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Executives

Deborah Stapleton – IR, Stapleton Communications Inc.

Eyal Waldman – Chairman, President and CEO

Michael Gray – CFO

Analysts

Adam Benjamin – Jefferies

Armand Pagosi [ph] – Credit Suisse

Kevin Cassidy – Thomas Weisel Partners

Brent Bracelin – Pacific Crest Securities

Apurva Patel –Ticonderoga

Jonathan Kreizman – Oscar Gruss

Rajesh Ghai – ThinkEquity

Mellanox Technologies, Ltd. (MLNX) Q4 2009 Earnings Call Transcript January 27, 2010 5:00 PM ET

Operator

Good afternoon, and welcome to the Mellanox Technologies’ fourth quarter 2009 year-end financial results conference call. All participants for today’s call are in a listen-only mode until the question-and-answer session. Today’s call is being recorded. I will now turn the call over to Ms. Deborah Stapleton who will introduce today’s speakers.

Deborah Stapleton

Thank you, Jason. Good afternoon everyone and welcome to our conference call. Leading the call today will be Eyal Waldman, Chairman, President and CEO of Mellanox Technologies and Michael Gray, the Chief Financial Officer.

By now, you've seen the press release and associated financial information that we furnished on Form 8-K this afternoon. In addition to reviewing our financial results, some of our comments today will include forward-looking statements within the meaning of section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities and Exchange Act of 1934 as amended, based on our current expectations.

These forward-looking comments entail various significant risks and uncertainties that could cause our actual results to differ materially from those expressed in such forward-looking statements.

Forward-looking statements in this conference are generally identified by words such as “believes,” “anticipates,” “expects,” “intends,” “may,” “will,” and other similar expressions. However, these words are not the only way we identify forward-looking statements. In addition, any statements that refer to expectations, projections, forecasts, predictions or other characterizations of future events or circumstances are forward-looking statements.

Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. We undertake no obligation to update any of the information contained in any forward-looking statement that we make today. We have provided additional information in today's press release and in our Form 10-K filed on March 12, 2009 and our 10-Q filed on November 4, 2009 about risk factors that could cause our actual results to differ materially from those in the forward-looking statements.

If you do not have copies of our 10-K or 10-Q, you can find them at ir.mellanox.com or we will be happy to provide you with them.

Now, let's turn the call over to Eyal for his opening remarks.

Eyal Waldman

Thank you, Debra. Good afternoon, everyone, and thank you for joining us for our Fourth Quarter and Fiscal Year 2009 Earning Conference Call.

On today's call, I will highlight our fourth quarter and 2009 results and achievements. I will then turn the call over to Michael Gray, our Chief Financial Officer, who will discuss the financial results in more details and provide our first quarter guidance. After that, we will be happy to take your questions.

Briefly recapping our fourth quarter results. Mellanox ended the quarter with record revenue of $35.5 million. 8.7% above the third quarter revenue of $32.7 million and 40.9% above fourth quarter 2008 revenue of $25.2 million. Operating income was $6.7 million or 18.9% of revenue.

Non-GAAP net income was $9.9 million or $0.28 per diluted share. This represents 115% quarterly year-over-year growth in non-GAAP earnings per share.

Gross margins were 75.6% and we generated cash from operations of $7.3 million ending the quarter with $213.2 million in cash and investments. Highlighting our year-over-year results, revenue was $116 million, up 7.7% from the $107.7 million in 2008 and non-GAAP net income decrease to $28.7 million compared to $32.2 million in 2008. We are proud that the company generated a record $32.8 million in cash from operations in 2009 and ended with more than $213 million in cash and investments.

We continue to see increased adoption of our industry leading InfiniBand and Internet products. Both volume and dollar shipment of our silicon adapters and switch systems increased year-over-year and quarter-over-quarter. We are proud to inform you that we shipped nearly 90,000 adapters in the fourth quarter, representing a run rate of 360,000 servers a year or about 5% of an estimated 7.3 million servers annual server market in 2010.

Revenue from 40-gigabit per second InfiniBand product increased and represented 57% of fourth quarter revenue, and our 10-gigabit and adapter products sold through HP, IBM and additional OEMs increased revenues as this design begins to ramp up in the marketplace. On Monday, we announced that our ConnectX-2 Adapter was selected by HP and is now their highest performance, lowest power 10 gigabit per second Ethernet adapter card available today.

This further demonstrates our ability to deliver industry leading return on investment and efficiency using our wide array of server and storage interconnect solutions in multiple end markets.

