Company Quick10K Filing
Quick10K
Mellanox Technologies
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$117.76 55 $6,420
10-Q 2019-03-31 Quarter: 2019-03-31
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-05-23 Other Events
8-K 2019-04-16 Earnings, Exhibits
8-K 2019-03-10 Enter Agreement, Regulation FD, Exhibits
8-K 2019-01-30 Earnings, Exhibits
8-K 2019-01-03 Officers, Regulation FD, Exhibits
8-K 2018-10-24 Earnings, Exhibits
8-K 2018-07-25 Officers, Shareholder Vote, Exhibits
8-K 2018-07-17 Earnings, Exhibits
8-K 2018-07-09 Officers
8-K 2018-06-19 Enter Agreement, Officers, Other Events, Exhibits
8-K 2018-03-15 Regulation FD, Exhibits
8-K 2018-02-20 Officers, Regulation FD, Exhibits
8-K 2018-01-18 Earnings, Exhibits
MET Metlife 45,120
INCY Incyte 17,590
FCNCA First Citizens Bancshares 5,100
CEPU Central Puerto 1,420
IOVA Iovance Biotherapeutics 1,330
PJT PJT Partners 1,040
VRML Vermillion 92
ILCC International Leaders Capital 0
UBLI Yinghong Guangda Technology 0
TDRP Teardroppers 0
MLNX 2019-03-31
Part I. Financial Information
Item 1 - Financial Statements
Note 1-The Company and Summary of Significant Accounting Policies:
Note 2-Revenue
Note 3-Balance Sheet Components:
Note 4-Fair Value Measurements:
Note 5-Investments:
Note 6-Goodwill and Intangible Assets:
Note 7-Derivatives and Hedging Activities:
Note 8-Employee Benefit Plans:
Note 9-Commitments and Contingencies:
Note 10-Share Incentive Plans
Note 11-Accumulated Other Comprehensive Income (Loss):
Note 12-Income Taxes:
Note 13-Other Income, Net:
Note 14-Leases:
Note 15-Restructuring Charges:
Note 16-Subsequent Event:
Item 2-Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3-Quantitative and Qualitative Disclosures About Market Risk
Item 4-Controls and Procedures
Part II. Other Information
Item 1-Legal Proceedings
Item 1A-Risk Factors
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 - Defaults Upon Senior Securities
Item 4 - Mine Safety Disclosures
Item 5 - Other Information
Item 6 - Exhibits
EX-10.1 ex101mlnx-ctrxtechnologyli.htm
EX-31.1 ex311rule13a-14a15dx14acer.htm
EX-31.2 ex312rule13a-14a15dx14acer.htm
EX-32.1 ex321sec1350certofceoq12019.htm
EX-32.2 ex322sec1350certofcfoq12019.htm

Mellanox Technologies Earnings 2019-03-31

MLNX 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 a2019033110-q.htm 10-Q Document


 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended: March 31, 2019
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to            

Commission File Number 001-33299
MELLANOX TECHNOLOGIES, LTD.
(Exact name of registrant as specified in its charter)
Israel
(State or other jurisdiction of
incorporation or organization)
 
98-0233400
(I.R.S. Employer
Identification Number)
Beit Mellanox, Yokneam, Israel 20692
(Address of principal executive offices, including zip code)
+972-4-909-7200
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x    No o
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes x    No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
 
 
 
 
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o    No x
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Ordinary Shares, nominal value NIS 0.0175 per share
MLNX
The Nasdaq Global Market

The total number of shares outstanding of the registrant's Ordinary Shares, nominal value NIS 0.0175 per share, as of May 3, 2019, was 54,775,549.
 
 
 
 
 



MELLANOX TECHNOLOGIES, LTD.
          PART I
Page No.
          FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

PART I. FINANCIAL INFORMATION
ITEM 1 — FINANCIAL STATEMENTS




MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 
March 31,
 
December 31,
 
2019
 
2018
 
(in thousands, except par value)
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
75,352

 
$
56,766

Short-term investments
477,211

 
381,724

Accounts receivable, net
171,718

 
150,625

Inventories
95,656

 
104,381

Other current assets
23,320

 
16,942

Total current assets
843,257

 
710,438

Property and equipment, net
107,509

 
105,334

Severance assets
5,067

 
17,043

Intangible assets, net
166,686

 
179,328

Right of use assets
65,733

 

Goodwill
473,916

 
473,916

Deferred taxes and other long-term assets
95,605

 
101,139

Total assets
$
1,757,773

 
$
1,587,198

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
 
 
 
Accounts payable
$
63,349

 
$
70,336

Accrued liabilities
145,901

 
121,878

Deferred revenue
22,840

 
20,558

Lease liabilities, current
17,730

 

Total current liabilities
249,820

 
212,772

Accrued severance
6,145

 
21,645

Deferred revenue
19,565

 
18,665

Lease liabilities, long term
53,660

 

Other long-term liabilities
33,673

 
32,468

Total liabilities
362,863

 
285,550

Commitments and Contingencies - (see Note 9)


 


Shareholders’ equity:
 
 
 
Ordinary shares: NIS 0.0175 par value, 200,000 shares authorized, 54,532 and 53,918 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively
236

 
233

Additional paid-in capital
1,023,943

 
982,677

Accumulated other comprehensive income (loss)
2,322

 
(1,051
)
Retained earnings
368,409

 
319,789

Total shareholders’ equity
1,394,910

 
1,301,648

Total liabilities and shareholders' equity
$
1,757,773

 
$
1,587,198


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3


MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands, except per share data)
Total revenues
$
305,217

 
$
251,000

Cost of revenues
108,086

 
88,998

Gross profit
197,131

 
162,002

Operating expenses:
 

 
 

Research and development
92,205

 
86,426

Sales and marketing
40,097

 
39,494

General and administrative
19,271

 
16,516

Restructuring and impairment charges
903

 
7,587

Total operating expenses
152,476

 
150,023

Income from operations
44,655

 
11,979

Interest expense
(14
)
 
(1,171
)
Other income, net
8,245

 
638

Interest and other, net
8,231

 
(533
)
Income before taxes on income
52,886

 
11,446

Provision for (benefit from) taxes on income
4,266

 
(26,397
)
Net income
$
48,620

 
$
37,843

Net income per share — basic
$
0.90

 
$
0.73

Net income per share — diluted
$
0.87

 
$
0.71

Shares used in computing net income per share:
 

 
 

Basic
54,227

 
51,819

Diluted
55,794

 
53,646


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
   

4


MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
Net income
$
48,620

 
$
37,843

Other comprehensive income (loss), net of tax:
 

 
 

Change in unrealized gains (losses) on available-for-sale securities, net of tax
782

 
(293
)
Change in unrealized gains (losses) on derivative contracts, net of tax
2,591

 
(1,338
)
Other comprehensive income (loss), net of tax
3,373

 
(1,631
)
Total comprehensive income, net of tax
$
51,993

 
$
36,212

 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


5


MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
 
 
Additional
 
Other
 
 
 
Total
 
Ordinary Shares
 
Paid-in
 
Comprehensive
 
Retained
 
Shareholders'
 
