Mellanox Technologies' CEO Discusses F4Q 2013 Results - Earnings Call Transcript

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 |  About: Mellanox Technologies, Ltd. (MLNX)
by: SA Transcripts

Mellanox Technologies, Ltd. (NASDAQ:MLNX)

F4Q 2013 Earnings Conference Call

January 29, 2014 17:00 ET

Executives

Gwyn Lauber - Director, Investor Relations

Eyal Waldman - President, Chief Executive Officer

Jacob Shulman - Chief Financial Officer

Analysts

Kevin Cassidy - Stifel

James Kisner - Jefferies

Steve Milunovich - UBS

Bill Choi - Janney

Andrew Nowinski - Piper Jaffray

Rajesh Ghai - Macquarie Capital

Saqib Jalil – JPMorgan

Brent Bracelin - Pacific Crest

Alex Gauna - JMP Securities

Srini Nandury - Summit Research

Joseph Wolf - Barclays

Operator

Good afternoon, and welcome to the Mellanox Technologies Fourth Quarter and Fiscal Year 2013 Financial Results Conference Call. At this time all participants have been placed in a listen-only mode. And the floor will be open for your questions following the presentation. (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 fourth quarter and fiscal 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 present important factors relating to our business that may potentially affect these forward-looking statements. These forward-looking statements are also subject to risks and uncertainties that may cause our 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 fourth quarter and fiscal 2013 results and achievement. I will then turn the call over to Jacob Shulman, our Chief Financial Officer, who will discuss our fourth quarter financial results in more detail and provide our first quarter 2014 guidance. After that we will take your questions.

For the fourth quarter of 2013, reported revenue of $105.5 million compared to $104.1 million in the third quarter of 2013 and $122.1 million in the fourth quarter of 2012. Fourth quarter 2013 non-GAAP gross margins was 68.5% and non-GAAP operating income was $9.1 million or 8.6% of revenues and non-GAAP diluted earning per share for the fiscal fourth quarter of 2013 were $0.21.

During the quarter, we generated $30.7 million in cash from operating activities. Highlighting our year-over-year results revenue was $390.9 million compared with $500.8 million in 2012 and non-GAAP net income was $40.9 million compared to $155.7 million in 2012. We ended the year with $330.2 million in cash and investments after using $123.5 million for acquisitions of Kotura and IPtronics.

Turning to our solutions, our FDR 56 gigabit per second InfiniBand revenue contribution was 55% of total revenue compared to 48% in the third quarter of 2013. Our Ethernet products contributed 15% of revenues. Our 40 gigabit Ethernet revenue grew 62% sequentially. While this is of small base, we believe that revenue from our 40 gigabit Ethernet solutions will continue to grow at end users upgrade from 1 and 10 gigabit Ethernet solutions.

During the quarter, we participated in the 2013 Supercomputing Conference and reported FDR InfiniBand continued penetration into high-performance computing as demonstrated by its increasing presence on the Top 500, our ranking of the world's most powerful supercomputers systems.

InfiniBand based supercomputers increased to 207 representing 41.4% of the top 500. The number of Petascale-capable systems connected with Mellanox's FDR InfiniBand grew 3x over last November list showing the continuing demand for faster Interconnect Solutions.

We connect nearly half of this Petascale Systems more than twice as many as our closest competitor. Examples of our leadership in high-performance computing include our recent announcements about the University of Cambridge, NVIDIA and Purdue University. Finally, Mellanox InfiniBand solutions enabled the most performance efficient systems on the least helping our end users to achieve more than 97% system and CPU efficiency.

Customers on the Top 500 use our FDR InfiniBand solutions for a diverse list of applications from traditional large scale high-performance computing to commercial computing including Web 2.0, Cloud and Enterprise data centers and we believe that the HPC market will return to growth in 2014. Storage remains one of our fastest growing segments as trends like flash arrays and cloud storage continue to create demand for our solutions.

During the quarter several of our partners announced the availability of solutions that utilize our InfiniBand and our Ethernet technologies. For example, EMC announced XtermIO and ScaleIO products that include our solutions. Also flash and scale-out storage vendors NetApp, Quantum and Symantec announced clustered storage solutions that support InfiniBand. This product offer both front-end and back-end storage connectivity that improved customers experience and provide better price performance density and flexibility. We expect more design wins to go into production in 2014 and we believe these activities could lead to continued revenue growth from our storage related partners.

In the fourth quarter, we also generated revenue from customers that use our switches and adaptors and an integrated Microsoft environment. For example, Pensions First's began offering a private cloud business intelligence platform based on Windows Server 2012 Release 2 and Hyper-V as well as SQL Server 2012 gaining speed efficiency and flexibility with Mellanox RDMA based InfiniBand and Ethernet Interconnect.