During the quarter we introduced several new features and additions to our InfiniBand adapters and switch product families to provide end users with critical bandwidth performance and efficiency capabilities to enable the next generation of high performance computing, cloud infrastructures and enterprise data centers.

These features put Mellanox in the forefront of the industry. An increasing number of the world’s fastest super computers today rely on Mellanox performance and efficiency leading in InfiniBand solutions.

InfiniBand showed momentum in the top 500 list with 28% annual growth increasing to 182 systems representing 36% of the top 500. Five of the top 10, nine of the top 20 and 63% of the top 100 all using Mellanox performance leading interconnect solutions.

Also of note the number one top 500 supercomputer Jaguar at Oak Ridge National Lab is using Mellanox InfiniBand as the primary storage interconnect for over 40 Petabyte by their storage cluster.

Mellanox InfiniBand also connects the number one supercomputer in China which is the first Petascale system in Asia as well as 38% of the China top 100 list of supercomputers.

In cloud computing and hosting applications, the most important factor in driving profitability is system efficiency and utilization. So we expect this value proposition to drive the deployment of our technology into cloud and hosting applications. Thus we view ourselves as strategic to cloud computing Web 2.0 financial internet hosting database and other data center applications.

While 2009 was challenging year for the industry, Mellanox executed well, remained profitable, generated record cash and grew revenues year-over-year. We effectively managed operating expenses without reducing headcounts or sacrificing R&D. Furthermore, we introduced a wide array of new and competitive adapter products, switch and gateway systems, software and cables, all of which has been well received by our OEM customers and end users. This provided an immediate positive impact to our revenues and the Mellanox brand.

Now, I will turn the call over to Michael for a review of our fourth quarter 2009 financial results and our guidance for the first quarter of 2010. Michael?

Michael Gray

Thank you, Eyal. Good afternoon, everyone. Let me now take you through the financial details of our fourth quarter 2009. Total revenues in the fourth quarter of 2009 were $35.5 million, up 8.7% from $32.7 million in the third quarter of 2009 and up 40.9% from the $25.2 million reported in the fourth quarter of 2008. Revenues for the fiscal year 2009 were $116 million, an increase of 7.7% from a $107.7 million of revenues in 2008.

Gross margins in the fourth quarter were 75.6%, compared to 75.2% in the prior quarter, and 77.5% in the comparable period last year. Our 2009 gross margins were 75.3% of revenues compared with 78.3% in 2008.

A few selected fourth quarter 2009 revenue metrics for you. IC revenues increased sequentially and combined our IC and board revenues represented approximately 82% of our fourth quarter revenues. The increase in IC revenues contributed to the improvement in gross margin percentage as ICs yield higher gross margins.

Revenues from our 40-Gigabit per second InfiniBand based products increased and represented approximately 57% of fourth quarter 2009 revenues, compared to 59% in the third quarter of 2009. 20-Gigabit per second InfiniBand based products represented approximately 30% of revenues in the fourth quarter, compared to 28% in the third quarter. We had two greater than 10% customers in the fourth quarter that combined represented approximately 27% of revenues. They were IBM at 14% and HP at 13%. In the third quarter we had four greater than 10% customers that combined represented 53% of our revenues. They were HP at 15%, IBM at 14%, Sun Micro at 13% and Fujitsu at 11%.

In terms of revenue split by geography, North America represented 34% of our fourth quarter revenues, Europe 25% and Asia 41%. North America represented 37% of our third quarter revenues; Europe represented 23% of our third quarter revenues and Asia 40%.

Fourth quarter operating expenses increased 12.8% sequentially to $20.1 million and represented 56.7% of revenues compared with $17.9 million or 54.6% of revenues in the third quarter.

Our fourth quarter 2009 share base comp expense was $3.8 million compared with $2.4 million in the third quarter and included an adjustment of $900,000 due to a change in the method of applying forfeitures for stock based compensation calculation purposes. Current quarter share based compensation expense was distributed by organization accordingly. Research and development $2.362 million, sales and marketing $720,000, G&A $612,000 and cost of goods sold $106,000.

Moving down our income statement, research and development expenses were $12.6 million in the fourth quarter compared to $10.9 million in the third quarter representing an increase of approximately 14.7%. The increase was primarily due to share based comp expense, employee related expenses. During the fourth quarter of 2009, we reinstated employee wages to their pre 2009 levels. R&D expenses for the fiscal year 2009 were $42.2 million and represented 36.4% of revenues.

