Mellanox Technologies Management Discusses Q1 2013 Results - Earnings Call Transcript

Apr.24.13 | About: Mellanox Technologies, (MLNX)

Mellanox Technologies (NASDAQ:MLNX)

Q1 2013 Earnings Call

April 24, 2013 5:00 pm ET

Executives

Gwyn Lauber

Eyal Waldman - Co-Founder, Executive Chairman, Chief Executive Officer and President

Yakov Shulman - Chief Financial Officer, Principal Accounting Officer and Corporate Controller

Analysts

Joseph Wolf - Barclays Capital, Research Division

Alex Gauna - JMP Securities LLC, Research Division

Daniel F. Garofalo - Piper Jaffray Companies, Research Division

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

John Roy - UBS Investment Bank, Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Harlan Sur - JP Morgan Chase & Co, Research Division

Srinivas Nandury

Operator

Good afternoon, and welcome to the Mellanox Technologies First Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. And now I'd like to turn the conference over to Gwyn Lauber, who will introduce today's speakers. Please go ahead.

Gwyn Lauber

Good afternoon, and welcome to Mellanox Technologies' First Quarter 2013 Conference Call. Leading the call today will be Eyal Waldman, Chairman, President and CEO of Mellanox Technologies; and Yakov Shulman, Chief Financial Officer.

By now, you've seen our press release and associated financial information that we furnished to the SEC on Form 8-K this afternoon. If not, you may access them on our website at ir.mellanox.com. As a reminder, today's discussion will include forward-looking statements including predictions, expectations, estimates or other information that might be considered forward-looking. Throughout today's discussion, we will present some important factors relating to our business which may potentially affect these forward-looking statements.

These forward-looking statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements made today. As a result, we caution you against placing undue reliance on these forward-looking statements and encourage you to review our most recent reports including our 10-K and 10-Q and any applicable amendments for a complete discussion of these factors and other risks that may affect our future results or the market price of our stock.

And finally, we're not obligating ourselves to revise our results or publicly release any revisions of these forward-looking statements in light of new information or future events.

Finally, as a reminder to our shareholders, we will hold our Annual General Meeting on May 13. Proxy information can be found on ir.mellanox.com.

Now I will turn the call over to Eyal for opening remarks. Eyal?

Eyal Waldman

Thank you, Gwyn. Good afternoon, everyone, and thank you for joining us. On today's call, I will highlight our first quarter 2013 results and achievements. I will then turn the call over to Yakov Shulman, our Chief Financial Officer, who will discuss the financial results in more detail and provide our fiscal second quarter guidance. After that, we will take your questions.

For the first quarter 2013, Mellanox reported revenue of $83.1 million compared to $122 million in the fourth quarter of 2012 and $88.7 million in the first quarter of 2012. First quarter non-GAAP gross margins were 68.1%. Non-GAAP operating income was $4.9 million, or 5.8% percent of revenue, and non-GAAP diluted earnings per share were $0.10. Total cash and investments decreased $23.4 million to $402.9 million at March 31, 2013, compared to $426.3 million at the end of December 31, 2012.

In the first quarter, our FDR 56 gigabit per second InfiniBand revenue share increased from 39% to 50%, demonstrating the continued demand for our highest performance InfiniBand products. Our 10 and 40 gigabit Ethernet products contributed 9% of revenues.

Mellanox continues to be the only provider of end-to-end 40 gigabit Ethernet interconnect solution and was selected by HP for their 40 gigabit per second Ethernet blade switches.

We expect that our future growth will be driven by the increased adoption of FDR InfiniBand as well as our 10, 40 and 56 gigabit Ethernet products.

Data is growing exponentially, and the ability to move and analyze information faster is becoming a critical business and security advantage. This is why companies like IBM, Oracle, Teradata, Microsoft and more have built and are building their database and data warehousing solutions based on Mellanox interconnects.

In the first quarter, we've continued to expand our data warehousing presence with new product launches by Microsoft and Teradata. The new Microsoft SQL Server 2012 Parallel Data Warehouse appliance utilizes our FDR 56 gigabit per second InfiniBand adopters and switches for both server and storage connectivity to enable higher performance and scalability while reducing customers' CapEx and OpEx.

