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Mellanox Technologies (NASDAQ:MLNX)

Q3 2013 Earnings Call

October 23, 2013 5:00 pm ET

Executives

Gwyn Lauber

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

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

Analysts

John Roy - UBS Investment Bank, Research Division

Daniel F. Garofalo - Piper Jaffray Companies, Research Division

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

Joseph Wolf - Barclays Capital, Research Division

Ryan Carver - Crédit Suisse AG, Research Division

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

Alex Gauna - JMP Securities LLC, Research Division

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

William H. Choi - Janney Montgomery Scott LLC, Research Division

Saqib Jalil - JP Morgan Chase & Co, Research Division

Srinivas Nandury

Operator

Good afternoon, and welcome to the Mellanox Technologies Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. And now I would 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 Third Quarter 2013 Conference Call. Leading the call today will be Eyal Waldman, President and CEO of Mellanox Technologies; and Jacob 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 includes predictions, expectations, estimates and other information, all of which we consider to be forward-looking statements. Throughout today's discussion, we will present important factors relating to our business that may potentially affect these forward-looking statements. These forward-looking statements are 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 we encourage you to review our most recent SEC reports including our 10-K and 10-Q for a complete discussion of these factors and other risks that may affect our future results or the market price of our ordinary shares.

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

Now I will turn the call over to Eyal for his 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 third quarter 2013 results and achievements. I will then turn the call over to Jacob Shulman, our Chief Financial Officer, who will discuss our third quarter financial results in more detail and provide our fourth quarter guidance. After that, we will take your questions.

For the third quarter of 2013, Mellanox reported revenue of $104.1 million compared to $98.2 million in the second quarter of 2013 and $156.5 million in the third quarter of 2012.

Third quarter 2013 non-GAAP gross margins were 69%, non-GAAP operating income were $13.7 million or 13.1% of revenues, and non-GAAP diluted earnings per share were $0.29 for the fiscal third quarter of 2013.

Total cash and investments were $306.4 million at September 30, 2013, compared to $411.3 million at June 30, 2013. During the quarter, we paid $123.5 million for the acquisitions of Kotura and IPtronics, and we have generated $16.4 million in cash from operating activities.

In the third quarter, our FDR 56Gb/s InfiniBand revenue contribution was 48% of total revenue compared to 52% in the second quarter of 2013. Our Ethernet products contributed 15% of revenue. Our 40-gigabit Ethernet revenue grew 31% sequentially.

The amount of data created and consumed by businesses and consumers continues to grow at a remarkable pace and yet, only a fraction of the data is available -- is used. Businesses are challenged in their attempt to utilize data efficiently and to provide consumers with access to data. Our interconnect products enable our customers to keep up with data growth and gives them a competitive advantage and better return on investment.

Unmatched bandwidth and extremely low latency remains key to their success and have proven to be competitive differentiators for our customers in cloud, Web 2.0, storage, database and financial services market. For example, PayPal utilizes Mellanox's InfiniBand solutions to help them detect fraud within their 13 million financial transactions per day. We continue to be a technology leader in providing high bandwidth, low latency solutions to these markets. Many of whom look to Mellanox as the high-performance computing leader for world-class data center architectures.

Our Ethernet Virtual Modular Switch solution continued to gain traction. In the third quarter, we won a deal with a leading European Web 2.0 company to provide them with our end-to-end Ethernet solutions to run their search engine and network infrastructure. As we continue to offer our customers the flexible high bandwidth and low latency solutions that they require, we expect this part of our business to become more meaningful.

Web 2.0 remain a strong market for us, and we had several new design wins during the quarter. As we discussed, we ship hundreds of thousands of devices to these customers each quarter. We believe that this market is helping build a steady base on which we can continue to grow.

We announced during the quarter that VMware integrated our 40Gb/s drivers into vSphere 5.5, enabling a new price performance record for virtualized data centers. By using Mellanox's end-to-end 40Gb/s Ethernet interconnect solution over VMware vSphere 5.5, IT managers can accelerate business applications and reduce their infrastructure cost and power. They are able to meet the growing demand of mobile cloud users and run more applications over smaller footprints. These abilities are now critical goals for cloud providers if they want to stay competitive in their industry.