Shares
 
Amount
 
Capital
 
Income (Loss)
 
Earnings
 
Equity
 
(In thousands, except share data)
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
53,918,208

 
$
233

 
$
982,677

 
$
(1,051
)
 
$
319,789

 
$
1,301,648

 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
 
 
 
 
48,620

 
48,620

Unrealized gains on available-for-sale securities and derivative contracts, net of taxes
 
 
 
 
 
 
3,373

 
 
 
3,373

Share-based compensation
 
 
 
 
24,242

 
 
 
 
 
24,242

Issuances of shares through employee equity incentive plans
451,535

 
2

 
5,970

 
 
 
 
 
5,972

Issuance of shares through employee share purchase plan
162,573

 
1

 
11,054

 
 
 
 
 
11,055

Balance at March 31, 2019
54,532,316

 
$
236

 
$
1,023,943

 
$
2,322

 
$
368,409

 
$
1,394,910

 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
51,487,650

 
$
221

 
$
873,979

 
$
1,618

 
$
181,630

 
$
1,057,448

 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
 
 
 
 
37,843

 
37,843

Unrealized losses on available-for-sale securities and derivative contracts, net of taxes
 
 
 
 
 
 
(1,631
)
 
 
 
(1,631
)
Effect of adopting Topic 606
 
 
 
 
 
 
 
 
4,501

 
4,501

Share-based compensation
 
 
 
 
14,974

 
 
 
 
 
14,974

Issuances of shares through employee equity incentive plans
384,523

 
2

 
2,708

 
 
 
 
 
2,710

Issuance of shares through employee share purchase plan
288,017

 
1

 
11,347

 
 
 
 
 
11,348

Balance at March 31, 2018
52,160,190

 
$
224

 
$
903,008

 
$
(13
)
 
$
223,974

 
$
1,127,193



The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


6


MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 
 
Three Months Ended March 31,
 
 
2019
 
2018
 
 
(in thousands)
Cash flows from operating activities:
 
 

 
 

Net income
 
$
48,620

 
$
37,843

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
23,962

 
26,442

Deferred income taxes
 

 
(26,827
)
Share-based compensation
 
24,242

 
14,974

Gain on short-term investments, net
 
(2,758
)
 
(886
)
Gain on sale of an investment in a privately-held company
 
(9,128
)
 

Impairment charges
 
2,544

 
139

Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
(21,093
)
 
11,316

Inventories
 
7,293

 
(5,654
)
Prepaid expenses and other assets
 
(3,552
)
 
(1,349
)
Accounts payable
 
(7,407
)
 
3,911

Accrued liabilities and other liabilities
 
25,709

 
(4,504
)
Net cash provided by operating activities
 
88,432

 
55,405

 
 
 

 
 
Cash flows from investing activities:
 
 
 
 
Purchase of severance-related insurance policies
 
(90
)
 
(317
)
Purchase of short-term investments
 
(191,203
)
 
(20,899
)
Proceeds from sales and maturities of short-term investments
 
99,256

 
37,047

Proceeds from sale of an investment in a privately-held company
 
16,887

 

Purchase of property and equipment
 
(7,686
)
 
(7,226
)
Purchase of intangible assets
 
(1,678
)
 
(6,315
)
Purchase of investments in privately-held companies
 

 
(2,500
)
Net cash used in investing activities
 
(84,514
)
 
(210
)
 
 
 
 
 
Cash flows from financing activities:
 
 

 
 
Principal payments on term debt
 

 
(39,000
)
Payments on intangible asset financings
 
(2,303
)
 
(2,173
)
Proceeds from issuances of ordinary shares through employee equity incentive plans and employee share purchase plan
 
17,027

 
14,058

Net cash provided by (used in) financing activities
 
14,724

 
(27,115
)
 
 
 
 
 
Net increase in cash, cash equivalents, and restricted cash
 
18,642

 
28,080

Cash, cash equivalents, and restricted cash at beginning of period
 
64,650

 
70,498

Cash, cash equivalents, and restricted cash at end of period
 
$
83,292

 
$
98,578

 
 
 
 
 
Supplemental disclosure of non-cash investing and financing activities
 
 
 
 
Intangible assets financed with debt
 
$
717

 
$
549

Unpaid additions to property and equipment
 
$
2,771

 
$
2,254

Transfer from inventory to property and equipment
 
$
1,432

 
$
425



The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


7


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1—THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Company
Mellanox Technologies, Ltd., an Israeli corporation (the "Company" or "Mellanox"), was incorporated and commenced operations in March 1999. Mellanox is a supplier of high-performance interconnect products for computing, storage and communications applications.
Pending Merger with NVIDIA Corporation
On March 10, 2019, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with NVIDIA Corporation, a Delaware corporation (“NVIDIA”), NVIDIA International Holdings Inc., a Delaware corporation and wholly owned subsidiary of NVIDIA (“Parent”) and Teal Barvaz Ltd., a wholly owned subsidiary of Parent organized under the laws of the State of Israel and wholly owned subsidiary of Parent (“Merger Sub”). NVIDIA has agreed to guarantee the payment and performance obligations of Parent under the Merger Agreement. The Merger Agreement and the Merger (as defined below) have been approved by the boards of directors of the Company, NVIDIA, Parent and Merger Sub.
The Merger Agreement provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will be merged with and into the Company (the “Merger”) in accordance with Sections 314-327 of the Companies Law 5759-1999 of the State of Israel, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Parent.
At the effective time of the Merger (the “Effective Time”), each ordinary share, par value NIS 0.0175 per share, of the Company (a “Company Share”) issued and outstanding immediately prior to the Effective Time, other than any shares owned by the Company, Parent and their respective subsidiaries or any shares held in the Company’s treasury, will be deemed to have been transferred to the Parent in exchange for the right to receive $125.00 in cash, without interest and subject to applicable withholding taxes.
The Merger Agreement contains customary representations, warranties and covenants. The consummation of the Merger is conditioned on the receipt of the approval of the Company’s shareholders, as well as the satisfaction of other customary closing conditions, including domestic and foreign regulatory approvals and performance in all material respects by each party of its obligations under the Merger Agreement. Consummation of the Merger is not subject to a financing condition. Closing of the Merger is expected by the end of calendar year 2019.
The Merger Agreement contains certain customary termination rights by either the Company or Parent, including if the Merger is not consummated by December 10, 2019, subject to two three-month extensions in order to obtain required regulatory approvals. If the Merger Agreement is terminated under certain circumstances, including termination by the Company to enter into a superior proposal, a termination by Parent following a change of the Company’s board of directors’ recommendation or a termination by Parent as a result of a willful material breach of the Merger Agreement’s no-solicitation obligations by the Company, the Company will be obligated to pay to Parent a termination fee equal to $225 million in cash. If the Merger Agreement is terminated under certain circumstances involving the failure to obtain certain regulatory approvals, Parent will be obligated to pay the Company a termination fee equal to $350 million in cash.
The Company recorded transaction-related costs of $4.4 million, principally for investment banking and legal fees associated with the pending acquisition, during the three months ended March 31, 2019. These costs are recorded in general and administrative expenses included in the condensed consolidated statement of operations for the three months ended March 31, 2019. Additional transaction-related costs are expected to be incurred through the closing of the Merger.
Principles of presentation
The unaudited condensed consolidated financial statements include the Company's accounts as well as those of its wholly owned subsidiaries after the elimination of all intercompany balances and transactions.
The unaudited condensed consolidated financial statements included in this quarterly report on Form 10-Q have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The year-end balance sheet data were derived from audited consolidated financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States ("GAAP"). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures contained in