As an example, Hy-Vee, a supermarket chain in 8 states in the U.S., is leveraging the Microsoft Parallel Data Warehousing appliance to reduce data analysis curing time from 20 minutes to 20 seconds, allowing them to react to trends before the business day starts. Also in the quarter, Teradata chose Mellanox InfiniBand interconnect for its enterprise data warehouse platform. With Mellanox end-to-end InfiniBand, Teradata's appliance delivers up to 20x faster communication, enabling the processing of large amounts of data and the delivery of results in record time. With these design wins and more, most of the major data warehousing solutions providers use Mellanox as their compute and storage interconnect.

Our penetration in storage applications has continued as companies require faster and more efficient ways to store and access data. To take advantage of the performance benefits of solid-state disks, companies turn to Mellanox for our low-latency and high-throughput interconnects. This quarter, NetApp announced new block storage and flash array products that leverage our interconnects. In addition, DataDirect Networks released a scalable storage platform based on Mellanox for cloud and Big Data applications. This is in addition to EMC, IBM, Oracle, Xyratex, Microsoft, Teradata and more that already are using our interconnect for their storage solutions.

To meet the growing demand for cloud computing services, providers must increase their efficiency and scale their infrastructure. To solve the challenge, Mellanox recently introduced ConnectX-3 Pro interconnect adapter, which accelerates virtualized cloud networks. ConnectX-3 Pro highlights our innovation and leadership position in the growing cloud market.

For scaling cloud infrastructures and data centers, we extended our MetroX long-haul product line by introducing MetroDX. The MetroX and new MetroDX products enables fast InfiniBand and Ethernet connectivity within data center buildings and data centers across a metro area to form large-scale clouds.

Highlighting our continued leadership in financial services, we announced that NASDAQ OMX London-based interest rate derivatives platform adopted InfiniBand as its core trading interconnect technology. The new platform utilizes our InfiniBand solution to enable fast, reliable trading in this highly competitive market. We expect more large financial entities to adopt our Ethernet and InfiniBand technologies into their data centers.

In the era of cloud computing and Web 2.0 applications, IT managers must control their data center network in order to achieve higher levels of utilization and scalability. The move away from closed platforms towards open source software represents a disruption to the Ethernet switch market. Our open Ethernet initiative allows network managers to use their code or any commercial or open source software on top of the Mellanox Ethernet Switches. By creating the industry's first open platform, Mellanox offers a differentiated solutions in the competitive Ethernet switch market. We're seeing that the same low latency, scalable architecture that is used for supercomputing is also being adopted in cloud, Web 2.0, database, Big Data and storage markets. Thus, we expect to experience growth of our interconnect solutions in these new growing markets.

Now I will turn the call over to Yakov for our review of our first quarter 2013 financial results and our expectations for the second quarter 2013. Yakov?

Yakov Shulman

Thank you, Eyal. Good afternoon, everyone. Let me now review some more financial details relative to our first quarter 2013. Total revenues in the first quarter were $83.1 million, down approximately 32% from $122.1 million in the fourth quarter of 2012 and down approximately 6.4% from $88.7 million in the first quarter of 2012. Our non-GAAP gross margins in the first quarter were 68.1%, down from 70% in the fourth and first quarters of 2012. Major reconciling items from GAAP to non-GAAP gross profit are share-based compensation expenses of $465,000 and amortization of acquired intangibles of $2 million.

The following are a few selected Q1 2013 revenue metrics for you. Combined revenues from our IC and board products represented 42% of the first quarter revenues. Switch systems revenues accounted for 43%. Revenues from our 56 gigabit per second InfiniBand-based products represented 50% of revenues in Q1 2013, up from 39% of revenues in Q4 2012. Revenues from our 40 gigabit per second InfiniBand-based products represented 30% of revenues in Q1 2013, down from 37% of revenues in Q4 2012. 20 gigabit per second InfiniBand-based products represented 4% of revenues in the first quarter compared to 7% of revenues in the fourth quarter of 2012. Ethernet related revenues represented 9% of the first quarter revenues compared to 11% of revenues in the fourth quarter of 2012.

We had 2 more-than-10% customers in the first quarter that combined represented 35% of revenues. They were IBM with 19% and HP with 16%.