We recently announced our collaboration with Microsoft in their Windows Server 2012 R2, release 2, SMB Direct offering. By running Windows Server 2012 R2, SMB Direct over Mellanox's end-to-end FDR 56Gb/s InfiniBand solution, users experienced 2x faster access to file storage and 10x greater virtual machine migration acceleration. We expect Microsoft support of our InfiniBand technology to translate to additional sales revenue in the coming quarters. In fact, U.K. risk management firm, Pensions First, recently announced that their private cloud architecture is based on Microsoft Windows Server 2012 R2 and uses Mellanox's RDMA-based InfiniBand and Ethernet interconnect to provide a high performance and cost-effective solution that scales easily. They chose Mellanox because of the performance and flexibility that RDMA gives them.

As a provider of end-to-end data center interconnect solutions, we continue to expand our portfolio and broaden the reach of high-speed connectivity and to increase the return on investment of our customers. We announced a general availability of our MetroX solution that extends InfiniBand and Ethernet RDMA connectivity from the data center to metro and wide access network. MetroX allows for rapid disaster recovery and improved utilization of remote storage and compute infrastructures across distances of up to 80 kilometers and multiple geographic sites.

On a competitive front, companies continue to try to catch up with us, but no one competitor has been able to match our high-bandwidth, low-latency, high-return-on-investment efficient solutions. We believe we remain ahead of the competition in our technology leadership and that we are continuing to take share with our InfiniBand and Ethernet offerings. While our competitors are moving to 10 and 40Gb/s today, we've had 40 and 56Gb/s since 2008 and 2011, respectively.

Now I will turn the call over to Jacob for a review of our third quarter 2013 financial results and our expectations for the fourth quarter 2013. Jacob?

Yakov Shulman

Thank you, Eyal. Good afternoon, everyone. Let me now review some more financial details relative to our third quarter of 2013. Please note that our financial results for the third quarter of 2013 include the impact of IPtronics for the full quarter and Kotura for half of the quarter.

Total revenues in the third quarter were $104.1 million, up approximately 6% from $98.2 million in the second quarter of 2013 and down approximately 33.5% from $156.5 million in the third quarter of 2012. To remind you, our third quarter 2012 revenues included approximately $25 million of pent-up demand associated with Romley repair cycle.

Our non-GAAP gross margins in the third quarter was 69%, down from 69.4% in the second quarter and 70.5% in the third quarter of 2012. Major reconciling items from GAAP to non-GAAP gross profit are share-based compensation expenses of $461,000, the amortization of acquired intangibles of $3.6 million and $699,000 of acquisition-related charges.

The following are a few selected Q3 2013 revenue metrics for you. Combined, revenues from our IC and board products represented 45% of third quarter revenues. Switch system's revenues accounted for 35%. Revenues from our 56Gb/s InfiniBand-based product remains essentially unchanged in absolute dollars and represented 48% of revenues in Q3 2013, compared to 52% in Q2 2013. Revenues from our 40Gb/s InfiniBand-based products represented 18% of revenues in Q3, down from 25% of revenues in Q2.

20Gb/s InfiniBand-based products represented 7% of revenues in Q3 2013, compared to 5% of revenues in Q2 2013. Ethernet-related revenues represented 15% of the third quarter revenue compared to 14% of the revenue in the second quarter. We got to more than 10% customers in the third quarter, that combined, represented 29% of revenues. They were IBM with 17% and HP with 12%.

Third quarter non-GAAP operating expenses increased by $5.8 million sequentially to $58.1 million and represented 55.8% of revenues compared with $52.3 million or 53.3% of revenues in the second quarter of 2013.

Major reconciling items from GAAP to non-GAAP operating expenses are stock-based compensation of $11.5 million, expenses related to the acquisitions of Kotura and IPtronics of $1.3 million and amortization of acquired intangibles of $1 million.

Moving down our income statement. Our non-GAAP research and development expenses in the third quarter were $36.8 million compared to $32.3 million in the second quarter of 2013, representing a sequential increase of 14.1%. The increase was primarily due to higher employee-related expenses, PayPal cost, higher facilities and maintenance expenses, and an increase in expense equipment.

Non-GAAP R&D expenses for Q3 2013 represented approximately 35.4% of revenues, up from 32.9% of revenues in the second quarter of 2013. Non-GAAP sales and marketing expenses were $14.6 million in the third quarter compared to $13.8 million in the second quarter, representing a sequential increase of 5.4%. The increase was primarily due to higher employee-related expenses, partially offset by a decrease in trade show expenses.

Non-GAAP sales and marketing expenses for Q3 2013 represented 14% of revenues, down from 14.1% of revenues in the second quarter of 2013. Non-GAAP general and administrative expenses were $6.8 million in the third quarter compared to $6.3 million in the second quarter, representing a sequential increase of 7.8%. The increase was primarily due to higher employee-related expenses.