8


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


this quarterly report comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended, for a quarterly report on Form 10-Q and are adequate to make the information presented not misleading. The unaudited condensed consolidated financial statements included herein reflect all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 21, 2019. The results of operations for the three months ended March 31, 2019 are not necessarily indicative of the results to be anticipated for the entire year ending December 31, 2019 or thereafter.
Risks and uncertainties
The Company is subject to all of the risks inherent in a company which operates in the dynamic and competitive semiconductor industry. Significant changes in any of the following areas could have a material adverse impact on the Company's financial position and results of operations: unpredictable volume or timing of customer orders; ordered product mix; the sales outlook and purchasing patterns of the Company's customers based on consumer demands and general economic conditions; loss of one or more of the Company's customers; decreases in the average selling prices of products or increases in the average cost of finished goods; the availability, pricing and timeliness of delivery of components used in the Company's products; reliance on a limited number of subcontractors to manufacture, assemble, package and production test the Company's products; the Company's ability to successfully develop, introduce and sell new or enhanced products in a timely manner; product obsolescence and the Company's ability to manage product transitions; the timing of announcements or introductions of new products by the Company's competitors; and the Company's ability to successfully integrate acquired businesses.
Use of estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of net revenue and expenses in the reporting periods. The Company regularly evaluates estimates and assumptions related to revenue recognition, allowances for doubtful accounts, allowances for price adjustments, investment valuation, warranty reserves, inventory reserves, share-based compensation expense, long-term asset valuations, useful lives of property, equipment, and intangibles, accounting for business combinations, goodwill and purchased intangible asset valuation, investments in privately-held companies, accounting and fair value of financial instruments and derivatives, deferred income tax asset valuation, uncertain tax positions, and litigation and other loss contingencies. These estimates and assumptions are based on current facts, historical experience and various other factors that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results that the Company experiences may differ materially and adversely from the Company's original estimates. To the extent there are material differences between the estimates and actual results, the Company's future results of operations will be affected.
Significant accounting policies
Other than our new accounting policy related to the new lease standard (see Note 14, "Leases"), there have been no changes in the Company’s significant accounting policies that were disclosed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 21, 2019.
Restricted cash
The Company maintains certain cash amounts that are restricted as to withdrawal or use over the long-term. The cash is securing bank guarantees primarily issued against long-term tenancy agreements. The long-term restricted cash balance of $7.9 million and $8.0 million was reported in other long-term assets on the balance sheet as of March 31, 2019 and 2018, respectively, and was included in the ending balance of cash, cash equivalents and restricted cash in the statement of cash flows for the three months ended March 31, 2019 and 2018, respectively. The following table provides a reconciliation of the cash and cash equivalents balances reported on the balance sheets and the cash, cash equivalents and restricted cash balances reported in the statements of cash flows:

9


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


 
March 31,
 
2019
 
2018
 
(In thousands)
Cash and cash equivalents, as reported on the balance sheets
$
75,352

 
$
90,578

Restricted cash in other long-term assets, as reported on the balance sheets
7,940

 
8,000

Cash, cash equivalents, and restricted cash, as reported in the statements of cash flows
$
83,292

 
$
98,578

Concentration of credit risk
The following table summarizes the revenues from customers (including original equipment manufacturers) in excess of 10% of the total revenues:
 
Three Months Ended March 31,
 
2019
 
2018
Dell Technologies Inc. ("Dell")
15
%
 
10
%
Hewlett Packard Enterprise ("HPE")
*

 
17
%
____________________
 
 
 
* Less than 10%
 
 
 
The following table summarizes accounts receivable balances in excess of 10% of total accounts receivable as of March 31, 2019 and December 31, 2018.
 
March 31, 2019
 
December 31, 2018
Dell
11
%
 
*
____________________
 
 
 
* Less than 10%
 
 
 

Product warranty
The following table provides changes in the product warranty accrual for the three months ended March 31, 2019 and 2018:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
Balance, beginning of the period
$
1,376


$
889

New warranties issued during the period
844


349

Reversal of warranty reserves
(5
)


Settlements during the period
(691
)

(301
)
Balance, end of the period
1,524


937

Less: long-term portion of product warranty liability
(318
)

(172
)
Current portion, end of the period
$
1,206


$
765


10


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


Net income per share
The following table sets forth the computation of basic and diluted net income per share for the three months ended March 31, 2019 and 2018:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands, except per share data)
Net income
$
48,620

 
$
37,843

Basic and diluted shares:
 


 

Weighted average ordinary shares outstanding
54,227


51,819

Effect of dilutive shares
1,567


1,827

Shares used to compute diluted net income per share
55,794

 
53,646

Net income per share — basic
$
0.90

 
$
0.73

Net income per share — diluted
$
0.87

 
$
0.71

The Company excluded 0.1 million and 0.2 million potentially dilutive share options and restricted share units ("RSUs") from the computation of diluted net income per share for the three months ended March 31, 2019 and 2018, respectively, because including them would have had an anti-dilutive effect.
Adoption of new accounting principles
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The standard requires lessees to recognize almost all leases on the balance sheet as a right-of-use asset and a lease liability and requires leases to be classified as either an operating or a finance type lease. The standard excludes leases of intangible assets or inventory.
The standard became effective for the Company on January 1, 2019. The Company elected the available practical expedients and implemented internal controls to enable the preparation of financial information on adoption. The adoption of the standard had a material impact on the Company's condensed consolidated balance sheets due to the recognition of the right-of-use ("ROU") assets and lease liabilities related to the Company's operating leases. In addition, a material portion of the Company's leases are denominated in currencies other than the U.S. Dollar, mainly in New Israeli Shekels ("NIS"). As a result, the associated lease liabilities were remeasured using the current exchange rate, which resulted in non-operating foreign exchange losses. The standard did not have a material impact on the Company's results of operations or cash flows. See Note 14, "Leases" for details about the impact from adopting the new lease standard and other required disclosures.
Recent accounting pronouncements
In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU clarifies the accounting treatment for implementation costs for cloud computing arrangements (hosting arrangements) that are service contracts. This standard becomes effective for the Company beginning January 1, 2020. The Company is currently assessing the effect that this ASU will have on its condensed consolidated financial statements and related disclosures. 