Sales and marketing expenses were $5 million in the fourth quarter compared to $4.3 million in the third quarter 2009. The increase was primarily due to share based compensation, tradeshow expenses and employee related items. Sales and marketing expenses for the fiscal year 2009 were $17 million and represented approximately 14.7% of revenues.

G&A expenses were $2.6 million in the fourth quarter, unchanged from the third quarter 2009, while overall expenses were flat quarter-over-quarter, an increase in bad debt and share based comp expense was primarily offset by a decrease in professional related expenses. G&A expenses for fiscal 2009 were $9.4 million and represented 8.1% of revenues.

Operating income was $6.7 million in the fourth quarter 2009 representing 18.9% of revenues compared to $6.7 million or 20.6% of revenue in the third quarter 2009, and $2.6 million or 10.2% in the fourth quarter 2008. Operating income for 2009 was $18.7 million or 16.2% of revenues compared to $21.3 million or 19.8% of revenues in 2008.

Other loss net in the fourth quarter was $346,000 and compared to other income net of a $126,000 in the third quarter. The change was primarily due to an impairment taken on an equity investment in a privately held company.

Income before taxes was $6.4 million or 18% of revenues in the fourth quarter compared to $6.9 million or 21% of revenues in the prior quarter. Income before taxes for the fiscal year 2009 was $18.7 million and represented 16.2% of revenue. The fourth quarter tax expense of $2.1 million consisted of approximately $1.9 million of tax from the realization of differed tax assets and $264,000 of current tax expense.

Our fourth quarter GAAP net income was $4.3 million compared to 4.8 in the third quarter. Our fourth quarter 2009 non-GAAP net income was $9.9 million or $0.28 per diluted share and includes adjustments of $3.8 million of share-based compensation and tax expense of $1.9 million as a of result of the utilization of certain deferred tax assets. This compares to $8.9 million or $0.25 per diluted share which includes adjustment of $2.4 million of share based comp and $1.7 million of tax expense in the third quarter.

2009 non-GAAP net income was $28.7 million or $0.81 per diluted share compared to $32.2 million or $0.92 per diluted share in 2008. Our GAAP diluted share count for the fourth quarter 2009 was $34.3 million, compared to $33.6 million in the third quarter. GAAP basic share count using computing income per share was $32.5 million for the quarter compared to $32.1 million in the third quarter.

Moving on to the cash flow statement, operating activities provided $7.3 million of cash during the fourth quarter of 2009 and $32.8 million for the year. Net cash used in investing activities during the fourth quarter was $30.4 million and consisted of net purchases of short-term investments of $25.2 million. And equity investment of $3.5 million on privately held company. And purchases of property and equipment of $1.5 million.

Net cash used in investing activities in the fiscal year 2009 was of $103.7 million. Net cash provided by financing activities during the fourth quarter was $2.8 million and consisted primarily of proceeds from option exercises of $1.6 million and excess tax benefits on share based compensation of $1.2 million. Net cash provided by financing activities in the fiscal year 2009 was $4.4 million.

Turning now to the balance sheet, in the fourth quarter our cash and investments increased from $208.1 million to $213.2 million. Our accounts receivable increased $1.4 million to $20.4 million during the quarter. Our days sales outstanding decreased by three days to 51 days compared to 54 in the prior quarter.

Fourth quarter ending inventory increased $2.7 million to $9.3 million compared to $6.6 in the third quarter. Our inventory turns were 4.4 times during the fourth quarter compared to 4.9 in the third quarter.

Short-term deferred tax assets increased $6 million to $8.6 million and correspondingly long-term assets decreased by $6.5 million to $800,000 during the fourth quarter. Most of the short-term deferred tax assets are associated with carry-forward losses in Israel and we current expect to utilize them fully in 2010. Total liabilities were $32.5 million at year end of which 24.1 were current and 8.4 million were long-term.

We currently expect our first quarter 2010 results to be as follows

Quarterly revenues to be approximately $35 million to $35.5 million. We believe our first quarter gross margin will be approximately 73% to 74%. On a GAAP basis, we expect sequential increase in operating expenses of approximately 3% to 4%. We do not expect to tape out in the first quarter.

We estimate our first quarter 2010 stock comp expenses to be between $2.9 million to $3.4 million. GAAP basic share count guidance for the first quarter 2010 is 32.7 million to 33.2 million shares. Non-GAAP basic share count guidance for the first quarter 2010 is 32.8 million to 33.3 million. GAAP diluted share count guidance for the first quarter is 34.9 mm to 35.4 million shares. Non-GAAP diluted share count guidance for the first quarter 2010 is 35.7 million to 36.2 million shares.