Also during the quarter, Red Hat announced that Mellanox solutions passed the OpenStack certification test for its storage and networking offerings making Mellanox the first adapter vendor to be Red Hat certified for the cloud. Mellanox brings great value and differentiation to OpenStack users in applications like network virtualization and storage which utilize our 10 and 40 gigabit Ethernet, our end-to-end FDR InfiniBand solutions and our eSwitch adapter technology.

Our Ethernet solutions continue to be adapted by end users. In the quarter we announced that we contributed our 10 and 40 gigabit Ethernet switch designs to support Open Compute Project, OCP. We also announced that our 40 gigabit Ethernet NICs are available as part of OCP as well.

Our Ethernet Switches and 40 gigabit NICs would provide building blocks for open cloud and open data centers. Today Mellanox is the only company that provides full end to end 10 and 40 gigabit solutions to the OCP ecosystem.

Late in the quarter, we announced that our 10 and 40 gigabit Ethernet NICs are now available with Dell's PowerEdge servers and networking solutions. The availability of this solutions will allow PowerEdge customers to experience high-performance and increased efficiency and return on investment that our solutions provide.

We recently announced that our InfiniBand and Ethernet Interconnect Solutions are now available through SYNNEX GSA Schedule providing U.S. Federal State and Local Government agencies an easier path for purchasing our solutions.

Through SYNNEX government agencies can significantly reduce costs associated with deploying Mellanox's high-speed low latency end-to-end Interconnect Solutions. Throughout 2013, we made progress in many of the programs that we highlighted to you at the start of the year. Both our InfiniBand and our Ethernet solutions gained greater traction in the market that we focus on.

We grew our revenue sequentially from the first quarter levels, we acquired two companies that expand our product line and will help us to provide 100 gigabit per second solutions and beyond. The integration of this company is going well and we are developing new products using this new technology.

2012 was an exceptional year because it included approximately $50 million of revenue from 2011 and approximately $50 million from 2013. Looking back we now understand why our revenues decreased from 2012 to 2013. We are proud of what we accomplished throughout 2013.

Now I will turn the call over to Jacob for our review of our fourth quarter and fiscal 2013 financial results and our expectations for the first quarter 2014. Jacob?

Jacob Shulman

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

Our total revenues in the fourth quarter were $105.5 million, up approximately 1.4% from $104.1 million in the third quarter of 2013 and down approximately 13.6% from $122.1 million in the fourth quarter of 2012. Total revenues for fiscal year 2013 were $390.9 million down approximately 22% from $500.8 million for fiscal 2012.

Our non-GAAP gross margins in the fourth quarter were 68.5%, down from 69% in the third quarter of 2013 and down compared to 70% in the fourth quarter of 2012. Major reconciling items from GAAP to non-GAAP gross profit, our share-based compensation expenses of $469,000, amortization of acquired intangibles of $3.2 million and acquisition-related expenses of $208,000. Our non-GAAP gross margins in the fiscal year 2013 were 68.8% compared to 70.3% in the fiscal year 2012.

The following are a few selected Q4 2013 revenue metrics for you. Combined, revenues from our IC and board products represented 48% of the fourth quarter revenues. Switch system revenues accounted for 33%. Revenues from our 56 gigabit per second InfiniBand-based product represented 55% of revenues in Q4 2013, up from 48% of revenues in Q3 2013. Revenues from our 40 gigabit per second InfiniBand-based products represented 17% of revenues in Q4, down from 18% of revenues in Q3.

Ethernet related revenues represented 15% of the fourth quarter revenue and remind unchanged as a percent of revenues in comparison to the third quarter. We had two more than 10% customers in the fourth quarter that combined represented 26% of revenues. They were HP with 15% and IBM with 11%.

Fourth quarter non-GAAP operating expenses increased by $5.1 million sequentially to $63.2 million and represented 59.9% of revenues compared with $58.1 million or 55.8% of revenues in the third quarter of 2013.

Major reconciling items from GAAP to non-GAAP operating expenses our stock-based compensation of $11.2 million, amortization of acquired intangibles of $1.2 million and acquisition related charges of $700,000.

Moving down our income statement, our non-GAAP research and development expense in the fourth quarter were $40.3 million compared to $36.8 in Q3 2013 representing a sequential increase of 9.6%. The increase was primarily due to higher employee related expenses and increase in development and tape out cost partially offset by decrease in other R&D costs.

Non-GAAP R&D expenses for Q4 2013 represented approximately 38.2% of revenues up from 35.4% of revenues in Q3 2013. Non-GAAP sales and marketing expenses were $15.5 million in Q4 2013 compared to $14.6 million in Q3 2013 representing a sequential increase of 6.1%. The increase was primarily due to higher employee related expenses and increase in trade shows and promotion activities and an increase in other sales and marketing costs.