11


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


NOTE 2—REVENUE
Revenues by geographic region for the three months ended March 31, 2019 and 2018 were as follows:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
United States
$
110,294

 
$
96,260

China
78,140

 
56,213

Europe
47,246

 
35,996

Other Americas
25,729

 
27,740

Other Asia
43,808

 
34,791

Total revenues
$
305,217

 
$
251,000

The following tables represent our total revenues for the three months ended March 31, 2019 and 2018 by product type and interconnect protocol:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
ICs
$
60,623

 
$
28,587

Boards
108,430

 
118,051

Switch systems
82,058

 
55,647

Cables, accessories and other
54,106

 
48,715

Total revenues
$
305,217

 
$
251,000

 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
InfiniBand:
 
 
 
HDR
$
23,193

 
$

EDR
59,643

 
55,946

FDR
40,598

 
41,748

QDR/DDR/SDR
14,704

 
5,444

Total
138,138

 
103,138

Ethernet
160,893

 
136,948

Other
6,186

 
10,914

Total revenues
$
305,217

 
$
251,000

Contract balances
The Company recognizes contract liabilities, or deferred revenues, when it receives advance payments from customers before performance obligations primarily related to extended warranty and post-contract customer support have been performed. Advance payments are received at the beginning of the service period and the related deferred revenues are reclassified to revenue ratably over the service period. The balance of deferred revenues approximates the aggregate amount of the transaction price allocated to the unsatisfied performance obligations at the end of reporting period. The Company expects to recognize the long-term portion of deferred revenue over the remaining service period of up to five years.

12


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


The following table presents the significant changes in the deferred revenue balance during the three months ended March 31, 2019:
 
(in thousands)
Balance, beginning of the period
$
39,223

New deferred revenue
11,155

Reclassification to revenues during the year (1)
(7,973
)
Balance, end of the period
42,405

Less: long-term portion of deferred revenue
19,565

Current portion, end of the period
$
22,840

(1) Of the total reclassification from deferred revenue to revenues, $6.2 million was related to the beginning balance, and $1.8 million was related to the new deferred revenue during the period.
Unsatisfied performance obligations, other than extended warranty and post-contract customer support, primarily represent contracts with future delivery dates. As of March 31, 2019, the Company had $69.5 million of unbilled transaction price allocated to performance obligations that were unsatisfied or partially unsatisfied related to contracts with an original duration over one year. The Company expects to invoice and recognize the revenue as it satisfies each performance obligation during a period of three years. The foregoing excludes the value of the remaining unsatisfied performance obligations related to contracts that have original durations of one year or less.
The Company recognizes assets for the material incremental costs of obtaining contracts with customers if it expects the benefit of those costs to be longer than one year. The Company allocates these assets proportionally to the performance obligations in the contracts and amortizes them as the performance obligations are satisfied. During the three months ended March 31, 2019, the Company recognized $11.3 million of assets related to costs to obtain contracts, and amortized $3.5 million of these assets during the same period. The unamortized balance of the assets was $7.8 million as of March 31, 2019.


13


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


NOTE 3—BALANCE SHEET COMPONENTS:
 
 
March 31, 2019
 
December 31, 2018
 
 
(in thousands)
Accounts receivable, net:
 
 

 
 

Accounts receivable, gross
 
$
179,218

 
$
156,525

Less: unearned distribution price adjustments allowance
 
(7,000
)
 
(5,400
)
Less: allowance for doubtful accounts
 
(500
)
 
(500
)
 
 
$
171,718

 
$
150,625

Inventories:
 
 

 
 

Raw materials
 
$
18,442

 
$
19,391

Work-in-process
 
35,305

 
39,425

Finished goods
 
41,909

 
45,565

 
 
$
95,656

 
$
104,381

Property and equipment, net:
 
 

 
 
Computer, equipment, and software
 
$
187,033

 
$
180,125

Furniture and fixtures
 
1,876

 
2,140

Leasehold improvements
 
47,169

 
46,179

 
 
236,078

 
228,444

Less: Accumulated depreciation and amortization
 
(128,569
)
 
(123,110
)
 
 
$
107,509

 
$
105,334

Deferred taxes and other long-term assets:
 
 

 
 
Equity investments in privately-held companies
 
$
30,807

 
$
40,300

Deferred taxes
 
50,660

 
50,660

Long-term restricted cash
 
7,940

 
7,884

Other assets
 
6,198

 
2,295

 
 
$
95,605

 
$
101,139

Accrued liabilities:
 
 

 
 
Payroll and related expenses
 
$
87,346

 
$
76,788

Accrued expenses
 
37,446

 
28,821

Intangible asset financings
 
4,171

 
4,488

Derivative contracts payable
 
318

 
2,536

Product warranty liability
 
1,206

 
1,090

Other
 
15,414

 
8,155

 
 
$
145,901

 
$
121,878

Other long-term liabilities:
 
 
 
 
Income tax payable
 
$
31,116

 
$
25,600

Deferred rent
 

 
2,532

Other
 
2,557

 
4,336

 
 
$
33,673

 
$
32,468



14


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


NOTE 4—FAIR VALUE MEASUREMENTS:
Fair value hierarchy:
The Company measures its cash equivalents and marketable securities at fair value. The Company’s cash equivalents are classified within Level 1. Cash equivalents are valued primarily using quoted market prices utilizing market observable inputs. The Company's investments in debt securities and certificates of deposits are classified within Level 2 as the market inputs to value these instruments consist of market yields, reported trades and broker/dealer quotes. In addition, foreign currency contracts are classified within Level 2 as the valuation inputs are based on quoted prices and market observable data of similar instruments. The Level 3 valuation inputs include the Company's best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument's valuation. As of March 31, 2019 and December 31, 2018, the Company did not have any assets or liabilities valued based on Level 3 valuations.
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis:
The following table represents the fair value hierarchy of the Company's financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2019:
 
Level 1
 
Level 2
 
Total
 
(in thousands)
Money market funds
$
2,842

 
$

 
$
2,842

Certificates of deposit

 
123,972

 
123,972

U.S. Government and agency securities

 
70,683

 
70,683

Commercial paper

 
71,234

 
71,234

Corporate bonds

 
159,983

 
159,983

Municipal bonds

 
18,403

 
18,403

Foreign government bonds

 
32,936

 
32,936

 
2,842

 
477,211

 
480,053

Long-term restricted cash

 
7,940

 
7,940

Derivative contracts

 
796

 
796

Total financial assets
$
2,842

 
$
485,947

 
$
488,789

Derivative contracts

 
318

 
318

Total financial liabilities
$

 
$
318

 
$
318


15


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


The following table represents the fair value hierarchy of the Company's financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2018:
 
Level 1
 
Level 2
 
Total
 
(in thousands)
Money market funds
$
1,265

 
$

 
$
1,265

Certificates of deposit

 
95,038

 
95,038

U.S. Government and agency securities

 
50,670

 
50,670

Commercial paper

 
57,443

 
57,443

Corporate bonds

 
128,765

 
128,765

Municipal bonds

 
17,506

 
17,506

Foreign government bonds

 
32,302

 
32,302


1,265

 
381,724

 
382,989

Long-term restricted cash

 
7,884

 
7,884

Derivative contracts

 
96

 
96

Total financial assets
$
1,265

 
$
389,704

 
$
390,969

Derivative contracts

 
2,536

 
2,536

Total financial liabilities
$

 
$
2,536

 
$
2,536

There were no transfers between Level 1 and Level 2 securities during the three months ended March 31, 2019 and 2018.

