obviously included our serviceable market where we will be able to increase end-to-end point. We believe that we have best hardware today and we want to sell the hardware, which would allow third-parties to develop software based on our hardware. That would drive our revenues.

Andrew Nowinski - Piper Jaffray

Okay. And on the topic, if there is questions from the audience feel free to raise your hand and I can see.

Question-and-Answer Session

Unidentified Analyst

How do you your ASPs for end solutions? How much of that goes with consumer products? How are you looking to increase it?

Andrew Nowinski - Piper Jaffray

I will just repeat the question, if you bring a mike up as well. So the question for those that are on the webcast is, how do you increase the ASP portfolio?

Jacob Shulman

So, today, we do not sell Ethernet switches at all, very immaterial revenues for us from Ethernet switching. All our Ethernet revenues today come from sales of adapter cards NICs. We captured certain market share of the Ethernet market by selling Ethernet switches to connect those endpoints. We will be able to increase ASP per endpoints. This is an incremental revenue for us.

Andrew Nowinski - Piper Jaffray

Okay. There is one more out there. Yeah. Go ahead.

Unidentified Analyst

What are the sizes of the Ethernet switch revenue potential relative to the NIC cards that you are currently selling? And two, your service and support people are primarily all InfiniBand, are you going to have to increase your service and support staff tremendously and how much would you be increasing that cost bucket?

Jacob Shulman

Okay. So, today, our ethernet switch revenue is very much relative to the overall Ethernet revenues, primarily the revenues again come from seven NIC cards. So, Ethernet would be -- Ethernet revenues would be incremental and we haven’t quantified it yet. It depends on how successful the program would be and overall Ethernet switch market is a very big market.

Unidentified Analyst

(Inaudible)

Jacob Shulman

ASPs, the end point for switch is several times factor base, higher base factor material times going to as compared to the NIC. All right.

Unidentified Analyst

Three, four times.

Jacob Shulman

Three, four times, yeah. And today we’re selling again Ethernet and InfiniBand, so our support people, they proficient in both protocols. So we do not expect to materially increase the number of support people to support that initiative.

Andrew Nowinski - Piper Jaffray

Its sound very interesting, so it’s a, I think a very exciting time. Maybe moving on to last quarter, one of the issues that you have for this March quarter in terms of big items that was bit below our expectations, was that, you had a large OEM customer and they had a big inventory build-up there? Is there, what progress, I guess, are you aware of that, your large OEM customer has in terms of burning down that inventory this quarter?

Jacob Shulman

Yeah. So, you are right, absolutely right. During Q4 we realize that one of our large OEM over bought inventory primarily due to two reasons, one is, there was personal change that large OEM, and secondly, they hope to close some of the deal that they bought ahead off and those deals probably were not successful for them.

As a result, they had an excessive inventory of approximately $30 million. We expect that the significant portion of that inventory will be depleted during Q1 into the market and some of that will still into Q2.

Andrew Nowinski - Piper Jaffray

Okay.

Jacob Shulman

By the way, during Q1, that same OEM customer discontinued buying from us, because of the product mix and the inventory they had.

Andrew Nowinski - Piper Jaffray

Okay. So it doesn’t sound like it was driven by any sort of longer term customer referrals sort of similar to what huge I/O experienced with some of their bigger customers…

Jacob Shulman

No. That’s absolutely. We think that absolutely to two unrelated events. Really we do not see any major changes in our market. We think the market is there and we will be successful if we execute.

Andrew Nowinski - Piper Jaffray

Okay. Very good. Our next question, why don’t we move on to the topic of InfiniBand, and I wanted to talk about your recent announcement with Microsoft SQL Server, was that just announcing that your products are certified to work with Microsoft, the Parallel Data Warehouse or the more to than that, are they reselling it or owning, et cetera?

Jacob Shulman

So, first of all, that’s another example of how successful InfiniBand would be in the data center market, and it’s not just announcement, our adapter cards and switch, InfiniBand is just the part of their solution business that sold to the market.

Andrew Nowinski - Piper Jaffray

Okay. And what were the, I guess, previously using further data activity on the Data Warehouse prior they know?

Jacob Shulman

So this announcement just an upgrade to our latest generation InfiniBand as their product, 56 gigabit per second product, Microsoft has been using our previous generation 40 gigabit per second product.

Andrew Nowinski - Piper Jaffray

Okay. So if they upgrade to 56 gig, I guess, any idea on how big that, because it evolve in 2013 during the upgrade cycle?

Jacob Shulman

We haven’t quantified that. They haven’t allowed to give data to the market.

Andrew Nowinski - Piper Jaffray

Okay. Okay. Well, moving another kind of interesting customer, I want to touch on is ProfitBricks, and sort of what they are doing. It’s sound like their basing their called architecture on InfiniBand as well. Just wondering if you can provide any color on the opportunity and sort of what is InfiniBand enable to do that that Ethernet is not capable of doing it at ProfitBricks?