First quarter non-GAAP operating expenses increased by $2.4 million sequentially to $51.7 million and represented 62.2% of revenues compared with $49.3 million or 40.4% of revenues in the fourth quarter of 2012. Major reconciling items from GAAP to non-GAAP operating expenses are stock-based compensation of $9.9 million and amortization of acquired intangibles of $439,000.

Moving down now with income statements. Our non-GAAP research and development expenses were $32.3 million in Q1 2013 compared to $30.3 million in Q4 2012, representing a sequential increase of 6.6%. The increase was primarily due to higher tape-out costs, depreciation and amortization costs and facilities and maintenance expenses. Non-GAAP R&D expenses for Q1 2013 represented approximately 38.9% of revenues, up from 24.8% of revenues in Q4 2012. Non-GAAP sales and marketing expenses were $13.9 million in Q1 2013 compared to $13.7 million in Q4 2012, representing a sequential increase of 1.2%. The increase was primarily due to higher employee-related expenses, partially offset by a decrease in trade shows and promotions-related expenses and lower travel expenses.

Non-GAAP sales and marketing expenses for Q1 2013 represented 16.7% of revenues, up from 11.2% of revenues in Q4 2012. Non-GAAP general and administrative expenses were $5.5 million in Q1 2013 compared to $5.3 million in Q4 2012, representing a sequential increase of 4.5%. The increase was primarily due to higher facilities and maintenance expenses, partially offset by a decrease in professional services expenses.

Non-GAAP G&A expenses for Q1 2013 represented 6.6% of revenues, up from 4.3% of revenues in Q4 2012. Non-GAAP operating income was $4.9 million in Q1 2013 and represented 5.8% of revenues compared to $36.2 million or 29.6% of revenues in Q4 2012. Other income of $213,000 in Q1 2013 compared to Other income of $269,000 in the fourth quarter of 2012.

Non-GAAP income before taxes was $5.1 million or 6.1% of revenues in Q1 2013 compared to income before taxes of $36.4 million or 29.8% of revenues in Q4 2012.

The first quarter tax expense of $754,000 compares to $5.7 million tax expense in the fourth quarter of 2012. The tax rate in the first quarter remains essentially unchanged from the prior quarter.

Our Q1 2013 non-GAAP net income was $4.3 million or $0.10 per diluted share and included adjustments of $10.4 million for share-based compensation and amortization of acquired intangible assets of $2.4 million. This compares to Q4 2012 non-GAAP net income of $30.7 million or $0.69 per diluted share, which included adjustments of $10 million for share-based compensation and amortization of acquired intangible assets of $2.3 million.

Q1 2012 non-GAAP net income was $22 million or $0.51 per diluted share. Our GAAP diluted share count for Q1 2013 was 42.9 million shares compared to 44.6 million shares in Q4 2012. Our non-GAAP diluted share count used in computing income per share for the first quarter was 44.8 million shares compared to 44.3 million shares for the fourth quarter of 2012.

Moving onto the cash flow statement. Cash used in operating activities during the first quarter 2013 was $6.6 million compared to $25.4 million of cash provided by net operating activities in the fourth quarter of 2012.

Net cash provided by investment activities during the first quarter was $9.5 million and consisted of net sales and maturities of short-term investments of $32.9 million, partially offset by purchases of property and equipment and leasehold improvements of $13.9 million, purchases of intangible assets of $6.3 million and an equity investment of $3 million in a private company.

Net cash provided by financing activities during the first quarter was $6.3 million and consisted primarily of cash proceeds from option exercises of $5.7 million and exercise benefits from option exercises of $932,000, partially offset by capital lease payments of $279,000.

Turning to the balance sheet. Our cash and investments at the end of the quarter were $402.9 million compared to $426.3 million at December 31, 2012. During the quarter, our accounts receivable increased $629,000 to $59.1 million. Our days sales outstanding increased to 64 days compared to 42 days in the prior quarter. Approximately 99% of our outstanding accounts receivable amounts are current or less than 30 days overdue.