Non-GAAP sales and marketing expenses for Q4 2013 represented 14.6% of revenues up from 14% of revenues in Q3 2013. Non-GAAP general and administrative expenses were $7.4 million in the fourth quarter compared to $6.8 million in the third quarter representing a sequential increase of 10.2%. The increase was primarily due to higher employee related expenses and an increase in professional services.

Non-GAAP general expenses for Q4 2013 represented 7.1% of revenues up from 6.5% of revenue in the third quarter. Non-GAAP operating income was $9.1 million in the fourth quarter of 2013 and represented 8.6% of the revenues compared to $13.7 million or 13.1% of revenues in Q3 of 2013. Other income was $301,000 in Q4 compared to $483,000 in Q3 of 2013.

Non-GAAP income before taxes was $9.4 million or 8.9% of revenues in Q4 2013 compared to income before taxes of $14.1 million or 13.6% of revenues in Q3 2013. The fourth quarter had a tax benefit of $300,000 compared to tax expense of $1.1 million in the third quarter. The non-GAAP tax rate for the fiscal 2013 was 8.4%. Our Q4 2013 non-GAAP net income was $9.7 million or $0.21 per diluted share and included adjustments of $11.7 million or share based compensation, amortization of acquired intangible assets of $4.4 million and acquisition related charges of $900,000.

This compares to our Q3 2013 non-GAAP net income of $13.1 million or $0.29 per diluted share which 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. Q4 2012 non-GAAP net income was $30.7 million or $0.69 per diluted share.

Our GAAP diluted share count for Q4 2013 was 43.9 million shares compared to 43.6 million in Q3 2013. Our non-GAAP diluted share count using computing income per share for the fourth quarter was 45.8 million shares compared to 45.5 million for the third quarter of 2013.

Moving on to the cash flow statement, cash provided by operating activities during the fourth quarter of 2013 was $30.7 million compared to $16.4 million of cash provided by operating activities in the third quarter of 2013. Net cash used in investing activities during the fourth quarter was $6.1 million and consisted of purchases of property and equipment and leasehold improvements of $6.9 million, net purchases of short-term investment of $5.4 million and purchases of intangible assets of $1 million partially offset by decreases in the receipt of cash of $7.4 million.

Net cash provided by financing activities during the fourth quarter was $600,000 and consisted primarily of cash proceeds from option exercises of $1.1 million partially offset by capital payments of $283,000.

Turning to the balance sheet, our cash and investments at the end of the quarter were $330.2 million compared to $306.4 million at September 30, 2013. During the quarter our accounts receivable decreased $3.3 million to $70.6 million. Our day sales outstanding remains unchanged at 63 days in comparison to the prior quarter. Approximately 99% of our outstanding accounts receivable amount at current or less than 30 days over due.

Fourth quarter ending inventory increased $3.5 million to $36 million compared to $32.5 million in Q3 2013. Our inventory turns remained unchanged quarter-over-quarter and were at 4.3x. Net intangible assets and goodwill were $54.4 million and $199.6 million respectively, at the end of the quarter. Total liabilities were $140.8 million at quarter end, of which $99.6 million were current and $41.2 million were long-term.

Going forward we will not be indicating whether our operating expenses include tape outs due to increased rates of tape outs and the relatively insignificant cost of individual tape outs to operating expenses. We currently expect our Q1 2014 non-GAAP results to be as follows. Quarterly revenues of $100 million to $105 million, Q1 2014 gross margins of 67.5% to 68.5% reflecting our latest forecasted product mix. We expect a sequential increase in non-GAAP operating expenses of 2% to 4%. We estimate our Q1 2014 stock compensation expense to be between $12 million to $12.5 million. Non-GAAP diluted share count guidance for Q1 2014 is 46 million to 46.5 million shares.

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

Eyal Waldman

Thank you, Jacob.

Looking ahead to 2014 there are multiple opportunities in front of us that will fuel our growth. Many of these opportunities are possible because of the remarkable pace at which data is being created, stored and analyzed. We see a trend where data is kept alive and accessible for much longer time. The demand, the businesses and consumers have using data increases with the creation of more applications and more sources of data.

Businesses are challenged in utilizing data efficiency. By using our Interconnect Solutions our customers can take advantage of the data growth and gain a competitive advantage over their competitors. Not only do we see this in our traditional markets we're also seeing our solutions move into mainstream markets. They too need to find ways to quickly and efficiently analyze data. We are working on our 100 gigabit per second solutions and believe we will be the first vendor to offer 100 gigabit per second products to the market. We continue to believe that we will be able to offer our 100 gigabit per solutions in the 2014, 2015 timeframe.