NOTE 5—INVESTMENTS:
Cash, cash equivalents and short-term investments:
The short-term investments are classified as available-for-sale securities. The cash, cash equivalents and short-term investments at March 31, 2019 and December 31, 2018 were as follows:
 
March 31, 2019
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
 
(in thousands)
Cash and cash equivalents
$
72,510

 
$

 
$

 
$
72,510

Money market funds
2,842

 

 

 
2,842

Certificates of deposit
123,971

 
18

 
(17
)
 
123,972

U.S. Government and agency securities
70,562

 
142

 
(21
)
 
70,683

Commercial paper
71,280

 
11

 
(57
)
 
71,234

Corporate bonds
159,727

 
350

 
(94
)
 
159,983

Municipal bonds
18,390

 
21

 
(8
)
 
18,403

Foreign government bonds
32,875

 
64

 
(3
)
 
32,936

Total
552,157

 
606

 
(200
)
 
552,563

Less amounts classified as cash and cash equivalents
(75,352
)
 

 

 
(75,352
)
Short-term investments
$
476,805

 
$
606

 
$
(200
)
 
$
477,211



16


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


 
December 31, 2018
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
 
(in thousands)
Cash and cash equivalents
$
55,501

 
$

 
$

 
$
55,501

Money market funds
1,265

 

 

 
1,265

Certificates of deposit
95,080

 
1

 
(43
)
 
95,038

U.S. Government and agency securities
50,643

 
64

 
(37
)
 
50,670

Commercial paper
57,529

 

 
(86
)
 
57,443

Corporate bonds
129,042

 
27

 
(304
)
 
128,765

Municipal bonds
17,512

 
2

 
(8
)
 
17,506

Foreign government bonds
32,294

 
26

 
(18
)
 
32,302

Total
438,866

 
120

 
(496
)
 
438,490

Less amounts classified as cash and cash equivalents
(56,766
)
 

 

 
(56,766
)
Short-term investments
$
382,100

 
$
120

 
$
(496
)
 
$
381,724

Interest income and gains on short-term investments, net were $3.0 million and 1.0 million for the three months ended March 31, 2019 and 2018, respectively. At March 31, 2019, gross unrealized losses on investments that were in a gross unrealized loss position for greater than 12 months were $0.2 million. These investments were not deemed to be other-than-temporarily impaired and the gross unrealized losses were recorded in other comprehensive income (loss) ("OCI").
The contractual maturities of short-term investments at March 31, 2019 and December 31, 2018 were as follows:
 
March 31, 2019
 
December 31, 2018
 
Amortized
Cost
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
 
(in thousands)
Due in less than one year
$
332,122

 
$
332,157

 
$
281,303

 
$
280,959

Due in one to three years
144,683

 
145,054

 
100,797

 
100,765

 
$
476,805

 
$
477,211

 
$
382,100

 
$
381,724

Equity investments in privately-held companies:
As of March 31, 2019 and December 31, 2018, the Company held a total of $30.8 million and $40.3 million, respectively, in equity investments in privately-held companies. During the three months ended March 31, 2019, one of the investees of the Company's equity investments in privately-held companies was acquired. As a result, the Company recorded a gain on sale of $9.1 million in the first quarter of 2019. In addition, $3.2 million of the consideration owed to the Company was held back in an escrow account as of March 31, 2019. The final amount released from escrow, if any, will be recognized as an additional gain on sale when released. While performing its review for impairment for the first quarter of 2019, the Company noted an observable price change related to one of its investments in a privately-held company. As a result, the Company recorded an impairment charge of $1.8 million in the first quarter of 2019. The gain on sale and the impairment charge were reported in other income, net on the condensed consolidated statement of operations.

NOTE 6—GOODWILL AND INTANGIBLE ASSETS:
There has been no change in the carrying amount of goodwill of $473.9 million during the three months ended March 31, 2019.

17


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


The carrying amounts of intangible assets as of March 31, 2019 were as follows:
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Useful Life
 
(in thousands)
 
(in years)
Licensed technology
$
51,941

 
$
(33,547
)
 
$
18,394

 
1-8
Developed technology
285,443

 
(174,114
)
 
111,329

 
4-7
Customer relationships
69,776

 
(32,813
)
 
36,963

 
4-9
Trade names
5,600

 
(5,600
)
 

 
3
Total intangible assets
$
412,760

 
$
(246,074
)
 
$
166,686

 
 
The carrying amounts of intangible assets as of December 31, 2018 were as follows:
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Useful Life
 
(in thousands)
 
(in years)
Licensed technology
$
49,546

 
$
(30,062
)
 
$
19,484

 
1-8
Developed technology
285,443

 
(164,406
)
 
121,037

 
4-7
Customer relationships
69,776

 
(31,246
)
 
38,530

 
4-9
Trade names
5,600

 
(5,323
)
 
277

 
3
Total intangible assets
$
410,365

 
$
(231,037
)
 
$
179,328

 
 
Amortization expense of intangible assets totaled approximately $15.0 million and $16.3 million for the three months ended March 31, 2019 and 2018, respectively.
The estimated future amortization expense from amortizable intangible assets is as follows:
 
(in thousands)
2019 (remainder of the year)
$
47,339

2020
51,784

2021
39,343

2022
11,982

2023
8,115

Thereafter
8,123

Total
$
166,686


NOTE 7—DERIVATIVES AND HEDGING ACTIVITIES:
The Company enters into foreign currency forward and option contracts with financial institutions to protect against foreign exchange risks, mainly the exposure to changes in the exchange rate of the NIS against the U.S. dollar that are associated with forecasted cash flows and existing assets and liabilities. The Company accounts for its derivative instruments as either assets or liabilities and carries them at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.

18


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


Fair Value of Derivative Contracts
The fair value of derivative contracts in the unaudited condensed consolidated balance sheets at March 31, 2019 and December 31, 2018 were as follows:
 
 
Other current assets
 
Accrued liabilities
 
Other current assets
 
Accrued liabilities
 
 
March 31, 2019
 
December 31, 2018
 
 
(in thousands)
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
Currency forward and option contracts
$
796

 
$
300

 
$
27

 
$
2,122

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
 
Currency forward and option contracts
$

 
$
18

 
$
69

 
$
414

Total derivatives
$
796

 
$
318

 
$
96

 
$
2,536

The gross notional amounts of derivative contracts were NIS denominated. The notional amounts of outstanding derivative contracts in U.S. dollars at March 31, 2019 and December 31, 2018 were as follows:
 
March 31, 2019
 
December 31, 2018
 
(in thousands)
Derivatives designated as hedging instruments
 
 
Currency forward and option contracts
$
74,257

 
$
92,956

Derivatives not designated as hedging instruments
 
 
 
Currency forward and option contracts
$
45,389

 
$
57,844

Effect of Derivatives Designated as Hedging Instruments on Accumulated Other Comprehensive Income
The following table represents the unrealized gains (losses) of derivatives designated as hedging instruments, net of tax effects, that were recorded in accumulated other comprehensive income as of March 31, 2019 and December 31, 2018 and their effect on OCI for the three months ended March 31, 2019:
 
(in thousands)
December 31, 2018
$
(1,978
)
Amount of gain recognized in OCI (effective portion)
2,553