First quarter ending inventory increased $2.4 million to $45.7 million compared to $43.3 million in Q4 2012. Our inventory turns were at 2.6x during the first quarter compared to 4x in the fourth quarter of 2012. Net intangible assets and goodwill were $20 million and $132.9 million, respectively, at the end of the quarter.

Total liabilities were $128.3 million at quarter end, of which $92.4 million were current and $35.9 million were long-term.

We currently expect the Q2 2013 non-GAAP Mellanox results to be as follows: quarterly revenues of $92.5 million to $97.5 million; Q2 2013 gross margins of 68% to 69%, reflecting our latest forecasted product mix. We expect a sequential increase in non-GAAP operating expenses of 10% to 11%. We expect to incur tape-out costs in the second quarter of 2013. We estimate our Q2 2013 stock compensation expense to be between $11.3 million to $11.8 million. Non-GAAP diluted share count guidance for Q2 2013 is $44.9 million -- sorry, 44.9 million shares to 45.4 million shares.

I will turn it back to Eyal now for a few closing comments.

Eyal Waldman

Thank you, Yakov. The start of the year has been challenging across the industry as well as a whole and for Mellanox as well. We expect to see quarter-over-quarter growth from where we are today, as implied in our guidance for revenue growth of 14% from Q1 to Q2. We continue to focus and execute on our 100 gigabit per second InfiniBand and Ethernet solutions and we plan to bring to market in the 2014 and 2015 timeframe.

The fundamentals of our business haven't changed, and we see demand for our solutions in our core markets such as High Performance Computing, Web 2.0, cloud, storage, enterprise data center and financial services. We remain a leader and an innovator in a large market that is estimated to be approximately $6 billion. We are a generation ahead of the competition in InfiniBand and in Ethernet mix, and we believe we have taken and will continue to take share in compute, storage and embedded interconnect markets due to our cutting-edge technology and our strength in developing superior hardware.

Lindy, we will now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Joseph Wolf with Barclays.

Joseph Wolf - Barclays Capital, Research Division

Could you spend a little bit of time talking about the status of the inventory that was built by your OEM customer at the end of last year? And how much do you think have you sold, or was sold in the first quarter, in terms of what the real demand or the actual demand for Mellanox product was? That would be my first question.

Eyal Waldman

So what we're seeing is we are seeing depletion of the inventory. It's slower than what we were hoping for, but it's also a good thing because we're seeing nice revenues from that customer. We think they depleted less than half than what they had put in inventory at the end of last year.

Joseph Wolf - Barclays Capital, Research Division

So if you look at them as -- I'm assuming some of your larger customers -- that they're still large customers in the first quarter, what does that say about the order patterns and the mix?

Eyal Waldman

It says that even though they have a large inventory in place, they continue to order new products from Mellanox, probably because it's for other customers and other configurations that they need different material. And we expect this also to continue in Q2 and so on. So we continue to expect them to slowly deplete their inventory and at the same time continue their purchases from Mellanox.

Joseph Wolf - Barclays Capital, Research Division

Okay. And then just by end market, if we look at the mix of the 56 gig and the Ethernet mix in the quarter, could you talk a little bit about the cloud versus HPC? Is HPC stronger than expected and cloud a little bit off seasonally? Or is that just looking too much into the mix?

Eyal Waldman

It's harder for us to know, but again, HPC is our largest market. We still believe that more than 50% of our revenue is coming from HPC. But the cloud and Web 2.0 is growing in a nice way.

Joseph Wolf - Barclays Capital, Research Division

So from looking at that 56, can you tell the kind of the mix between the 2 end markets here? Or you're not doing that kind of transparency?

Eyal Waldman

No, we don't have those numbers.

Operator

Our next question comes from Alex Gauna with JMP Securities.

Alex Gauna - JMP Securities LLC, Research Division

I was wondering, Eyal, if you could give us a little bit more color around the moving pieces of the up sequential guidance. It sounds like we're halfway through the HP recovery, so it's not so much about inventory. Are you starting to see some of your Web 2.0 come through? Is that bolstering the outlook? Are there any key products ramping?

Eyal Waldman

We expect to grow, like we said, 14% from Q1 to Q2. I can tell you that today, our numbers are showing continuous growth quarter-over-quarter through the year, so we expect those to continue growing. The main growth is coming actually from Web 2.0, cloud, storage, database and so on.