Cloud is becoming a more significant method of data center deployment for multiple applications and markets. Due to our superior Interconnect Solutions we expect to gain significant market share in cloud solutions and appliances. We are working with multiple partners in the ecosystem to create a more significant value-add to cloud solutions and consumers.

Storage is growing exponentially and the use of flash and low latency storage as a percentage of storage systems is growing. Thus, we believe that the use of our Interconnect in the storage market will continue to grow rapidly taking market share from legacy and proprietary Interconnects. We expect to see a transition from 10 to 40 gigabit per second Ethernet in 2014. We are the only company that has a proven 40 gigabit network interface adapter and 40 gigabit end-to-end solutions. With this expected transition, we expect to grow our Ethernet market share.

In 2014, we expect to see growth in our penetration in storage growth with our Ethernet market share as customers transition from 10 to 40 gigabit per second, we expect HPC to resume growth this year. We expect our 2014 annual revenues to increase over 2013. Our first quarter 2014 revenue guidance represents a 23% increase over our first quarter 2013 results and is higher than our first quarter 2012 results.

Operator, we will now take questions.

Question-and-Answer Session

Operator

The floor is now open for questions. (Operator Instructions) We'll take our first question from Kevin Cassidy with Stifel. Please go ahead.

Kevin Cassidy - Stifel

Yes. Thank you for taking my question. Just on the revenue guidance I wonder if you could give us some other moving parts, are you expecting any growth in HPC in the first quarter or is there any growth in storage? I guess just want to know what isn't growing and what will be growing?

Eyal Waldman

We don't break our revenues to segments and some times we have more visibility than others. So we can't go into details into this question.

Kevin Cassidy - Stifel

Okay. Maybe just for the year you think that HPC will grow compared to 2013, what's giving you the confidence of that?

Eyal Waldman

We are expecting we are working on multiple deals that we expect to occur this year and on top of that we expect the Grantley launch by Intel to expedite some of the deployments that people are waiting for the new CPU generation.

Kevin Cassidy - Stifel

I guess just to make sure I understand that was at a -- is some of the HPC deployments are depending on Grantley or all of them is it, or is all second half type of growth for HPC?

Eyal Waldman

Some of them are waiting for Grantley, I don't want to say all of them but a large portion of them are waiting for Grantley.

Kevin Cassidy - Stifel

Okay. Thanks. I'll go back in the queue.

Eyal Waldman

Thank you.

Operator

Thank you. We'll take our next question from James Kisner with Jefferies. Please go ahead.

James Kisner - Jefferies

Hi, thank you for taking my question. Do you hear me?

Eyal Waldman

Yes.

James Kisner - Jefferies

So the first question is drilled down like -- the first question, I believe you said at your Analyst Day that you thought that you would sort of buck the trend on seasonality in Q1, that you're obviously below the street for guidance. I'm just wondering did something soften related [indiscernible], I mean its better than seasonally, I guess guide, but still down, did HPC we can further do commercial adoption not happen this fast and I'm also just wondering we will take your results from IBM are pretty weak and I'm wondering if perhaps this server divestiture could be backing the results? Thanks.

Eyal Waldman

The way we do our forecast is what we get from our customers and sometimes the end customers as well and those are the numbers we feel comfortable for this quarter. We don't see significant softness in any particular market. We do believe that we'll continue growing in 2014 and like we said we expect our annual revenue for 2014 to be higher than 2013.

James Kisner – Jefferies

Okay. Thank you.

Eyal Waldman

Thank you.

Operator

Thank you. Our next question comes from Steve Milunovich from UBS.

Steve Milunovich - UBS

Thank you. Can you first remind us what percentage of revenue last year was represented by hyperscale storage and HPC?

Eyal Waldman

I think what we said is that HPC is about 50% of our revenues we said that storage is our second largest revenue segment in 2013. And I don't think we gave any specific numbers.

Steve Milunovich - UBS

Okay. And can you bring us up to date on what 2.0 installations I think there were some talk in the Analyst Day and so forth about some delays. What are you seeing with your customers right now?

Eyal Waldman

So with the ones that have already been using us for quite sometime they continue to use us. And again, we're shipping hundreds of thousands of 10 gigabit Ethernet into Web 2.0 and cloud customers. People that too slow are now starting to deploy more but it's again in a slower pace than we would have hoped for.

Steve Milunovich - UBS

Is there any lumpiness you have visibility on today kind of like hey right now it looks like there is potentially a big deal in 2Q that sort of thing?

Eyal Waldman

In 2013, we had zero large deals when we define large deals its more than $5 million. We do expect in 2014 to have some large deals in the order of magnitude of $4 or $5 million.