Jacob Shulman

So we said we have approximately nine, 10 cloud customers and all of them use InfiniBand. So using InfiniBand they can build more cost effective system. They can save on CapEx and OpEx using InfiniBand. This guy is basically deals more powerful, more efficient and cost effective systems that give them a competitive edge and ProfitBricks is a good example.

They have been able to increase number of virtual machines from each physical seller by the factor of 3x. Also the hypervisor, it allows them to move a virtual machine from one physical server to another physical server even without virtual machine knowing that. So this allows them to maximize virtualization from a physical server and therefore, offer competitive prices.

Also, Microsoft Egypt is another cloud provider who uses InfiniBand. So, Microsoft Egypt demonstrated 33% lower application cost as compared to any other cloud provider on the top cloud provider, at least.

Unidentified Analyst

So these cloud providers that are going with InfiniBand, are they -- in referenced to sort of a lower cost is expected to go with InfiniBand in most cases. Is it just because Ethernet switching a cost that is supporting 100 gigabits, are simply too higher and that’s why InfiniBand is much more cost effective, or is that and do you see that coming down and becoming more in parity with InfiniBand over time?

Jacob Shulman

InfiniBand is a better product today that’s provides data ROI. It allows better scalability to cloud guys that can provide them better utilization than any Ethernet today. Okay.

Andrew Nowinski - Piper Jaffray

And moving on to, if there is no question on InfiniBand, I will move on to the Web 2.0 customers, which I think are actually more aligned with the Ethernet protocols in some cases so. It sounds like they are deploying more 40-gig Ethernet and leveraging your VPI technology. So, I guess can you just help us understand, what’s the difference between a Web 2.0 customer that deploys 40-gig Ethernet versus the cloud providers that is InfiniBand?

Jacob Shulman

Absolutely. So the way we define Web 2.0 customers is when the gap customers built one supercomputer to run one application and the cloud guys are the guys who built one supercomputer to run multiple applications or sometime even to allow same customers to run applications on those machines.

So you are absolutely right. Web 2.0 is a very big market on the Ethernet side for us, although we also have InfiniBand Web 2.0 customers who deploy full end-to-end solution on InfiniBand side. I think we said that we have handful number of customers in that market, approximately 40% of them using InfiniBand end-to-end and the rest 60% using Ethernet end-to-end.

And so Ethernet peaks not InfiniBand, I apologize. And in terms of Ethernet solutions, primarily how Ethernet solutions came from selling 10 gig cards. We see market transitioning to 40-gigs so far, 40-gig market revenues. It worked very much well for us. But we expect them to grow into 2013.

Andrew Nowinski - Piper Jaffray

And do you think you are opening Ethernet initiatives and that what will and then you will take these Web 2.0 customers that are running in Ethernet. It makes only right now into a bigger more of end-to-end solution with InfiniBand or is there an opportunity there at the Web 2.0 space?

Jacob Shulman

If this problem is successful then absolutely yeah. We don’t look out to the, who can provide full end-to-end 40-gig Ethernet Solutions. There are switch vendors that have 40-gigabit Ethernet switches. No one except Mellanox has 40-gig Ethernet end points. So obviously, we would like to drive more, full end-to-end solutions on 40-gig Ethernet. Okay.

Andrew Nowinski - Piper Jaffray

Okay. And then on those -- maybe just moving on to this actually the broader storage market. In the past you have talked about really your top three growth of revenue has been cloud, Web 2.0 and storage. So and we just discussed sort of the first two growth drivers at length. I was just wondering if you could talk about sort of the broader storage opportunities that move in the market.

Jacob Shulman

Absolutely. So we think that storage is a big opportunity for us. It’s a green field for us. We believe that fibre channel is going away and will be replaced with InfiniBand or Ethernet protocols. If you look at the trendsetters today, high performance computing, web 2.0, cloud, none of them using fibre channel in their new installations.

So we believe today InfiniBand is a better fabric for storage and that’s why we have multiple design wins in that market, EMC, IBM XIV, Oracle ZFS, Teradata and some others. With a huge growth in data creation and dedication, there is a need for high capacity mobile storage systems.

And we’ve seen that major storage vendors respond -- first capacity deploy the more need to be more efficient on the multisystem level and data center level. Also Flash becoming a norm and the Flash memory can drive extreme amount of data. That puts bottleneck on the I/O on the interconnect. That’s why we’re seeing that InfiniBand or high performance interconnect has become very strategic in those applications. And InfiniBand has good value to offer -- to solve those bottlenecks.

Andrew Nowinski - Piper Jaffray

Sure. I think there is no doubt that InfiniBand is more cost effective and certainly performance of InfiniBand over fibre channel was especially 56 fix speed versus 16 gig, that probably now is obviously a huge benefit but there is still -- just yesterday we had a number of other adapter vendors here that we’re talking about developing 32 gig and beyond on the fibre channel side.