Non-GAAP G&A expenses for the third quarter of 2013 represented 6.5% of revenues, up from 6.4% of revenues in the second quarter of 2013. Non-GAAP operating income was $13.7 million in Q3 2013 and represented 13.1% of revenues compared to $15.8 million or 16.1% of revenues in the second quarter. Other income was $483,000 in the third quarter compared to $232,000 in the second quarter.

Non-GAAP income before taxes was $14.1 million or 13.6% of revenues in Q3, compared to income before taxes of $16 million or 16.3% of revenues in Q2.

The third quarter tax expense of $1.1 million compares to $2.3 million of tax expense in the second quarter. The non-GAAP tax rate in the third quarter was 7.6% compared to 14.1% in the prior quarter.

Our Q3 2013 non-GAAP net income was $13.1 million, a $0.29 per diluted share, and included adjustments of $11.9 million for share-based compensation, amortization of acquired intangible assets of $4.6 million and acquisition-related charges of $2 million. This compares to our second quarter 2013 non-GAAP net income of $13.8 million or $0.30 per diluted share, which included adjustments of $11.2 million for share-based compensation, amortization of acquired intangible assets of $2.5 million and acquisition-related charges of $1.8 million.

Q3 2012 non-GAAP net income was $60.1 million or $1.37 per diluted share. Our GAAP diluted share count for Q3 2013 was 43.6 million shares compared to 43.3 million shares in the second quarter. Our non-GAAP diluted share count used in computing income per share for the third quarter was 45.5 million shares compared to 45.2 million shares for the second quarter of 2013.

Moving on to the cash flow statement. Cash provided by operating activities during the third quarter of 2013 was $16.4 million compared to $11.5 million of cash provided by the operating activities in the second quarter of 2013. Net cash used in investment activities during the third quarter was $112 million and consisted of purchase price paid for Kotura and IPtronics acquisitions of $123.5 million, net purchases of short-term investments of $26.1 million, and purchases of property and equipment and leasehold improvements of $5.1 million, partially offset by decreases in receipt of cash of $43.1 million.

Net cash provided by financing activities during the third quarter was $7.1 million and consisted primarily of cash proceeds from option exercises of $6.5 million and excise tax benefits from option exercises of $857,000, partially offset by capital lease payments of $265,000.

Turning to the balance sheet. Our cash and investments at the end of the quarter were $306.4 million compared to $411 million at June 30, 2013. In the third quarter, we completed our acquisitions of IPtronics and Kotura for a total net cash purchase price of approximately $123.5 million.

During the quarter, our accounts receivable increased by $6.2 million to $73.8 million. Our days sales outstanding increased to 63 days compared to 59 days in the prior quarter. Approximately 97% of our outstanding accounts receivable amounts are current or less than 30 days overdue.

Third quarter ending inventory decreased $4 million to $32.5 million compared to $36.5 million in the second quarter of 2013. Our inventory turns were at 4.3x during the third quarter compared to 3.1x in the second quarter of 2013.

Net intangible assets and goodwill were $57.9 million and $199.6 million, respectively, at the end of the quarter.

Total liabilities were $125.9 million at quarter end, of which $83.9 million were current and $42 million were long-term.

Following completion of our acquisition of Kotura, effective August 15, 2013, our Q4 2013 guidance will include Kotura results for the full quarter. We currently expect our Q4 2013 non-GAAP results to be as follows: quarterly revenues of $105 million to $110 million; Q4 2013 gross margins of 67% to 68%, reflecting our latest forecasted product mix; we expect a sequential increase in non-GAAP operating expenses of 9% to 11%; we estimate our Q4 2013 stock compensation expenses to be between $12.1 million to $12.6 million; non-GAAP diluted share count guidance for Q4 is 45.7 million to 46.2 million shares.

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

Eyal Waldman

Thank you, Jacob. The acceptance of our products and the reciprocation into new markets allowed us to grow revenues each quarter from the first quarter of 2013, despite the HPC market's relatively slow pace. We expect our sequential revenue growth to continue in the fourth quarter. We are happy that our storage business has grown and is now the second-largest revenue contributor. Several of the design wins that we mentioned in the past have started to contribute to our revenue and should become more meaningful in 2014.

HPC now accounts for less than 50% of our year-to-date revenue. Data is growing, and so is business and consumer demand for it. Efficient infrastructures are a key competitive advantage for our end users, and they look for ways to keep up with the demand for data.

For many end users, especially cloud providers, improving their efficiency through better CPU utilization is only one way that they can stay competitive and achieve their business goals.