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

Eyal Waldman

Thank you, Mike. We are pleased with our progress during the fourth quarter and 2009 as a whole. We are strategically positioned to increased market share in the server and storage industries and believe our robust end-to-end connectivity products including adaptors, switches, gateways, cables and software will further gain interaction worldwide.

Our 10-Gigabit Ethernet products demonstrate the highest performance and lowest power in multiple market applications that we expect our 10-Gigabit per second Ethernet products to gain market share. On top of that, we continue to see the momentum of using InfiniBand as backend storage interconnect and expect that it will become the leading backend storage interconnect replacing proprietary and Fibre Channel protocols.

We are experiencing tool [ph] from various high performance computing and enterprise markets for Mellanox end-to-end solutions including strong interest from Web 2.0 cloud and hosting companies. We continue to execute on our product roadmap and are experiencing new system design win momentum in multiple vertical markets.

We expect design win to mature and going to production by Tier-1 storage and server companies in the coming quarters. Mellanox will be attending a numbers of investor conferences in the coming months. More information on this event maybe found on our website at ir.mellanox.com.

Jason, we will now take questions please.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And we’ll go first to Adam Benjamin with Jefferies.

Adam Benjamin – Jefferies

Hey, thanks guys. Just a couple of clarifications. First, just generally about the business, Eyal, can you talk about the environment order trends just what you are seeing out there from your customers?

Eyal Waldman

We are pleased to continue see the momentum continue. Basically there is a steady state of purchase orders coming into Mellanox, and we hope to see increase in 2010.

Adam Benjamin – Jefferies

Got you, and then typically you guys do have a fair amount of turns, can you just give us some perspective as to where that finished up in Q4 and kind of what you are looking at in terms of guidance for Q1?

Eyal Waldman

I think we actually have to see no change in our visibility, so we kind of came into the quarter with about half of it booked.

Adam Benjamin – Jefferies

Okay, got you. And then couple of clarifications Mike, just on the P&L, tax rate it has kind of bounced around where were we looking at that for 2010?

Michael Gray

I think that you should expect us to continue to amortize the deferred tax asset that’s now on short term, but I think I might call it a cash based basis excluding that DTAP [ph]. It should be in a range of like 10 to 14%.

Adam Benjamin – Jefferies

Okay. And just like last quarter it was a couple of percent it was like, its exactly in 3% or 4%, you are saying it jumps back roughly about 10 to 14% on a pro forma basis.

Michael Gray

Well, there is – there were some discrete tax items, but I think, again, you should really assume probably low double-digits as we move forward excluding the DTAP. Remember, what drive would some degree that an effective tax rate is also the mix of our revenues by geography.

Adam Benjamin – Jefferies

Okay. And then on the tape out, you mentioned that there wouldn’t be tape out in Q1, can you give us some perspective as to what kind of timeframe we're looking at for that now?

Michael Gray

We expect to have basically two tape outs in 2010. Hopefully, one in second quarter and second one in the second half.

Adam Benjamin – Jefferies

Okay. And then just one last question, Eyal, I mean as you look at the business versus a year ago things were obviously a lot better in terms of the environment but what are the one or two things do you think investors really need to be focused on with respect to Mellanox going forward in terms of your growth prospects that may or may not be fully factored in by people as they look at the story.

Eyal Waldman

So, I think there are multiple like growth trends they are driving us forward. Number one, I think that the option of InfiniBand into more applications, we're seeing that database Oracle X data, IBM, DB2 in a fewer scale platform. We expect additional database applications to adopt in InfiniBand, that’s one area. Another area is internet Web2.0 and cloud computing where we’re starting to see traction because people see the efficiency and utilization they get in utilizing InfiniBand. And because of the maturity of InfiniBand in high performance computing, we have now – supercomputers that have 7,000 nodes that are very robust that’s 40-Gigabit per second. So this is now penetrating more and more into the data centers, into hosting, into internet. So that’s one trend that I think InfiniBand will continue to take market share.

The second trend we're seeing our 10-Gigabit Ethernet products are proving to be the best performance lowest power, 10-Gigabit per second Ethernet in the market. And we are seeing financial institutions coming back to the Tier-1 sever companies and they’re telling and they’re saying, they’re asking we want Mellanox 10-Gigabit Ethernet products in our applications because we get significant better performance, significant better results than using someone else’s 10-Gigabit Ethernet. So we are seeing this also pick up and we are selling thousands of 10-Gigabit Ethernet and moving to thousands of 10-Gigabit Ethernet into the market pretty soon. So I think we will expand market share there. The third thing is like we said backend storage. We are seeing momentum because backend storage is kind of inside the box connectivity and more and more storage companies are adopting InfiniBand as their fabric for the backend storage because they see – they get the best return on investment.