Alex Gauna - JMP Securities LLC, Research Division

And you had talked about in the past about a couple of big deals. In the pipeline there are a few big deals. Are some of those starting to turning on, or is that still maybe further out in the back half of the year?

Eyal Waldman

Yes. So actually in Q2, we don't see any significant large deal. We do expect to start seeing -- I wouldn't call them large, but larger than what we're seeing in Q2 -- deals start appearing in Q3 and then larger deals in Q4.

Alex Gauna - JMP Securities LLC, Research Division

And is it fair to say because you're not all the way through the HP inventory burn that there's some benefit potentially from that as we look beyond June and into the December quarter? Is that your basic expectation right now?

Eyal Waldman

Yes, we hope that as that customer depletes more of their inventory, we'll see higher growth in our revenue moving forward in the year.

Operator

Your next question comes from Andrew Nowinski with Piper Jaffray.

Daniel F. Garofalo - Piper Jaffray Companies, Research Division

It's Dan Garofalo on for Andy. Just a related follow-up to the inventory issue with the OEM partner. How confident are you guys that the procedures are now in place to prevent kind of a similar unexpected channel inventory build in the future?

Eyal Waldman

This is not under our full control. What we do have now is regular updates from several of our large customers in terms of their inventory status, and the only thing we can say and we can point out. But basically, it's their responsibility. Because of this procedure of getting regular updates, we feel more comfortable that we may be able to prevent it, but this is not 100% under our control.

Daniel F. Garofalo - Piper Jaffray Companies, Research Division

Got it. Okay. And then just one follow-up from me. I think you mention -- you touched on tape-outs in your prepared comments. It sounds like you did one in Q1, and you're perhaps planning another one for Q2. I'm just wondering, for 2013, have you firmed up whether you'll do just the 2 or are you planning on doing more than 2 during 2013?

Eyal Waldman

Well, the tape-out in Q2 is a test chip for the 100 gigabit per second, and so is the 20 nanometer test. It's not a full tape-out, and the cost is not a full tape-out expense. I think, as we said, we expect to have 2 full tape-outs. I don't count this test chip as a tape-out, but we expect to have 2 full tape-outs in 2013.

Operator

And your next question comes from Kevin Cassidy with Stifel.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

On the technical problem that you had in the fourth order, how much of that got shipped into the first quarter that was FDR?

Eyal Waldman

We don't really have a number to give you, but again, the cable problem we had is behind us since the second half of Q4. And obviously, you've seen the increase. We were 57%, I think, in Q3. We went down to 39% of FDR in Q4. And now we climbed back to 50%, which is great evidence that this problem is behind us.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Okay, great. And the switch revenue was a higher percentage than normal. Is that just more of the inventory and you expect that to go back to the, let's say, 20% or 30% range?

Eyal Waldman

Well, it sounds like this inventory in some places is also a mix. I think some of the storage companies are starting to kick in, and there we may see a higher percentage in switches, so it's a combination.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And just one last question. When we were talking about tape-outs, it seemed the OpEx came in a little lower than guidance. Was there any tape-out that was expected in the first quarter that flipped out in the second quarter?

Eyal Waldman

No, no. We did do a tape-out in Q1. We had just announced ConnectX-3 Pro last week. That's the tape-out we did in Q1.

Kevin E. Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Okay. So the lower OpEx was just travel and cutting back on growth?

Eyal Waldman

It was trying to manage our expenses. We didn't see -- the top line went down. We're trying to manage our expenses as responsibly as we can.

Operator

Our next question comes from Rajesh Ghai with Craig-Hallum.

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

I wanted to understand this ConnectX-3 product you just launched. What is the ramp in terms of revenue that you're expecting? Obviously, that's a key product for the cloud market, and the cloud appears to be a market that's probably going to be key in terms of growing in the future. What kind of a ramp are you expecting over the next few quarters?

Eyal Waldman

First, I think we're going to see a transition. I think the majority of our customers will continue to use ConnectX-3, only several that have specific features like channeling and so on, and ConnectX-3 Pro will start utilizing it this year, probably mid this year. And I think it will ramp pretty fast. And we don't give forward expectations, but with some of those customers, we hope to have a nice ramp in growth.