Mellanox's architecture remains the best way to achieve better performance and return on investment, since our solution increase productivity while reducing cost. These advantages are critical for many industries, including HPC, cloud, Web 2.0, storage, database and financial services. Whether requiring better ROI in their data centers, better performance, lower cost, or a combination, our customers understand that they achieve unmatched results in their data centers when they choose our InfiniBand and/or our Ethernet solutions.

Our development of Mellanox's 8th generation of interconnects that will provide speeds of 100Gb/s in the 2014, 2015 timeframe is on track. We are a generation ahead of the competition, and we believe we are increasing the gap between their technology and ours. We completed our acquisitions of Kotura and IPtronics in the third quarter, and the integration of these teams and their advanced silicon photonics technologies is going very well. These technologies will help Mellanox to continue to lead the fast interconnect market with our InfiniBand and Ethernet offerings, and to offer market-leading solutions for high-performance computing, Web 2.0, cloud, storage, database and financial applications.

The growth in handheld applications and data drives the need for more compute and storage infrastructure. The more handhelds sold, the more application used, the more data generated and consumed, all drive the requirement for faster data centers. We have the best interconnects, thus we believe that more applications, more markets and more customers will use our product to utilize the data efficiency. Because of this demand, our customers are already asking us for 100Gb/s interconnect solutions, which we believe will start to be deployed in the 2014, 2015 timeframe.

With that, we'll take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from John Roy with UBS.

John Roy - UBS Investment Bank, Research Division

It's John for Steve Milunovich, UBS. Really, could you give us a little bit of color around cloud and service provider sales? It's certainly becoming a topic, a lot of investors. And in conjunction with that, and relates to your 40-gigabit Ethernet, and how do you win those sales when you do win them? What are people looking for?

Eyal Waldman

So there are multiple, I think more than 10 cloud providers, that use our InfiniBand end-to-end solutions already in their production data centers. So multiple cloud vendors -- by the way, as a result of publicly using InfiniBand in their HPC cloud offerings. But we're seeing more cloud vendors offering InfiniBand end-to-end. Then on the Ethernet side, there are a number of cloud vendors that are using our 10-gigabit Ethernet mix looking forward also to migrate to 40Gb/s Ethernet mix in the 2014 timeframe. There, we have not yet won the Ethernet Switch market for cloud market, but we believe that in 2014, we will have more Ethernet Switch design wins in the cloud infrastructure. So basically, today, it's the mainly InfiniBand end-to-end solution for the cloud providers, and some that are using our Ethernet endpoints today at 10Gb/s will migrate to 40 in the 2014 timeframe.

John Roy - UBS Investment Bank, Research Division

That sounds great. When you look at the switches next year and Ethernet, do you think you'll need to have 100 to start winning some sales? Or do you think that that's not required?

Eyal Waldman

No, we actually just announced that we've already won in Europe, a Web 2.0 customer that chose our Ethernet end-to-end, and they'll use us both for 10 and actually also for 56Gb Ethernet in their solution. So we don't need the 100 to see more Ethernet Switch design wins.

Operator

Our next question comes from Andrew Nowinski with Piper Jaffray.

Daniel F. Garofalo - Piper Jaffray Companies, Research Division

It's Dan Garofalo on for Andrew. You touched on the HPC segment decreasing as a percentage of mix. There towards the end of your prepared comments. I just wanted to ask on the HPC market, any exposure there to Federal spending? We've had at least one notable pre-announcement there. Can you just provide us some color on what you're seeing in terms of order flow, and have you experienced any pushouts in deals given the Federal funding challenges?

Eyal Waldman

We're like a second away from the end customers, but we're very much engaged with them. What we're seeing is because of the Romley release in 2012, we've seen a huge buildup of clusters and supercomputers in the first 3 quarters of 2012. Actually, through all of 2013, we're not seeing any significant HPC deal come to market, or being built with us. We do expect to see large HPC clusters being built, computers being built in the 2014, 2015 timeframe. I guess it's during the schedule of those guys when they want to deploy, is when Intel releases their newest CPU architecture into the market. So we were expecting the HPC market to be down. We're glad that storage, Web 2.0, cloud, database, business intelligence and those applications, markets are actually covering and enabling us to grow. We believe that when HPC comes back, we'll see an additional growth on top of what our growth with the other markets is.

Daniel F. Garofalo - Piper Jaffray Companies, Research Division

Okay. Great. And then on the Ethernet side, you posted a nice sequential increase after a strong June quarter. I guess, kind of a 2-part question for you, Eyal. When you look at that business, what are some of the factors driving the performance? And should we think about sequential growth being sustainable going forward?