Steve Milunovich - UBS

Okay. That's helpful. Jacob is there anything you can say in terms of expense growth for the full year kind of what range you're thinking of, I would imagine you've got to think on a full year basis for expenses?

Jacob Shulman

Yes. I think in the past we've said that we expect to grow our operating expenses low-single digit percentage quarter-over-quarter from Q4 base and we still reiterate this guidance.

Steve Milunovich - UBS

Okay. And then finally, fiber channel and think Eyal you've been fairly negative on fiber channel, you talked about InfiniBand taking more share. Fiber channel seems to be holding in pretty well and may be its just because the environment is weak so it's easier for people to add to what they know. But how do you see that playing out going forward? Do you see yourself replacing more fiber channel in 2014?

Eyal Waldman

Yes. I think we are. The fact that storage grew to be our second largest revenue segment demonstrate that and we are seeing now more people have announced their products with our Interconnect as supposed to fiber channels. And again, if you look at the trendsetters such as Web 2.0, Cloud, Big Data and more you don't see any fiber channel presence there at all.

Steve Milunovich - UBS

Okay. Thank you.

Eyal Waldman

Thank you.

Operator

Thank you. We'll take our next question from Bill Choi with Janney. Please go ahead.

Bill Choi - Janney

Thanks. So the thoughts on HPC market growth, you said it partially depends on Grantley. So clearly we want to get a little understanding of -- if there is any clarity on the timing of it from last quarter? And also budgets from federal government is becoming available, does that play a factor in some of these customers coming back with larger deals this year?

Eyal Waldman

So regarding schedule I guess its Intel's information. But I understand the industry is waiting [ph] sometime in the second half of this year. In terms of government budgets, yes, we do see them to be out there and we do expect to see deployments this year.

Bill Choi - Janney

I'm curious, when you said HPC revenue to grow, you also mentioned that really $50 million should have been in 2013 rather than 2012. When you include that would you still expect growth in HPC market?

Eyal Waldman

I think the product that were purchased in 2012 and deployed in 2013 are not HPC related. They are more Web 2.0 related.

Bill Choi - Janney

Okay, got it. And then, can you provide some thoughts here on the switching business that's one of the segment that was down sequentially in revenue. I know a software for that Switch was what's been holding you back particularly with some of the large web scale guys. You made that available to OCP, you're open to working with third party operating systems. Dell, I guess couple of days ago decided to work with Cumulus Networks opened that up and hoping to get some more web deals. What is going to get the switching business back on track to growth any outlook this year for that business?

Eyal Waldman

Yes. We do believe that our Ethernet business will grow this year. Again, what you're seeing quarter-over-quarter distribution is nothing I would read anything significant into just quarterly timing basis. We do expect our switching revenue to continue growing in 2014.

Bill Choi - Janney

But what's of the issue on the software front that prevented you from gaining a lot of share in Web?

Eyal Waldman

There are number of layer 3 protocols that are now in the works that will get out during 2014 that will enable us to drive our Ethernet switching into the Web 2.0 and cloud customers.

Bill Choi - Janney

Any clarity on timing?

Eyal Waldman

This year.

Bill Choi - Janney

Okay. Last question, I guess Jacob in the past you obviously had to go to the nuance of talking about tape out if you notice [ph] to do $3 million per tape out and why are you moving away from that when its still a lumpy item, are you including tape outs, are you really guiding for a smooth 2% to 3% sequential type of growth from Q4 all the way through the rest of the year?

Jacob Shulman

So in the past, we said that we want to increase the rate of tape outs from 1 to 2 per year, 3 to 4 per year. We believe that this increased the rate of tape out and the cost of each individual tape out being insignificant to overall operating expenses does not provide any additional value to investors. We believe we will continue to guide to increases in operating expenses including tape out.

I just want to reiterate the guidance for Q1, operating expense increased, we said that the operating expenses will increase 2% to 4% that includes everything. So total increase in operating expenses is expected to be between 2% to 4%.

Bill Choi - Janney

That's great. Just one to make sure that also that none of the projects that really required tape out discussion in the past, no slip outs in anything that you have been working on whether Kotura or 100 gig or anything else?

Eyal Waldman

No, we are roughly on target.

Bill Choi - Janney

Okay. Thank you.

Eyal Waldman

Thank you.

Operator

Thank you. Our next question comes from Andrew Nowinski from Piper Jaffray. Please go ahead.

Andrew Nowinski - Piper Jaffray

Okay. Good afternoon. On the storage side, I guess clearly Oracle's exit [indiscernible] strong again and but EMC just gave a more muted outlook for 2014, they think their storage revenue actually decelerate in 2014. So I know you have relationships with all the other Tier-1 storage vendors. So I guess, your conviction the storage market more specific to the all flash market versus the broader HDDs storage market?