And that's something that's continue to happen, we are getting more momentum, more design wins there, more activity and we are also starting to see some more front end storage connectivity. So, all those trends are pretty significant. We are seeing the design wins, we are seeing the platforms roll out and now markets are adopting them in various applications.

Adam Benjamin – Jefferies

Got you. That's helpful. Just one last follow-up on Ethernet side, you mentioned a good strength there, HP, IBM and one other – would you care to give us some kind of perspective as to what kind of percent of revenue you could exit the year or run rate on the Ethernet side?

Eyal Waldman

First, it's hard to predict and we don’t give such guidance because we don’t have enough visibility, but what we do expect in 2010 which is interesting, we do expect tier 1 server companies to adapt our Virtual Protocol Interconnect technology, which basically means that in once they do that we cannot give you an answer if you are using that's for Ethernet or InfiniBand. In 2011, 2012 you we are selling more InfiniBand and Ethernet. We will not be able tell you – we are selling 40-Gigabit second connectivity and at some time they can be used as InfiniBand. At other times they can use Ethernet and we don’t really care what they use this for. So, we are seeing momentum of 10 Gigabit Ethernet play [ph]. We are seeing more adoption on InfiniBand, and we think it will take more market share in both, with both protocols. And this year we hope to see more or additional Tier-1 server companies come out with VPI technology adoption into the market.

Adam Benjamin – Jefferies

Got you guys, thanks a lot. That’s all I have.

Michael Gray

Thank you, Adam.

Operator

And we’ll go next to Armand Pagosi [ph] with Credit Suisse.

Armand Pagosi – Credit Suisse

Yes, hi, congrats on the quarter. Could talk a little bit about, can you hear me well?

Michael Gray

Yes, very well.

Armand Pagosi – Credit Suisse

Could you talk a little bit about the inventory what happened there with the increase? And I have another question, if you don’t mind.

Michael Gray

Well, the inventory as far as it grew from quarter-to-quarter as I mentioned in absolute dollars it grew from $6.6 million to $9.3 million. What I can tell you is that given what we've seen in terms of demand, we’re kind of increasing our overall safety stock in the past. We've kept the certain months number of months of IC, inventory as well as board. And we’re increasing that slightly to be able to prepare to response to new orders.

Eyal Waldman

If I can add to that because of the volume increase this is now and off the shelf product, it's not a niche product anymore. It's more becoming a mainstream. And to support the rate of orders and the variety of customers that we have that is increasing, we as a methodology decided to increase our inventory in order to fulfill off the shelf business model. And that’s why you’ve seen a slight growth in our inventory.

Armand Pagosi – Credit Suisse

Okay, and when you say off the shelf is that the specific, which type of components would that be?

Michael Gray

Obviously we try to do it on the product that consist the majority of our volume, but basically today everything that you sell – buy whether it’s ICs, boards, modules, switch blades, switch systems we want you to be able and inventory be available so you can get them pretty soon after you order them.

Armand Pagosi – Credit Suisse

I appreciate that. Now, relative to kind of understanding the built-up inventory, relative to demand expectation, can you help me understand on that background the guidance for revenues to be down a little bit in the first quarter sequentially and gross margins to be down as well slightly. What’s the puts and takes of, I assume it’s too early to talk about seasonality for you, what’s the puts and takes for the guidance for the revenue to be, sort of, not grow that much and margins to be down?

Eyal Waldman

Well, first of all, I think it’s more of a flat guidance, I wouldn’t – so this is a flat guidance, not a down guidance. That’s number one. And you know, there is always potential to growth because of some returns that may happen. But moving forward, we do see the different mix between our products and we do want to serve our customers in the right way, and I think we are preparing the company for growth that we expect to be visible in the coming quarters.

Armand Pagosi – Credit Suisse

Got it. Got it. Okay, thank you.

Eyal Waldman

Thank you.

Michael Gray

Thanks, Armand.

Operator

And we'll go now to Kevin Cassidy with Thomas Weisel Partners.

Kevin Cassidy – Thomas Weisel Partners

Thanks for taking my question. Just a reporting, is the Ethernet now considered a single data rate, is that how you when you break it out between the double rate, quad rate?