Eyal Waldman

So on the Ethernet side, we're getting more momentum. We're seeing large Web 2.0 guys putting nearly all of the 10-gigabit Ethernet solutions on Mellanox, and it's multiple of those guys, not just 1 or 2. And that's a great sign for us that the endpoints we are winning today at 10Gb/s, we already have people playing. I don't want yet to say deploying our 40-gigabit Ethernet endpoints, but we believe in 2014, there'll be a nice migration into 40-gigabit Ethernet mix in those markets. I believe we're taking more market share there. I think the low latency is very important. The bandwidth is there. No one else has yet really in production 40-gigabit Ethernet mix. We heard rumors about Emulex, we hear rumors about Intel, but we don't see anyone really shipping in -- really in production 40-gigabit Ethernet mix. We're the only guys that have the mix and we're the only guys that have the full end-to-end solution. So I think, when they'll get to the 40, we'll already be starting shipping 100Gb/s solutions. So we'll keep our advantage, and I think people need more data and more bandwidth out there.

Daniel F. Garofalo - Piper Jaffray Companies, Research Division

Okay. And then just one last one for me, I guess, on guidance. So comparing your Q4 guidance last year -- or your performance last year, what you would have done absent the cabling issue, I guess maybe that number would have been $140 million. And I don't believe you called out any sort of Romley-related deals in that number, correct me if I'm wrong. But I'm wondering, in terms of the disparity between that number and your Q4 guidance number, is that a function of the HPC deals, or what would that be related to?

Eyal Waldman

Yes, I think some of it is based to HPC, not deploying too many large things. Then there was an inventory and that you remember we said, there was a large OEM customer that had a large inventory build to this quarter, about $30 million. So all those kind of build up to those numbers. Again, what we're showing is, like we said earlier this year, we're growing sequentially quarter-over-quarter in the past 3 quarters, and the guidance we gave to Q4, we expect to continue growing healthy into 2014 and we don't think we're losing any market share, actually we're gaining more market share. It takes longer than we expected, but it's -- we see the growth in front of us.

Operator

Our next question comes from Kevin Cassidy with Stifel.

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

You came in -- in the third quarter, your revenues came in at the low end of your guidance and gross margins came in at the high end of the guidance or above guidance. Can you tell us the dynamics happening there? Were there some orders that you're expecting that didn't come through or...

Eyal Waldman

We build our guidance according to our bottoms-up forecast. We're in our target range. Usually, we kind of exceed it, so we still hit our guidance. This time, we're in the lower part. Some of it is because of the delays some of our customers have experienced. We do not -- we cannot point to any specific delays we've seen in the end markets, but I guess some of our OEM customers have seen some delays and probably, that's the reason.

Yakov Shulman

And in terms of the gross margins -- Kevin, this is Jacob. When we enter the quarter, we typically have less than 50% of orders on the backlog, so we typically build some different forecast to see what will be the product mix. And our gross margins are very dependent on the product mix. At the end, actual product mix was slightly better than we expected, and that's the reason for our gross margins to be higher than guided.

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

Okay. And one other question on Ethernet, are you selling any Ethernet that are integrated circuits? Or are they all NIC cards?

Eyal Waldman

We're selling also silicon devices, a lot of silicon devices as well. So we have 2 types of customers. Some of them are buying our cards with their open-compute platform form factor, PCI Express form factors, several blade form factors. And there are some people that just buy our silicon and design their own network interface card, their own card, where they use or put it on their motherboards.

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

Okay. And one other question, and I think, Jacob, you had mentioned in the OpEx was a tape-out charge. Are you expecting a tape-out charge in the fourth quarter?

Yakov Shulman

So I think in the past, we said that we want to increase the rate of it -- of tape-outs, especially with the acquisitions of IPtronics and Kotura. In addition to major tape-outs, we're going to have smaller-sized tape-outs. So we do expect to have a kind of number of small tape-outs in Q4.

Operator

Our next question comes from Joseph Wolf with Barclays.

Joseph Wolf - Barclays Capital, Research Division

I just was hoping, given the 10-gig Ethernet performance, could you give some comments? Could you go into the percentage of your wins that are based on low latency, and could you talk about the competitive environment? I mean, you're showing the InfiniBand trade association for the RDMA over Converged Ethernet, and are pushing that forward, and I'm wondering how Emulex and InfiniBand and Intel are doing in the low-latency Ethernet market right now.