Eyal Waldman

So first we do have more presence in the all flash market, but second because we are trying from a very low market share, percentage of the market. Even if the home market goes down we can still grow and take market share.

Andrew Nowinski - Piper Jaffray

Is that just displacing fiber channel in that market?

Eyal Waldman

Fiber channel proprietary networks.

Andrew Nowinski - Piper Jaffray

Proprietary okay. And then with regard to Ethernet, it's been increasing in mix, I guess pretty nicely. Just wondering which of your end markets is really the core driver of your Ethernet revenue is that cloud or Web 2.0 or both?

Eyal Waldman

It's mainly Web 2.0, cloud some financial services those are the three main drivers for Ethernet revenues.

Andrew Nowinski - Piper Jaffray

In which of those three do you have, would you say the best of ability into in terms of avoiding any lumpy quarters -- from orders from those customers?

Eyal Waldman

I think the Web 2.0 and I think all three are pretty good in giving us forecast. So it changes plus minus some percentages. But we are getting pretty good visibility into Web 2.0, cloud and financial services.

Andrew Nowinski - Piper Jaffray

Which verticals were the more problematic ones in terms of you had less visibility into that?

Eyal Waldman

There is multiple. I mean they can also change but in the past several quarters I think we were okay with them.

Andrew Nowinski - Piper Jaffray

Okay. Very good thanks.

Eyal Waldman

Thank you.

Operator

Thank you. Our next question comes from Rajesh Ghai from Macquarie Capital. Please go ahead.

Rajesh Ghai - Macquarie Capital

Yes. Thanks. I wanted to ask you about your expectations for the magnitude of the Grantley bump this year. Do you expect it to be a factor as Romley was in 2012 or do you kind of expect it to be relatively muted? And also if Grantley is going to show up in the second half of 2014, do you expect the HPC market to be – to further slowdown in the first half of 2014?

Eyal Waldman

So we don't expect Grantley pent-up demand to be as large as it happened with Romley. We expect it to be smaller. And we do expect to see more deployments in the second half rather than in the first half.

Rajesh Ghai - Macquarie Capital

Okay. And the Analyst Day you talked about some Web 2.0 and cloud wins essentially two big accounts that there were on NDA, have they started contributing revenue yet or you still you think that's going to show up sometime later during the year?

Eyal Waldman

I know they are already contributing revenues.

Rajesh Ghai - Macquarie Capital

You mentioned earlier in the call that you had some large deals in the pipeline, was those HPC or were those left to your own cloud?

Eyal Waldman

The ones I referring to were HPC.

Rajesh Ghai - Macquarie Capital

Okay. Thank you so much.

Eyal Waldman

Thank you.

Operator

Thank you. Our next question comes from Harlan Sur with JPMorgan. Please go ahead.

Saqib Jalil – JPMorgan

Hey, good afternoon this is Saqib Jalil for Harlan Sur. Eyal, I was just wondering if you can talk a little bit beyond the first quarter in terms of what market you are expecting to outperform in 2014, especially would you be able to grow in each quarter sequentially in 2014 or should we expect some sort of air pockets in the mid-year? And also to add to that question any demand weakness are you guys seeing related to state-owned enterprises particularly from China?

Eyal Waldman

So we expect, today the information we have is, we expect to grow sequentially through the quarters of 2014. And so we expect most of the signals to grow for us.

Saqib Jalil – JPMorgan

Okay.

Eyal Waldman

Okay. And also compared 2013 to 2014 as well.

Saqib Jalil – JPMorgan

Okay. Any weakness geography wise you are seeing?

Eyal Waldman

I don't think we are seeing any weakness geography wise.

Saqib Jalil – JPMorgan

Okay. And a follow-up question basically how are you guys positioned to take advantage of the data center architecture we are seeing that's going -- under changes basically the OpenFlow enabled software defined data centers. Can you talk a little bit about it?

Eyal Waldman

Yes. I think this is working in our favor because what's happening there is basically as you probably know InfiniBand was a software-defined network from day one basically the FabNet manager was software controlling and managing the whole FabNet and Interconnect.

So we are now seeing the whole industry move with Ethernet to software-defined network and I think we are in a great position to take advantage of them.

Saqib Jalil – JPMorgan

Okay. And then just last question. In terms of – for the FDR InfiniBand, can we expect it to grow a gain in the first quarter?

Eyal Waldman

In absolute – again, we currently expect to be kind of flat Q4 to Q1. So that's where we are.

Saqib Jalil – JPMorgan

Okay. Thank you.