Amount of loss reclassified from OCI to income (effective portion)
38

March 31, 2019
$
613

Effect of Derivative Contracts on the Unaudited Condensed Consolidated Statement of Operations
The effect of derivative contracts on the unaudited condensed consolidated statements of operations for the three months ended March 31, 2019 and 2018 was as follows:
 
 
Derivatives designated as hedging instruments
 
Derivatives not designated as hedging instruments
 
 
Three Months Ended March 31,
 
Three Months Ended March 31,

 
2019

2018

2019

2018
 
 
(in thousands)
Operating income (loss)
 
$
(38
)
 
$
535

 
$

 
$

Other income, net
 
$

 
$

 
$
1,563

 
$
(890
)


19


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


NOTE 8—EMPLOYEE BENEFIT PLANS:
Under Israeli law, the Company is required to make severance payments to certain of its retired or dismissed Israeli employees. For employees hired prior to January 1, 2007 ("Group One"), the severance pay liability is calculated based on the last monthly salary of each employee multiplied by the number of years of such employee's employment and is presented in the Company's balance sheet in long-term liabilities, as if it was payable at each balance sheet date on an undiscounted basis. This liability is partially funded by the purchase of insurance policies or pension funds in the name of the employees. The surrender value of the insurance policies or pension funds is presented in long-term assets.
The severance pay detail is as follows:
 
March 31, 2019
 
December 31, 2018
 
(in thousands)
Accrued severance liabilities
$
6,145

 
$
21,645

Severance assets
5,067

 
17,043

Unfunded portion
$
1,078

 
$
4,602

For other Israeli employees ("Group Two"), the Company's contributions for severance pay replace its severance obligation. When the Company makes the monthly contribution equal to 8.3% of the employee's monthly salary to an insurance policy or pension fund, no additional calculations shall be conducted between the parties regarding the matter of severance pay and no additional payments will be made by the Company to the employee. Further, the related obligation and amounts deposited on behalf of the employee for such obligation are not stated on the balance sheet, as the Company is legally released from the obligation to employees once the deposit amounts have been paid.
During the first quarter of 2019, a significant portion of the employees in Group One elected to move to Group Two under settlement agreements with the Company. Under Israeli law, and according to the settlement agreements, the Company is obligated to settle these employees' net severance liabilities that had been accumulated for them up to June 30, 2018. The Company reclassed the accumulated amount of severance assets and accrued severance liabilities as of June 30, 2018 related to these employees to accrued liabilities as of March 31, 2019. The Company paid the net severance liabilities in April 2019.

NOTE 9—COMMITMENTS AND CONTINGENCIES:
Commitments
Leases
See Note 14 "Leases" for lease-related commitments as of March 31, 2019.
Purchase commitments

At March 31, 2019, the Company had the following non-cancelable purchase commitments:
 
(in thousands)
2019 (remainder of the year)
$
167,626

2020
8,817

2021
1,093

2022
327

Total
$
177,863

Other Commitments
Unrecognized tax benefits
Due to the inherent uncertainty with respect to the timing of future cash outflows associated with the Company's unrecognized tax benefits, it is unable to reliably estimate the timing of cash settlement with the respective taxing authorities.

20


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)



As of March 31, 2019, the Company's unrecognized tax benefits totaled $52.7 million, out of which an amount of $31.8 million would reduce the Company's income tax expense and effective tax rate, if recognized.
Contingencies
Legal proceedings
The Company is involved in a variety of claims, suits, investigations and proceedings that arise from time to time in the ordinary course of its business, including actions with respect to contracts, intellectual property, taxation, employment, benefits, securities, personal injuries and other matters. The results of these proceedings in the ordinary course of business are not expected to have a material adverse effect on the Company’s condensed consolidated financial position or results of operations.
The Company records a liability when it believes that it is both probable that a liability will be incurred, and the amount of loss can be reasonably estimated. The Company evaluates, at least quarterly, developments in its legal matters that could affect the amount of liability that has been previously accrued and makes adjustments as appropriate. Significant judgment is required to determine both the probability and the estimated amount of a loss or potential loss. The Company may be unable to estimate the reasonably possible loss or range of loss for a particular legal contingency for various reasons, including, among others: (i) if the damages sought are indeterminate; (ii) if proceedings are in the early stages; (iii) if there is uncertainty as to the outcome of pending proceedings (including motions and appeals); (iv) if there is uncertainty as to the likelihood of settlement and the outcome of any negotiations with respect thereto; (v) if there are significant factual issues to be determined or resolved; (vi) if the proceedings involve a large number of parties; (vii) if relevant law is unsettled or novel or untested legal theories are presented; or (viii) if the proceedings are taking place in jurisdictions where the laws are complex or unclear. In such instances, there is considerable uncertainty regarding the ultimate resolution of such matters, including a possible eventual loss, if any.

NOTE 10—SHARE INCENTIVE PLANS
Share option plans
On July 25, 2018, the Company's shareholders approved the Mellanox Technologies, Ltd. Third Amended and Restated Global Share Incentive Plan (2006) (the “Third Restated Plan”), which constitutes an amendment and restatement of the Mellanox Technologies, Ltd. Second Amended and Restated Global Share Incentive Plan (2006) (the “Second Restated Plan”). The Third Restated Plan increased the ordinary shares reserved for issuance under the Second Restated Plan by 2,077,000 shares to 4,467,000 shares plus any shares subject to issued and outstanding awards under certain of the Company’s prior equity plans that expire, are cancelled or otherwise terminated after March 14, 2016, the effective date of the first amendment and restatement of the Global Share Incentive Plan (2006). The Third Restated Plan also implements certain additional amendments, including specifically providing for the grant of performance share units.
Share option activity
Share option activity under the Company's equity incentive plans in the three months ended March 31, 2019 is set forth below:
 
Options Outstanding
 
Number
of Shares
 
Weighted
Average
Exercise
Price
Outstanding at December 31, 2018
494,503

 
$
50.73

Options exercised
(174,616
)
 
$
34.20

Options canceled
(920
)
 
$
101.37

Outstanding at March 31, 2019
318,967

 
$
59.63

The total pretax intrinsic value of options exercised in the three months ended March 31, 2019 and 2018 was $12.0 million and $5.0 million, respectively. This intrinsic value represents the difference between the fair market value of the Company's ordinary shares on the date of exercise and the exercise price of each option. Based on the closing price of the

21


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


Company's ordinary shares of $118.36 on March 29, 2019, the last trading day of the quarter ended March 31, 2019, the total pretax intrinsic value of options outstanding at March 31, 2019 was $18.7 million. The total pretax intrinsic value of options outstanding at December 31, 2018 was $21.8 million.
There were 318,238 and 493,462 options exercisable at March 31, 2019 and December 31, 2018, respectively. The total pretax intrinsic value of exercisable options at March 31, 2019 was $18.7 million. The total pretax intrinsic value of exercisable options at December 31, 2018 was $21.7 million.
Restricted share unit activity
RSU activity under the Company's equity incentive plans in the three months ended March 31, 2019 is set forth below:
 
Restricted Share
Units Outstanding
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
Non-vested restricted share units at December 31, 2018
3,294,163