Eyal Waldman

So we know our performance and when we compare it to -- of the other vendors. We're still the lowest latency results throughout and that's why I think we're still gaining market share in the Web 2.0 and cloud, 10-gigabit Ethernet mix solutions. I'm not sure any of those numbers are public yet. We have some more data, but I'm not sure we could share it because it's not public. But we feel comfortable with the technology advantage we have in terms of latencies for 10-gigabit Ethernet, 40-gigabit Ethernet, obviously theres the 56-gigabit Ethernet, and InfiniBand is even lower latency than Ethernet.

Joseph Wolf - Barclays Capital, Research Division

And I guess you gave a sequential uptick number in the 40-gig Ethernet, but how measurable is that in terms of revenues right now? And given the mix and the positive mix, I guess going into the quarter, was the 40-gig part of the reason for the uptick in the gross margin?

Eyal Waldman

Yes, but very small. It wasn't a large, significant revenue for us. So I can't say that it was a major implicator for the gross margins, but everything else. So it is somewhat -- we do expect that in 2014 and maybe later this year, we'll see more 40-gigabit Ethernet, so that will have more impact on our gross margin.

Operator

Our next question comes from John Pitzer with Crédit Suisse.

Ryan Carver - Crédit Suisse AG, Research Division

This is Ryan Carver in for John. I want to get back on the gross margin side. So it looks like you guys hit the high end of your gross margins on the low end of the revenue. It looks like the 14 data rate came down as a percentage of revenue. And I guess if we sort of look historically, I mean, we -- going back to sort of Q1 of '12, your 10-gig revenue's up, your FDR and QDR is essentially revenue from neutral, but you've mixed higher into FDR. Cabling is up a little bit, but your gross margin's relative to the C1Q '12, down 100 bps and you're guiding it down another 150. I guess can you help us walk through sort of the -- it would appear that the Ethernet is the positive driver for mix and gross margins. Can you -- is this the right way to think of it? Or I guess how should we think about sort of the margin profile going forward? Is this change just a result of the cabling coming on from a revenue perspective, or I guess how should we think about sort of margins going forward?

Yakov Shulman

So our margins are basically more dependent on the product mix in terms of whether we sell silicon, boards, switches and cables. And then the secondary input because whether it's InfiniBand or Ethernet. So in Q3, actually, our mix of silicon and boards was more favorable than in prior quarters. Also cables, which is the lowest gross margin category for us today was on the -- somewhat lower percentage of revenues comparing to Q2. That all contributed to more kind of favorable mix as opposed to the guidance.

Ryan Carver - Crédit Suisse AG, Research Division

Great. And as my follow-up question, Eyal, if we look at sort of the ISP CapEx numbers over the last couple of quarters, you've been looking at on kind of a year-on-year basis. I mean, we've seen sort of the major ISP guys sort of grow in sort of the 30% to 40% range on a full year year-on-year basis. I guess, how should we sort of look at your growth relative to sort of ISP CapEx? And is that the right way to think about it, looking at you guys growing within that CapEx? But can I just -- maybe can I just kind of relate that to your revenue growth opportunity relative to the ISP that you guys service?

Eyal Waldman

Yes. So we are gaining more momentum at multiple ISP companies. And yes, I believe that their CapEx will eventually translate to our revenues once we get their design wins, yes.

Operator

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

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

You only mentioned some web work or design wins. Are those Ethernet and are they exclusive? And also, if you could tell us something about declining in magnitude or revenue from these wins, most specifically, but is it going to be 2014 or first half, second half, some sort of indication?

Eyal Waldman

Yes, the majority are Ethernet-based, some are InfiniBand. And, yes, we believe that we are starting to see some of the revenue from them, and we believe we'll grow in 2014.

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

Are these exclusive or are they...

Eyal Waldman

No -- so it's always that usually they're -- no one ever gives us exclusivity. But what we're seeing is we're gaining a percentage, let's say, initially 20%, 30%. Today, in some places, we're 100%. But it doesn't mean we have exclusivity, is it that we offer them better return on investments? So these are so all over the place. And so usually, we start with the Web 2 guy at small tens of percentages, growing to over 50%, and then in some, some were getting to 100%. But I can't say we have exclusivity.

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

Okay. And in terms of the Federal shutdown, did that impact your results, both the quarter and the guide, and considering that these issues may not end in 2013, may continue into 2014, do you potentially see an impact of those issues on your HPC business?

Eyal Waldman

So we believe there is some impact. There's nothing we can point to and say this is caused because of this and this. But, yes, we do believe. I mean, we've seen SGIP announce. We've seen also maybe some other of our customers have delays because of the shutdown. So probably, there is some impact that we're seeing in Q3 and Q4.