Eyal Waldman

Thank you.

Operator

Thank you. We will take our next question from Brent Bracelin from Pacific Crest. Please go ahead.

Brent Bracelin - Pacific Crest

Thank you. Couple of questions if I could hear, one is, want to go back to the revenue growth drivers this year, it sounds like obviously you are guiding – rebounding growth in Q1, it sounds like you would like to grow sequentially each quarter this year. You mentioned HPC and the storage as the two areas that you feel the most confident about, you didn't or I didn't catch the cloud side. Do you think there is a little bit of timing issue around the cloud and help us understand the drivers this year, is it going to mostly be the two big areas HPC and storage that drives the bulk of growth for you this year?

Eyal Waldman

I think we will also grow in the Web 2.0 and the cloud as well.

Brent Bracelin - Pacific Crest

Okay. And then looking at Ethernet business in Q4, I know that its going to be a little lumpier but you did see good growth its now 15% of the mix here up from call it 90% last year, but it did slow year-over-year, I think below 20% year-over-year. Is there some catalyst or reaccelerate kind of growth on the Ethernet side, what's your level of confidence in growing that say faster than your InfiniBand business next year or will it grow slower than your InfiniBand business next year?

Eyal Waldman

So we don't know relative to InfiniBand, but we do expect our Ethernet business to grow year-over-year.

Brent Bracelin - Pacific Crest

At a high level. Okay. And then as it relates to the quarter itself clearly you got cut-off guard last year buy some excess inventory at HP, IBM I know they are declining as a percentage of the business but they are still 10% plus customer. Have you factored in the assumption there would be a disruption because of that Lenovo, IBM transaction in the current quarter and in your guidance?

Eyal Waldman

Yes. We are in touch with both IBM and Lenovo. I think it's going to take some time until this deal closes. And we working with both entities to hopefully help us smooth transition. So yes, what we have in our forecast takes it into account.

Brent Bracelin - Pacific Crest

Okay. And two more quick questions here if I could. One on storage, you mentioned 10 gig going to 40 gig as being a driver of the business there as you think about the InfiniBand portfolio versus the Ethernet portfolio, what's the big driver of storage, is it on the InfiniBand side or are you seeing good design wins on 40 gigE as well?

Eyal Waldman

The majority of our storage revenue is InfiniBand base. We are seeing more design wins on the Ethernet Interconnect and storage as well.

Brent Bracelin - Pacific Crest

Okay, helpful. And then my last question will really be around kind more of a futures question around the next version of InfiniBand called 112 gig InfiniBand, are you add-in in the 100 gig race, what are the type of applications that that need north of 100 gig of bandwidth and what's the appetite and timeline to deliver a solution there and have a kind of market advantage over some of the competitors out there?

Eyal Waldman

So I think we said that we expect 100 gigabit per second technology in the 2014-2015 timeframe. We believe we'll be the first guys with 100 gigabit per second for the markets we are addressing. We are seeing 100 gigabit per second people waiting for that in the high performance computing market storage Web 2.0 and I think after that not in the first one, also the cloud. But HPC storage and Web 2.0, they are waiting for the 100 gigabit per second Interconnect.

Brent Bracelin - Pacific Crest

And 2014, 2015 pretty wide range there, I mean, obviously we are already in 2014, shall kind of think about that as more of a late 2014 early 2015 or do you still have work to do relative to finalizing that product?

Eyal Waldman

We have our schedules but the way we presented to the market is 2014-2015 timeframe.

Brent Bracelin - Pacific Crest

Okay. I tried. Thank you.

Eyal Waldman

Thank you.

Operator

Thank you. Our next question comes from Kevin Cassidy with Stifel. Please go ahead.

Kevin Cassidy - Stifel

Thanks for taking the follow-up question. Just – I know that the inventory is up in the quarter, what inventory levels are you comfortable with and are you building for certain programs?

Jacob Shulman

Yes. Obviously, our inventory turns unchanged at 4.3x at the quarter end. Typically we target inventory turns above 4 and above. So we are currently comfortable with the inventory levels we currently have.

Kevin Cassidy - Stifel

Okay. Thanks.

Operator

Thank you. Our next question comes from Joseph Wolf with Barclays. Please go ahead.

Gwyn Lauber

Joseph?

Operator

Mr. Wolf, please check your mute function.

We move next to Alex Gauna with JMP Securities. Please go ahead.

Alex Gauna - JMP Securities

Hey, thanks so much for taking my question. Hey, Eyal, I know you said not to expect the same sort of benefit from Grantley as we saw with Romley. But, I'm wondering if you can give some color in terms of other than thinking about the upgrade cycle and what it means for Intel or Grantley server demand in general, what would be the growth driver for you on top of that? Last time you benefited from 56 gig, is there a similar benefit we should expect from 100 gig or are there other factors that may drive some of your open compute initiatives. Thank you.