 
$
65.05

Restricted share units granted
1,016,833

 
$
100.59

Restricted share units vested
(276,919
)
 
$
51.23

Restricted share units canceled
(78,942
)
 
$
66.15

Non-vested restricted share units at March 31, 2019
3,955,135

 
$
75.14

The weighted average fair value of RSUs granted in the three months ended March 31, 2019 and 2018 was $100.59 and $65.62, respectively.
The total intrinsic value of all outstanding RSUs as of March 31, 2019 and December 31, 2018 was $468.1 million and $304.3 million, respectively.
The non-vested restricted share units at March 31, 2019 included 36,000 performance share units. The PSUs will vest and be earned based on the Company’s achievement of relative total shareholder return and average non-GAAP net operating margin over a three-year performance period commencing on January 1, 2018 and ending on December 31, 2020, subject to the continued service to the Company through the end of the performance period. The number of shares that will actually vest ranges from zero to 175% of the target.
Employee Stock Purchase Plan activity
There were 162,573 and 288,017 shares purchased under the ESPP for the three months ended March 31, 2019 and 2018 at an average price per share of $68.00 and $39.40, respectively.
Shares reserved for future issuance
The Company had the following ordinary shares reserved for future issuance under its equity incentive plans as of March 31, 2019:
 
Number of
Shares
Share options outstanding
318,967

Restricted share units outstanding
3,955,135

Shares authorized for future issuance
693,480

ESPP shares available for future issuance
2,772,773

Total shares reserved for future issuance as of March 31, 2019
7,740,355


22


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


Share-based compensation
The Company accounts for share-based compensation expense based on the estimated fair value of the share equity awards as of the grant dates.
The following weighted average assumptions were used to value ESPP shares issued pursuant to the Company's share incentive plans for the three months ended March 31, 2019 and 2018:
 
Three Months Ended March 31,
 
2019
 
2018
Dividend yield
%
 
%
Expected volatility
42.6
%
 
37.2
%
Risk free interest rate
2.44
%
 
1.20
%
Expected life, years
0.5

 
0.5


The following table summarizes the distribution of total share-based compensation expense in the unaudited condensed consolidated statements of operations:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
Cost of goods sold
$
684

 
$
411

Research and development
13,241

 
8,174

Sales and marketing
5,652

 
3,599

General and administrative
4,665

 
2,790

Total share-based compensation expense
$
24,242

 
$
14,974

At March 31, 2019, there was $268.3 million of total unrecognized share-based compensation costs related to non-vested share-based compensation arrangements. The costs are expected to be recognized over a weighted average period of approximately 3.23 years.


23


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


NOTE 11—ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
The following table summarizes the changes in accumulated balances of other comprehensive income (loss) for the three months ended March 31, 2019 and 2018:
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
Unrealized Gains (Losses) on Derivatives Designated as Hedging Instruments
 
Total
 
(in thousands)
Balance at December 31, 2018
$
927

 
$
(1,978
)
 
$
(1,051
)
Other comprehensive income/(loss) before reclassifications, net of taxes
775

 
2,553

 
3,328

Realized (gains)/losses reclassified from accumulated other comprehensive income
7

 
38

 
45

Net current-period other comprehensive income/(loss), net of taxes
782

 
2,591

 
3,373

Balance at March 31, 2019
$
1,709

 
$
613

 
$
2,322

 
 
 
 
 
 
Balance at December 31, 2017
$
693

 
$
925

 
$
1,618

Other comprehensive income/(loss) before reclassifications, net of taxes
(293
)
 
(803
)
 
(1,096
)
Realized (gains)/losses reclassified from accumulated other comprehensive income

 
(535
)
 
(535
)
Net current-period other comprehensive income/(loss), net of taxes
(293
)
 
(1,338
)
 
(1,631
)
Balance at March 31, 2018
$
400

 
$
(413
)
 
$
(13
)
The following table provides details about reclassifications out of accumulated other comprehensive income (loss) for the three months ended March 31, 2019 and 2018:
 
 
Realized (Gains)/Losses Reclassified from Accumulated Other Comprehensive Income (Loss)
 
Affected Line Item in the Statement of Operations
 
 
Three Months Ended March 31,
 
 
 
 
2019
 
2018
 
 
 
 
(in thousands)
 
 
Realized (gains)/losses on derivatives designated as hedging instruments
 
$
38

 
$
(535
)
 
Cost of revenues and Operating expenses:
 
 
2

 
(26
)
 
Cost of revenues
 
 
4

 
(64
)
 
General and administrative
 
 
3

 
(47
)
 
Sales and marketing
 
 
29

 
(398
)
 
Research and development
Realized (gains)/losses on available-for-sale securities
 
7

 

 
Other income, net
Total reclassifications for the period
 
$
45

 
$
(535
)
 
Total

NOTE 12—INCOME TAXES:
As of March 31, 2019 and December 31, 2018, the Company had gross unrecognized tax benefits of $52.7 million and $46.5 million, respectively. It is the Company’s policy to classify accrued interest and penalties as part of the unrecognized tax benefits and record the expense in the provision for income taxes. The amount of accrued interest and penalties related to unrecognized tax benefits totaled $2.5 million at March 31, 2019 and $2.6 million at December 31, 2018.