And despite the overrun or sort of the consensus view that fibre channel market, it may not go over night but certainly going away. We’re still developing on that and trying to improve performance. And the reason being is that they’re seeing that it’s just more cost effective and more reliable solution.

I guess -- then the alternative will be Ethernet, perhaps not -- certainly not compared to InfiniBand being more reliable. But I guess what is your view in terms of -- why would some of these vendors continue to cling to a market that’s in secular decline and develop another technology on the fibre channel side that won’t even come close to the performance of InfiniBand?

Jacob Shulman

So the storage market is a very slow market. And it takes a lot of time to get a design win in that market because if you lose a bit of bid on HPC side to just save over the computer. If you lose a bit of bid on storage side, you will lose it forever. That’s why it takes so long to the sell cycles or qualification cycles. And those markets are very, very long but then it becomes very sticky proposition, right because it’s very hard to deploy.

And we’ve seen that InfiniBand offers a lot of -- InfiniBand features such as loss of fabric and other -- they basically provide great value for fibre channel. We don’t say that fibre channel will go away over night.

Andrew Nowinski - Piper Jaffray

Okay.

Jacob Shulman

But again if you look at the trendsetter, web 2.0, cloud, none of them today use fibre channel in the new installation. They were used to buy fibre channel for their previous installation just to support, maintain but none of the new data centers are built with fibre channel.

And we not also on the InfiniBand side, we are not kind of extending field. We’re developing our next generation which is 100 giga in event that we expect to introduce in 2014. So if you would compare 100 gig to 32 gigabit per second for fibre channel, still InfiniBand is a better proposition.

Andrew Nowinski - Piper Jaffray

That was essentially my next question. So do you think that just a lag in the roadmap to our next generation protocol which is something that fibre channel is lacking. So it can get -- they are only going to 32 perhaps 64 next but there is no roadmap to 100. And so that’s something that storage OEMs are really looking beyond just the next two years are pulling a roadmap of at least 200 gig. Is that why you’ll are going with InfiniBand?

Jacob Shulman

Yeah. The data growing exponentially, right. Over the New Year’s eve, more than year-end features of product on Facebook, right. So there is always need for more and more storage capacity and more powerful interconnect. And obviously InfiniBand offers that roadmap regarding to the 100 gig next year and then beyond that. We did not see that on fibre channel.

Andrew Nowinski - Piper Jaffray

Okay. One of your bigger stars of OEM, the EMC in our last Analyst Day back in the fall had call out, we had number of programs in place with them. Anything changes, are we still going down the InfiniBand path with those programs?

Jacob Shulman

Yeah. So EMC, you are absolutely right. EMC presented at our Analyst Day that was held in last October. They said that we’ll have half a dozen programs together. Some of them went in production like Isilon, like Greenplum. Some of them expected to go into production latter part of 2013. It’s all -- overall, we believe that storage will have a meaningful impact for us in 2014 timeframe. When all of this design wins that we had and went into production just recently will become more meaningful in 2014.

Andrew Nowinski - Piper Jaffray

2014

Jacob Shulman

Yeah.

Andrew Nowinski - Piper Jaffray

Okay. Got you. We’re running out time here but I have one more question then we can certainly open it up to the audience for some more question. I just wanted to touch base on the -- I think last quarter you announced the formation of the federal system segment at Mellanox. And it’s -- I think that was due to a significant amount of activity from the federal sector? You have a sequestration impact at its pending plans, are any of your customers in that space?

Jacob Shulman

No. Probably haven’t seen any program delays or budget reduction strategies during sequestration?

Andrew Nowinski - Piper Jaffray

Okay. Great. And then are any of the large customer perhaps cutting any sort of spending in that federal sector. But I mean that’s the reason why we essentially created the segment in the first place?

Jacob Shulman

No. So farther, it was still no meaningful interconnect.

Andrew Nowinski - Piper Jaffray

Okay. Is there any question from the audience we have to take them as well?

Unidentified Analyst

Do you have any thoughts on Intel’s True Scale important solutions?

Andrew Nowinski - Piper Jaffray

The question for webcast is any thoughts on Intel’s True Scale?

Jacob Shulman

So Intel True Scale solution is not a new solution. This is a technology that’s been around two to three years that QLogic’s technology. What they’re doing is basically, they using to adopter cards to drive high bandwidth. However that solution is based on PCI Gen2.

Therefore -- although it says or Intel claims it’s 80 gigabit per second thorough the limit of the 56 gigabits per second. Basically -- having this solution basically defies the entire proposition of InfiniBand. InfiniBand provides a better ROI to be able to save in CapEx and OpEx having double cards -- double cables. Basically you increase your CapEx and that requires even more power. So your OpEx increases. We don’t think it’s a very competitive solution for us.

Andrew Nowinski - Piper Jaffray

Any one is out there. All right. Thank you very much Jacob for making the conference. I hope you have a great rest of the day, scheduled for investors. I know it’s a packed schedule so. Thank you very much.

Jacob Shulman

Thank you very much. Thanks.

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