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

Great. And turning to gross margin. It is down 200 basis points. I don't know if you discussed this already. But it seems -- FDR was up to 50% of in the mix. I don't know that switch revenue was up a little bit. Was there anything else other than the mix that was playing a part in terms of bringing the gross margin down sequentially?

Yakov Shulman

Rajesh, this is Yakov. So first of all, as you know, we garnished higher margins on ICs and boards, and combined, our revenues from ICs and boards represented 42% of the Q1 revenues compared to approximately 50% of revenues in Q4. So that played a major factor in terms of gross margin impact as well --and overall, our revenues were lower and, therefore, the overhead expenses represented a higher portion of the gross margin.

Operator

And we'll take our next question from John Roy with UBS.

John Roy - UBS Investment Bank, Research Division

Eyal, on the 100 gigabits per second stuff, you were saying you had a test tape-out coming, and you indicated something about 2014, 2015. Can you give us any more color on timing? Do you expect you would have a full tape-out after the test, or another test?

Eyal Waldman

It's not final yet. We may do a third test chip, but this is to test different elements of EDR of the 100-gigabit-per-second solution. As we said, we expect to be with EDR technology out there in 2014, 2015 timeframe.

Operator

[Operator Instructions] Our next question comes from Glenn Hanus with Needham & Company.

Glenn Hanus - Needham & Company, LLC, Research Division

So just to make sure I heard it right. The remainder of the inventory for that OEM, you expect that to be depleted in Q2 or it would take longer?

Eyal Waldman

We expect it to take longer.

Glenn Hanus - Needham & Company, LLC, Research Division

Will most of it come through next quarter?

Eyal Waldman

Again, it's not under our control. But as you've seen, we still see nice revenues from our top customers.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. So just to better understand the overall demand trends, I guess I was thinking it was more like if you got all the -- the true run rate of the business was going to be like 110 and you were going to grow off of that, obviously, things are a little softer than that. Can you kind of walk through what parts of the business are rolling out a little slower perhaps than you might have thought with federal, with HPC soft, just across-the-board? Can you kind of give us some color on what you're seeing on demand trends in the market?

Eyal Waldman

Yes, what we're seeing is, like we said, there's no large deals in Q2, as we've seen last year. Also the big program that we've expected to start shipping in Q2 is kind of partially pushed out probably a quarter or half a quarter. So those things are impacting us.

Glenn Hanus - Needham & Company, LLC, Research Division

That program, is that in the HPC sector or Web 2.0 sector, or where is that?

Eyal Waldman

It's not in the HPC sector.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. Can you talk about the HPC sector a little bit? What's the tone in the federal market, the commercial market, domestic versus abroad? I know it's not supposed to be a growth here there. How's the deal flow looking there? Has it slowed some or not? Or give us some color there.

Eyal Waldman

No, no. We don't think it slowed. We think people are executing according to their plans, and we expect to see HPC -- I mean we don't have surprises with our HPC customers. They’re executing to what they're planning.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. Is some of the -- when it grows again, would that be tied somewhat to the next Intel cycle with Ivy Bridge and that -- or is that not a big factor?

Eyal Waldman

Well, not this year. This year, we expect our sequential growth quarter-over-quarter to come from demand for the various applications in the markets, not from a significant refresh in the Intel architecture.

Glenn Hanus - Needham & Company, LLC, Research Division

And one clarification. What's your expectation now on tax rate for the year?

Yakov Shulman

Glenn, this is Yakov. We still expect a mid to high single-digit tax rate for the full year.

Operator

Our next question comes from Harlan Sur with JPMorgan.

Harlan Sur - JP Morgan Chase & Co, Research Division

Obviously, I think we all know that the macro environment continues to remain weak. However, as you said, Eyal, offsetting this is your customers' need to deal with the complexities and demand associated with data and bandwidth. And so as you think about your pipeline of engagements, and I'm not talking about backlog, I'm not talking about forecast, but just your pipeline of engagements, let's say looking out over the next 12 months, has that pipeline of engagements continued to expand? And if so, where are you seeing more of the new engagements? Is it HPC, is it web 2.0, is it cloud, is it storage, is it all of the above? Any color there would be great.