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

And you mentioned earlier that you do expect some large HPC clusters you will develop in the 2014 to 2015 timeframe. What sort of visibility do you have? And in general, say Grantley is launched in Q3, is there a potential for a positive HPC market ahead of that refresh?

Eyal Waldman

Again, we are talking to multiple entities that plan to build the large supercomputers in late '14 and '15 timeframe. Some of them even talk about it in 2017. So we are in conversations with them. The decisions are kind of made, but I believe that closer to deployment, the decisions may change and be different. So we do have some general visibility, but I wouldn't call that good visibility for now.

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

Okay. Last question, Kotura and IPtronics, was there any contribution? If you can quantify that in Q3, and what are you expecting in Q4?

Eyal Waldman

Yes. There was some contribution in Q3 and Q4. I don't think we quantified them.

Yakov Shulman

It's in line with our expectations.

Operator

Our next question comes from Alex Gauna with JMP Securities.

Alex Gauna - JMP Securities LLC, Research Division

Question. I was wondering to follow up on the IPtronics, Kotura question. Are there revenues for now flowing through your other category? And is there anyway you could ballpark the non-GAAP EPS impact from these in the last quarter?

Yakov Shulman

Yes. So we present in revenues from IPtronics and Kotura in our other category. And if you recall, when we announced acquisitions, we said that during 2013, IPtronics will be neutral to our results and Kotura will be dilutive up to $0.03, and the results in Q3 are based -- kind of in line with our expectations for the third quarter.

Alex Gauna - JMP Securities LLC, Research Division

And is there an opportunity as you integrate these acquisitions to bring back in through synergies or otherwise some of the OpEx expense that's increased here lately on these acquisitions? Or should we be thinking about ongoing gradual increases on your spending?

Yakov Shulman

In terms of the OpEx, obviously, there might be some synergies. Most of the impact from these acquisitions will be when we incorporate their products in our cable offerings, then we'll be able to see significant improvement in our gross margin for cable product family.

Alex Gauna - JMP Securities LLC, Research Division

And, Eyal, you mentioned having your 40-gigabit Ethernet drivers integrated to VMware vSphere 5.5, and I'm wondering if you could talk about what kind of strategic advantage you view that gives you, and maybe where some of your competitors are in trying to do the same thing.

Eyal Waldman

Yes, so this is the first time I think we're in box support with VMware. For us, this is a significant achievement. And I think VMware and their customers obviously were looking for more than 10-gigabits. We are the only guys that have 40Gb/s, and that's why we're in box there. I believe that people, cloud or any virtualized environment that uses the VMware that will look for more 10 Gb/s will use Mellanox because that's the only proposition, only solution out there. So I think it puts us in a big advantage, and we are now looking forward for the migration from 10 to 40 because there's more data, machines, they are growing and there's more applications out there.

Operator

Our next question comes from Daniel Amir with Lazard.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Just to understand a couple of things here, we -- just regarding to the revenue guidance, is it really around here that the HPC business is the business that's not growing, and the Ethernet business and I think your cloud business is growing? Is that the way to look at it? Because if you add the acquisitions in, it's kind of a flattish Q-over-Q essentially.

Eyal Waldman

It's not only that HPC is not growing, HPC for us is declining year-over-year. And we've seen this, and that's why you see this, it's the first time that HPC is less than 50% of our revenues. And on top of that, we're seeing growth for the companies. So other segments are growing very nicely. So your assumptions are correct.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

And in terms of -- historically, in terms of seasonality in the first quarter, HPC tends to kind of drop further just in terms of budgets. Is this year different given what happened here with the government shutdown, or how should be we looking at that HPC business here?

Eyal Waldman

We believe it may be different. Again, we're not guiding for Q1, but because HPC is a smaller portion of our revenues, I think we'll be less exposed to the HPC seasonality.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Okay. And then the final question is usage of cash. Given where the stock is, it does sound like you're incrementally more positive, I think, this quarter than last quarter in terms of design win activity. It looks like there's a lot of activity here in terms of design wins this past quarter. I mean, so is there any thought here of potential buyback or anything else?

Eyal Waldman

Well, we brought it a number of times in front of our board, and today, still our board thinks that the use of cash, is better to get more technologies and continue and open the gap with our solutions rather than doing buybacks.

Operator

[Operator Instructions] Our next question comes from Bill Choi with Janney.

William H. Choi - Janney Montgomery Scott LLC, Research Division

So given that you guys talked about potentially some Fed impact and some delays in deals, but you're -- one part, you removed from it. I'm curious when things kind of slow down or that it gets delayed, there's every now and then an impact on an inventory basis that might be sitting at your customer locations. I just wanted to see what you're picking up in terms of your OEM inventory situations and whether any of that has been impacted in your Q4 guidance?