Eyal Waldman

I mean, you can consider 10-Gigabit Ethernet as single data rate, yes.

Kevin Cassidy – Thomas Weisel Partners

Okay, I just want to make sure I was clear on that. So, what is the percentage difference in cost say in Ethernet port versus a quad data rate port or InfiniBand?

Michael Gray

I don’t think we provide those details and now there is a slight premium but it's not significant.

Kevin Cassidy – Thomas Weisel Partners

Okay. Thanks. Maybe turning to the cash you've mentioned before that you’re considering acquisition as use of that cash, do you have any developments there?

Eyal Waldman

There is nothing eminent. We continue to focus on our core business. We are seeing so much activity and growth in our organic business and market that's we are focusing on. If opportunity arises then we may act on that but today there is nothing eminent there.

Kevin Cassidy – Thomas Weisel Partners

Okay, great. Thanks for taking my question.

Eyal Waldman

Thank you very much.

Operator

And we will go next to Brent Bracelin with Pacific Crest.

Brent Bracelin – Pacific Crest Securities

Thank you. I want to follow-up on your commentary around design win with HP on the 10 Giga adapter card. On Monday, you talked about that being kind of one of HP's lowest, how are 10 Giga adapter cards? How is the price point playing out and more generically how are you kind of positioning your 10 Giga adopter cards from pricing clearly it's lower power solution but walk us through kind of how you or thinking about pricing that product and trying to drive adoption of that 10 Giga product?

Eyal Waldman

Right. So, first just to be clear there are three kinds of flavors of this 10-Gigabit Ethernet. One is that when sell silicon which LAN on motherboard and we have some design wins there. The second one is a standard form factor PCI Express plug in card and NIC Network Interface Card. And the third one is Mezz Card for server blades. We have all those three products for 10-Gigabit per second Ethernet. In terms of pricing our OEM customers make us to be competitive to our competitors, which is Broadcom and Intel that have their 10-Gigabit Ethernet product out there as well. So, I think we are attractive not just in terms of performance and power but we are also competitive in terms of pricing.

Brent Bracelin – Pacific Crest Securities

Okay. And then, the pull that you’ve seen so far, it sounds like some of the financial services customers you would credit some of those larger customers as bringing you in or what would you attribute success you had at HP to? Is it a combination of factors or is it now part of a poll program from some of your larger financial services customers.

Eyal Waldman

So first you know – first I think the OEMs themselves see the benefit of using the Mellanox 10-Gigabit Ethernet. They don’t necessarily need to pull from the end users but we see their tier wins [ph] and we have three tier-one server companies who uses 10-Gigabit Ethernet and they see it themselves.

Second, we do get the pull from end user demands from the financial service industry, that’s one, but we are also seeing now from other industries as well. There is now, a very large application that are seeing – we have low latency Ethernet. And our low latency Ethernet is the lowest latency internet in the planet. And that’s a very significant parameter for multiple applications. So we expect to see – now we are in kind of honeymoon period with some of those application vendors to test them out in their kind of labs. And I think once they feel it’s mature and it’s ready to go to market you will see more applications in more markets as for Mellanox 10-Gigabyte Ethernet because of their performance that they are seeing there.

Brent Bracelin – Pacific Crest Securities

My last question is kind of at the higher level of question. You now, it looks like you have a one rate of about a 5% tax rate to kind of server units. Our InfiniBand is at least, obviously you are going to have much higher exposure to the high performance computing market versus the enterprise market. Clearly, the enterprise side of the market is just probably showing the most significant kind of recovery off the bottom here given how bad kind of the enterprise spending on servers was of the last year. I guess my question here is how do you increase your penetration rate of InfiniBand and participate in the enterprise recovery? What do you seeing there? Anything you can do through accelerate adoption of InfiniBand on the enterprise side?

Eyal Waldman

Yes, I mean, database is a great example, right Oracle collects the [ph] data, IBM Pure Scale those are two great examples for enterprise data center. But there are more applications. Basically what we see there is a recovery but still CIOs are asked to do more for less. And that’s exactly what we provide them. We provide them the capability to do more with the same computing what facility they have or they use because the efficiency and utilization of the servers increase from let's say 50%, 60% at peak to 80%, 90% that we can provide because we opened I/O bottleneck. And that’s a significant feature that those CIOs are looking for to do more with their compute and storage systems with less investment.

Brent Bracelin – Pacific Crest Securities

Okay. Great. Thank you.

Eyal Waldman

Thank you.