Eyal Waldman

Yes, so we're actually seeing a nice expansion in our penetration in our pipeline moving forward. And again, as we've demonstrated, the Microsoft parallel data warehousing is the new appliance. Teradata is the new design win. We expect to continue to see more penetration of Mellanox and taking more market share in Web 2.0, in cloud, and when I say this is both InfiniBand and Ethernet, we expect to see more Ethernet switch design wins. We expect to grow in the storage market in a significant way in 2014. And you know, our Big Data, we're actually starting to see more financial service market opportunities. So yes, looking forward, we expect to take more market share, penetrate more applications, more customers in the next 2 years.

Harlan Sur - JP Morgan Chase & Co, Research Division

Okay, great. And then on the remaining inventory that your customer has left to burn, is this inventory tied directly to any customers that have just pushed out some of their programs? Or is this an inventory that has yet to be tied to a particular customer or program? And the reason why I asked this is that obviously, we've heard recently many OEMs, some of them who are your customers, have talked about deal push-outs and/or program push-outs. And so it would certainly give me a lot more confidence about the work-down of these inventories if they are in fact tied to specific customers. But maybe you can give us a bit more color on that.

Eyal Waldman

I think that's a specific inventory. The majority of that, not all of it, was tied to a specific customer. And I think now they're using it for various customers, not with a specific customer. But, yes, when they purchased it, it was tied for a specific customer.

Harlan Sur - JP Morgan Chase & Co, Research Division

Okay. And then my final question, obviously, you rolled out your open-platform Ethernet switching products, I know you mentioned it in your opening remarks. I think you started rolling out your SDK to these customers to develop their own custom applications, which obviously afforded them a bit more flexibility. When do you expect to actually start shipping these switching platforms in meaningful volumes?

Eyal Waldman

We are shipping them today, and we actually expect to even double our revenues from Ethernet switches from Q1 to Q2, even more than double, yes.

Operator

And our next question comes from Srini Nandury with Summit Research.

Srinivas Nandury

I have a question on the storage side of the business. And can you tell us how much storage contributed to revenues this quarter?

Eyal Waldman

I don't think we specified that number.

Srinivas Nandury

You don't? Okay. Going back, you said that storage is going to actually contribute a bigger portion of revenue over the years, right? I mean, do you have any preference that it’s Ethernet or InfiniBand? Are you guys agnostic where the revenue is coming from?

Eyal Waldman

We don't really care whether it's Ethernet or InfiniBand as long as we see the revenues. But I can tell you that the majority of our storage revenue is coming from InfiniBand.

Srinivas Nandury

Okay. And as we see the lower revenue volumes for the year, I mean, last quarter or a quarter before that, you talked about you're not finding enough people in R&D to hire. And now with the lower volume of revenue, how do you see the R&D hiring play out for the rest of the year?

Eyal Waldman

We're going to continue to grow. I mean, we invest, and we have a lot of things that we need to do, but at the same time, we're definitely watching very closely our bottom line, our profit and also our cash flow. So there's always this kind of friction between the growth required to kind of invest in our future product and at that the same time maintain bottom line growth. So we're contemplating on a nearly monthly basis within the company about those 2 things. But we will continue to grow in terms of R&D and also sales and marketing.

Srinivas Nandury

One final question for me. Generally, your HPC or Web 2.0 load pipelines, how much visibility do you have? I mean, which has the lowest visibility, which has the highest visibility and how do you rate it, I mean?

Eyal Waldman

We don't have good visibility at all. We have much better visibility on the storage product and the appliances because they build and it's a long lead time. We have some better visibilities with the Web 2.0 and the cloud guys. HPC, we have good, soft visibility, so we know what's going on. But then, the orders come in usually at the last minute. Financials, we have some better visibility. But again, it changes on a quarterly basis. I wouldn't say we have any good visibility today.

Operator

And we have no further questions at this time. I'd like to turn the call back over to Eyal Waldman for closing remarks.

Eyal Waldman

Thank you very much, and we look forward to seeing you at our investors events during the quarter. Thank you for interest in Mellanox.

Operator

This concludes today's conference call. Please disconnect your lines at this time, and have a good day.

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