Eyal Waldman

We're not aware of anything significant. We know some places, but nothing significant, and I think, yes, the number does kind of include some of the slow down that they have seen. But we're not seeing any significant thing or that we think is needed to be reported, or anything significant for us, material for us.

William H. Choi - Janney Montgomery Scott LLC, Research Division

Okay. And then just on ways to think about the high-performance computing for next year. I guess, there's 2 potentially big things that could really help in 2014, 2015 time -- kind of timeframe, and one is the Intel-Grantley chip, which will be relevant for that segment. But also, you've also talked about 100-gig around the same kind of timeframe. So just want to see what the feedback is on these larger deals getting done today? Have to have both? Can you just have one versus the other? Just what might be the impediments or timing of that depending on those 2 technology transitions?

Eyal Waldman

Well, it really depends who you ask, right? If you ask Intel, they'll probably say their interconnect is what works best with their CPU. The customers are still in a wait-and-see mode to see what the results, once silicon is available. We think that our interconnects will be better for HPC, so we think we'll take more of the deals to us than to Intel. But there's no very strong decoupling between the super interconnect and multiple interconnect, so as long as we have technology advantage, I think we'll take more of the market.

William H. Choi - Janney Montgomery Scott LLC, Research Division

So if Grantley comes out, it's not necessarily dependent on customers also waiting for your 100-gig product to deploy?

Eyal Waldman

They can use our 56Gb/s products, and they can use 100Gb/s, or they can use somebody else. But we believe we have an advantage compared to anything else that's out there today, and we believe also in that timeframe.

Operator

Our next question comes from Harlan Sur with JPMorgan.

Saqib Jalil - JP Morgan Chase & Co, Research Division

This is Saqib Jalil for Harlan Sur. Eyal, a quick question for the long term. As you look beyond 2013, how should we think about the pipeline building up for 2014? Would it be driven by Web 2.0, cloud, in terms of refresh cycle. I guess what's the confidence level as you look out in 2014? I mean, can we expect a repeat of what we saw in 2012?

Eyal Waldman

We have a bottoms-up number obviously in Mellanox. So we have some expectations. But I think the buildup is from obviously HPC. Then storage, that's now our second largest, which is a very significant growth and we believe we'll continue growing in '14, '15. I think we're taking over the Fibre Channel, interconnect into InfiniBand, mainly, and also Ethernet, and then also Web 2.0 cloud and the other segments. So, yes, we believe our growth, we have multiple engines. On top of that is winning more Ethernet suites, design wins, which will increase across multiple markets. So there are multiple growth engines that we believe will fuel our growth in 2014.

Saqib Jalil - JP Morgan Chase & Co, Research Division

Okay. And the next question is basically regarding the Kotura and IPtronics acquisitions. The team has had time to start the integration process. Have there been challenges or surprises so far as you've started the integration process?

Eyal Waldman

Actually, I'm pretty surprised with the smooth integration of the 2 companies. We only had 2 guys leave, 1 from Kotura and 1 from IPtronics, everybody else onboard. 2 weeks ago, we had a summit in our site in Israel of the 3 companies. I think we're making good progress. As you heard Jacob said, we are going to have tape-outs from both the Kotura and IPtronics this quarter and Q1, and I think we're on schedule that we set to the teams before the acquisitions. So I think we're doing okay with those. I'm pleasantly surprised with the progress we're making with IPtronics and Kotura, great teams, and we like working together.

Operator

Our next question comes from Srinivas Nandury with Summit Research.

Srinivas Nandury

I have a couple of questions on storage and the growth there. You talked about storage being one of the growth engines for you guys and going into 2014, what gives you the confidence that that's sort of just going to pull through?

Eyal Waldman

We're design wins. I mean, we're seeing design wins both in the back end and front end of our Infini -- mainly, InfiniBand technology and then also our Ethernet technology.

Srinivas Nandury

Okay. There's several startup companies in the pipeline, right? I mean, Violin Memory and a couple of other names recently announced IPOs. And I was wondering how's you're traction there.

Eyal Waldman

Yes, most of them, if not all of them, are using us.

Operator

Thank you. It appears we have no further questions at this time. I'll now turn the floor back to Eyal Waldman for any additional or closing remarks.

Eyal Waldman

Great. Thank you. Thank you for your interest in Mellanox, and we hope to see you at our Analyst Day in New York on Friday and at the Supercomputing 2013 Conference in Denver in November. Thank you very much.

Operator

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

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