Operator

And we'll go next to Apurva Patel with Ticonderoga.

Apurva Patel - Ticonderoga

Thank you. Just back to the order trends as Eyal alluded earlier and you said, that you are seeing increasing momentum, but for December quarter were they up month-over-month or there any last minute or rush order experience?

Eyal Waldman

No, I don’t they were, they were pretty evenly distributed. I would say that as far as linearity through the quarter, the fourth quarter is probably one of the best in recent time for us.

Apurva Patel - Ticonderoga

Okay. And in terms of your OpEx you did confirm that salary reinstatements occurred in December quarter, do you expect any of that in the March quarter at all? Is that already – all of it to be included in the December quarter results?

Eyal Waldman

What we did is in the fourth quarter we had – we took progress of pay cuts just to give a little history. We took progress of pay cuts throughout the company in the first quarter of calendar 2009, and we reinstated half of the pay cuts in the third quarter, and then the remaining 50% was reinstated in the fourth quarter. So, we are now today back at the pre-2009 level.

Apurva Patel - Ticonderoga

Understood. Can you update on (inaudible) about Ethernet, but can you update us on your 5X product or is that still few quarters out?

Eyal Waldman

We have some design wins with 5X that interesting companies, and we expect them to run production in 2010.

Apurva Patel - Ticonderoga

And is that ramp inline that ramp – did that ramp go in conjunction with 10 Gigabit Ethernet or is that separate (inaudible) in a portfolio, or does it come as a separate unit?

Eyal Waldman

It comes as a separate unit. It doesn’t necessarily attach to Mellanox’s 10-Gigabit Ethernet. It can be attached to other silicon vendors’ 10-Gigabit Ethernet products, and we are seeing multiple design wins that 10-Gigabit Ethernet products with various OEMs. You know that until now we didn’t have design wins with?

Apurva Patel - Ticonderoga

Got you. Thank you. And one last question on a 40-Gigabit Ethernet is it still on plan to introduced on 28-nanometer technology as it is going to be this year sometime or do you expect still to be may be 2011 story?

Eyal Waldman

We have actually introduced already our 40-Gigabit per second Ethernet network interface card in silicon and that's on the 19-nanometer technology. So, we are today to have the end point for 40-Gigabit per second and there is no switches that available once there is no more to production. Today we are testing 40-Gigabit Ethernet point-to-point understanding the performance and improving the capabilities of the 40-Gigabit and technology we will provide very soon. But people can get today 40-Gigabit Ethernet from Mellanox.

Apurva Patel - Ticonderoga

Thank you.

Michael Gray

Thank you.

Operator

And we’ll go next to Jonathan Kreizman with Oscar Gruss.

Jonathan Kreizman – Oscar Gruss

Hi, guys, congrats on the strong quarter.

Eyal Waldman

Thank you.

Jonathan Kreizman – Oscar Gruss

First of all, if you could talk a little bit about the switch revenue as a percentage of revenues within the quarter and generally how you see this play out during the year?

Eyal Waldman

There is no real specific trend that we can point to and that’s why I don’t think there is the significance in providing this. But we are seeing increase in our revenues from switch product. We expect to see more, we are now coming with more products on switch systems. And our end-to-end solution is very attractive in additional markets. So we are seeing end-to-end solutions in China and the largest supercomputer is there and we are getting more design wins in Europe like in Zurich [ph] and also in the US, so we expect to see more and more switch system business in the future.

Jonathan Kreizman – Oscar Gruss

Just to get the number along with that I think you reported 15% last quarter and 25% per quarter before that, could you provide the number of percent of switch revenues were in this quarter?

Eyal Waldman

You should assume they are pretty consistent with what we did in the prior quarter.

Jonathan Kreizman – Oscar Gruss

Towards the 15, ONE-FIVE.

Eyal Waldman

15, yes.

Jonathan Kreizman – Oscar Gruss

Okay. If you could provide the breakdown between enterprise and HPC and that’s change in anyway?

Eyal Waldman

We don’t that information because we sell to the OEMs and they sell to the end users. So we don’t have – we still think and a majority of revenues come HPC, but we don’t have the break down.

Jonathan Kreizman – Oscar Gruss

Okay. Headcount change for the quarter?

Eyal Waldman

In terms of headcount we exited the year with 343 employees, and that compares to 321 employees at the end of September. So we had at about 22 folks in terms of full time equivalence or staff in the fourth quarter.

Jonathan Kreizman – Oscar Gruss

Okay. And where are you allocating this additional headcounts in terms of the business?