Eyal Waldman

So the Grantley definitely it's a HPC play but we also expect to see other market choose the Grantley when it comes out. But, the first one that will adapt will be the high-performance computing market. We do expect to continue growing and demonstrate growth this year from storage Web 2.0 and cloud. So as you see year-over-year, it is a growth quarter compared to 2013 and 2012 and we expect to continue growing from here.

Alex Gauna - JMP Securities

Well, I guess its a follow-up on that, should we expect anything more than whatever Grantley does, I mean are you expecting to get more 40 gig of this or a richer mix of 56 gig is that something that goes along with this?

Eyal Waldman

We expect with the Grantley to have more higher mix of definitely 40, 56 and later on also 100.

Alex Gauna - JMP Securities

Okay. And then you mentioned the storage market where you're just in your infancy in terms of getting started in that market. Can you talk about either what you see the adoption rate of your solutions being or your type of accelerated solutions being the growth rate for the end market or may be even more specifically what you think you can grow your business within that envelope just in the storage application?

Eyal Waldman

So I believe we can demonstrate good growth in the storage market because we're going to take more market share like we said from proprietary and fiber channel Interconnects.

Alex Gauna - JMP Securities

And no color in terms of this is a 50% growth market doubling type of growth market nothing like that?

Eyal Waldman

No.

Alex Gauna - JMP Securities

Okay. Well, thanks very much.

Eyal Waldman

Thank you.

Operator

Thank you. Our next question comes from Srini Nandury with Summit Research. Please go ahead.

Srini Nandury - Summit Research

Thank you for taking my call. Eyal, you previously mentioned that you expect storage to be 20%, 25% of your revenue. What timeframe are we talking about here? Storage to be up to 20%, 5%?

Eyal Waldman

That storage will be up 25% of our revenues?

Srini Nandury - Summit Research

Yes, I mean 20% to 25% of your revenue in total its 15% right now, right?

Eyal Waldman

I don't think we gave out those numbers. But we do expect to continue growing in terms of revenues from storage. I think we did say that its in the teens in terms of storage revenues we do expect it to grow as percentage of revenues. But again, it really depends on how the other markets will also grow. So we expect to grow in all of the markets we're playing.

Srini Nandury - Summit Research

When you say you're replacing fiber channel when you say InfiniBand is replacing fiber channel, in which verticals are you talking about? Is this of the new assets of Web2.0 Cloud or even in Enterprise, if InfiniBand is replacing, is it replacing on the backend or is it also replacing on the front end?

Eyal Waldman

Today mainly on the back end and we're -- if EMC Isilon, if IBM XIV, if Teradata, if Exadata, some of the NetApp solutions and we are starting to see more and more and you've seen some announcement last quarter of InfiniBand front end connectivity as well.

Srini Nandury - Summit Research

Jacob, I have got one last question and I'll hit the floor. Are you guys expecting a sequential revenue growth for the full year? I mean quarter-over-quarter or every single quarter like last year?

Jacob Shulman

Quarter-over-quarter growth revenues.

Eyal Waldman

Yes. So we said, yes, we do expect to see revenue growth sequential this year in 2014.

Srini Nandury - Summit Research

Okay. Thank you.

Eyal Waldman

Okay.

Operator

Thank you. Our next question comes from Joseph Wolf with Barclays. Please go ahead.

Joseph Wolf - Barclays

Hi, can you guys hear me now?

Eyal Waldman

Yes.

Jacob Shulman

Yes. We can.

Joseph Wolf - Barclays

Okay, thank you. Just a question on 40 gig you guys have announced new products the NICs and I'm just wondering you got good growth, is your lead hurting, is your lead so far ahead that the market is just not developing right now, what are the I guess what are the break points that market where you start to see some real deployments and that could be $5 million to $10 million business for you?

Eyal Waldman

No. I think the market is using our technologies, I don't think we're ahead of the market.

Joseph Wolf - Barclays

So the fact that there is no competition isn't hurting growth just yet or still?

Eyal Waldman

No. Again, we are seeing deployments of 40 gig. I think it takes time and we do like we said we do expect to see a nice transition of multiple markets both some of the Web 2.0 some of the cloud definitely storage from 10 to 40 this year.

Joseph Wolf – Barclays

Okay. Thank you.

Eyal Waldman

Thank you.

Operator

And it appears we have no further questions at this time. I will now turn the call back to Eyal Waldman for any further comments.

Eyal Waldman

Thank you. Thank you for participating in our call. And have a great 2014. Thank you.

Operator

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

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