Eyal Waldman

I mean most of the headcount was within R&D and then to a lesser extent within the sales and marketing and business development organization.

Jonathan Kreizman – Oscar Gruss

Okay, got you. Last question from me, any intakes you can provide us with regards to Oracle’s acquisition of some, any disclosures you have stated that – impact your business which you can share with?

Eyal Waldman

You know there is not all that we can share because obviously I think Oracle needs to make some work on their side, but what believe is that this is positive for Mellanox because we think that Oracle’s InfiniBand and I think I have stated this multiple times as one of the strategic differentiation in terms of providing the whole solution. So, we think this is a positive for Mellanox.

Jonathan Kreizman – Oscar Gruss

All right. Okay, that would be all for me. Thanks and good luck.

Eyal Waldman

Thank you very much.

Operator

And we have time for one more question. We will now go to Rajesh Ghai with ThinkEquity.

Rajesh Ghai – ThinkEquity

Good afternoon and congratulations. Just one question on the Server Refresh cycle, that seems to have benefited your counterparts in the Fiber Channel HBA side quite significantly this quarter. And you mentioned that your tax rate to servers is around 5%, and I assume that’s gone up from where it was in the last quarter. I am just trying to understand the difference in the growth rate, sequential growth rates that you’ve reported versus what QLogic and Emulex may have reported this quarter. And also I wanted to understand going forward given that Server Refresh is expected to ramp from here onwards, how do you expect that impacting your business?

Eyal Waldman

We did see a volume increase in the second half of 2009 in both quarter we see an increase, and we expect to see an increase in volume in 2010.

Rajesh Ghai – ThinkEquity

Okay. And any color that you can provide us on the competitions from QLogic and Voltaire during the quarter as that ramped up or has that started impacting in pricing or anything else?

Eyal Waldman

We do see QLogic having their own silicon and their own solutions out there. We don’t see them gaining much business from us and I think we still have the majority share of the market. Voltaire is one of our important customers and they are using our silicon, so we work together doing design-wins there.

Rajesh Ghai – ThinkEquity

And in terms of the guidance that you provided, the gross margin guidance, is that more and – the sequential decline in that, is that more attributable to competition on the InfiniBand side or is that more to do with your expectation on 10 Gigabyte Ethernet ram.

Eyal Waldman

I really I think the primary driver behind the guidance we gave or has for the first quarter is really mixed expectation between the four categories of revenues that we have more than anything.

Rajesh Ghai – ThinkEquity

Then you would expect your card business to kind of decline sequentially in terms of mix or is that a fair assessment or?

Eyal Waldman

We don’t usually provide specifics by each of the four categories but at this time we would expect slightly a change in mix that’s consistence with the guidance we gave of 73 to 74%.

Rajesh Ghai – ThinkEquity

And Eyal you mentioned that couple of cases where customers have potentially pulled you in for 10 Gigabytes for high for front-end storage connectivity using 10 Gigabyte Ethernet. Is that a replacement of existing fiber channel deployment or is that replacement of (inaudible) 1 Gigabyte [ph] Ethernet deployments.

Eyal Waldman

No what I said is they pulled us in for 10 Gigabyte Ethernet connectivity we didn’t say about their storage or something else. So this is mainly for a server connectivity for that.

Rajesh Ghai – ThinkEquity

All right – sorry about that, and there was some safety stock increase that you mentioned Mike so do you expect the (inaudible) to stay at the same level for the rest of the year?

Michael Gray

We expect it to have our inventory turns on a quarterly basis to be four plus, within fours [ph].

Rajesh Ghai – ThinkEquity

Okay.

Michael Gray

It's just as we alluded to earlier; we are trying to carry a little more so that we can respond faster to our standard product offering. You would dully note that issue was raised before. I want to highlight for everybody that we have not historically had any issues in terms of offer [ph] lessons in terms of our inventory and what we carried the life expectancy is multiple years. So this is really to support what we feel our expanding and growing operations.

Rajesh Ghai – ThinkEquity

All right, thank you so much.

Eyal Waldman

Thank you.

Operator

That does conclude today's question and answer session. I would like to turn the call back over management for any additional or closing remarks.

Eyal Waldman

Thank you, Jason. I like to thank all of our employees for their dedication and contributions to our world class organization. Thank you to all of you for your interest in Mellanox. That concludes our call today. Thank you very much.

Operator

This does conclude today's conference. Thank you for your participation.

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Source: Mellanox Technologies, Ltd. Q4 2009 Earnings Call Transcript
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