24


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


As of March 31, 2019, the 2014 through 2018 tax years are open and may be subject to potential examinations in the United States. The Company has NOLs in the United States from prior tax periods beginning in 2003 which may be subject to examination upon utilization in future tax periods. As of March 31, 2019, the 2014 through 2018 tax years are open and may be subject to potential examinations in Denmark and Israel. As of March 31, 2019, the income tax returns of the Company and one of its subsidiaries in Israel are under examination by the Israeli Income Tax Authorities for certain years from 2014 to 2017.
The Company's operations in Israel were granted "Approved Enterprise" status by the Investment Center in the Israeli Ministry of Economy and Industry and "Beneficiary Enterprise" status from the Israeli Income Tax Authority, which makes the Company eligible for tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959 (the "Encouragement Law"). Under the terms of the Beneficiary Enterprise program, income that is attributable to the Company's operations in Yokneam, Israel, is exempt from income tax commencing fiscal year 2011 through 2021. Income that is attributable to the Company's operations in Tel Aviv, Israel is subject to a reduced income tax rate (generally between 10.0% and the current corporate tax rate, depending on the percentage of foreign investment in the Company) commencing fiscal year 2013 through 2021. The tax holiday has resulted in a cash tax savings of $8.5 million for the three months ended March 31, 2019, increasing diluted earnings per share by approximately $0.16 in the three months ended March 31, 2019.
On June 14, 2017, the Israeli government legislated new regulations regarding the "Preferred Technological Enterprise" regime, under which a company that complies with the terms may be entitled to certain tax benefits. The Company expects that its operation in Israel will comply with the terms of the Preferred Technological Enterprise regime. Therefore, the Company may utilize the tax benefits under this regime after the end of the benefit period of its Approved and Beneficiary Enterprise statuses (i.e., from fiscal year 2022 onwards). Under the new legislation, the majority of the Company’s income from its operations in Yokneam, Israel, will be subject to a corporate rate of 7.5%, while the majority of the income from its operations in Tel-Aviv, Israel, will be subject to a corporate rate of 12.0%.
The Company’s effective tax rate is highly dependent upon the geographic distribution of its worldwide earnings or losses, tax regulations and tax holiday benefits in Israel, and the effectiveness of the Company’s tax planning strategies. The Company’s effective tax rates were 8.1% and (230.6)% for the three months ended March 31, 2019 and 2018, respectively. The difference between the Company’s effective tax rate and the 21.0% federal statutory rate for the three months ended March 31, 2019 resulted primarily from the excess benefits related to share-based compensation, the tax holiday in Israel and foreign earnings taxed at rates lower than the federal statutory rates, partially offset by the accrual of unrecognized tax benefits, interest and penalties associated with unrecognized tax positions and non-tax-deductible expenses such as share-based compensation.
The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous, and the Company is required to make many subjective assumptions and judgments regarding its income tax exposures. In addition, interpretations of and guidance surrounding income tax laws and regulations are subject to change over time. Any changes in the Company’s subjective assumptions and judgments could materially affect amounts recognized in its condensed consolidated balance sheets and statements of operations.
At March 31, 2019, the Company maintained a valuation allowance against deferred tax assets of certain subsidiaries. The Company assesses its ability to recover its deferred tax assets on an ongoing basis. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. In evaluating the ability to recover deferred tax assets, the Company considers available positive and negative evidence including its recent cumulative losses, its ability to carry-back losses against prior taxable income and its projected financial results. The Company also considers, commensurate with its objective verifiability, the forecast of future taxable income including the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. A valuation allowance may be recorded in the event it is deemed to be more-likely-than-not that the deferred tax asset cannot be realized. Previously established valuation allowances may also be released in the event it is deemed to be more-likely-than-not that the deferred tax asset can be realized. Any release of valuation allowance will be recorded as a tax benefit which will positively impact the Company’s operating results. Management has determined on the basis of the quarterly assessment performed at March 31, 2019, that these deferred tax assets are not more-likely-than-not to be realized. 


25


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


NOTE 13—OTHER INCOME, NET:
Other income, net is summarized in the following table:
 
Three Months Ended March 31,
 
2019
 
2018
 
(in thousands)
Interest income and gains on short-term investments, net
$
3,003

 
$
967

Foreign exchange loss, net
(2,249
)
 
(182
)
Gain on sale of investment in a privately-held company
9,128

 

Impairment of investment in a privately-held company
(1,755
)
 

Other
118

 
(147
)
Other income, net
$
8,245

 
$
638


NOTE 14—LEASES:
On January 1, 2019, the Company adopted Topic 842 and elected the available practical expedient to recognize the cumulative effect of initially adopting Topic 842 as an adjustment to the opening balance sheet of the period of adoption (i.e., January 1, 2019). The Company also elected the other available practical expedients, and will not separate lease components from non-lease components, and will not reassess whether contracts are or contain leases, lease classification, or initial direct costs for existing leases as of January 1, 2019. Only the minimum lease payments in accordance with Topic 840 were included in the calculation of the ROU and liability for existing leases as of January 1, 2019. The condensed consolidated balance sheets and results from operations for reporting periods beginning after January 1, 2019 are presented under Topic 842, while prior period amounts are not adjusted and continue to be reported in accordance with the historic accounting under Topic 840.
The Company's leases include office buildings for its facilities worldwide and car leases in Israel, which are all classified as operating leases. Certain lease agreements include rental payments that are adjusted periodically for the consumer price index ("CPI"). The ROU and lease liability were calculated using the initial CPI and will not be subsequently adjusted. Certain leases include renewal options that are under the Company's sole discretion. The renewal options were included in the ROU and liability calculation if it was reasonably assured that the Company will exercise the option.
The cumulative effect of the changes made to the condensed consolidated balance sheet as of January 1, 2019 for the adoption of Topic 842 were as follows:
 
December 31, 2018
 
Adjustments
 
January 1, 2019
 
(in thousands)
 Right-of-use assets
$

 
$
69,102

 
$
69,102

 Accrued liabilities
$
121,878

 
$
(463
)
 
$
121,415

 Other long-term liabilities
$
32,468

 
$
(2,701
)
 
$
29,767

 Lease liabilities, current
$

 
$
17,081

 
$
17,081

 Lease liabilities, long term
$

 
$
55,185

 
$
55,185




MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


The components of lease expense and supplemental cash flow information related to leases for the three months ended March 31, 2019 were as follows:
 
 
(in thousands)
Components of lease expense
 
 
Operating lease cost
 
$
5,862

Supplemental cash flow information:
 
 
Cash paid for amounts included in the measurement of lease liabilities
 
$
4,817

Supplemental non-cash information related to lease liabilities arising from obtaining right-of-use assets
 
$
1,317

The weighted average remaining lease term is 6.4 years. The weighted average discount rate is 3.19 percent. The discount rate was determined based on the estimated collateralized borrowing rate of the Company, adjusted to the specific lease term and location of each lease.
Maturities of lease liabilities as of March 31, 2019 were as follows:
 
 
(in thousands)
2019 (remainder of the year)
 
$
18,118

2020
 
16,013

2021
 
10,768

2022
 
6,848

2023
 
6,879

Thereafter
 
20,798

Total (1)
 
79,424

less: Imputed interest
 
(8,034
)
Lease liability
 
$
71,390

(1) Future lease payments have not been reduced by minimum sublease rental income of $2.4 million owed to the Company in the future under noncancelable subleases.
The lease liabilities as of March 31, 2019 do not include the obligations under a lease agreement related to an office being built in Tel Aviv, Israel. The Company is not involved in the construction and will not be exposed to any risks during the construction period. The lease term expires 10 years after the expected lease inception. In addition, the lease contains a renewal option, which the Company determined is not reasonably assured to be exercised. As of March 31, 2019, the estimated total future lease obligation is approximately $30.1 million.

NOTE 15—RESTRUCTURING CHARGES:
In connection with the discontinuation of its 1550nm silicon photonics development activities, the Company initiated a restructuring plan in the first quarter of 2018 to wind down the business operations related to these activities, which primarily included terminating employees, exiting contracts with vendors, selling assets, and exiting facilities. The Company recorded $3.4 million, $3.2 million, and $1.0 million of employee separation and severance costs, contract exit costs with vendors, and impairment charges or losses on disposal of assets during the three months ended March 31, 2018, respectively. The Company is still using the facilities related to the discontinued activities and therefore has not recorded any related restructuring charges. The Company does not expect any significant facility related charges in the future.


27


MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)


NOTE 16—SUBSEQUENT EVENT:
On May 1, 2019, a purported class action suit, entitled Marc Henzel v. Mellanox Technologies, Ltd., et al., was filed in the United States District Court for the Northern District of California against the Company and the members of its board of directors. On May 2, 2019, a purported class action suit, entitled Michael Kent v. Mellanox Technologies, Ltd., et al., was filed in the United States District Court for the Southern District of New York. Also on May 2, 2019, a purported class action suit, entitled David Thornton v. Mellanox Technologies, Ltd., et al., was filed in the United States District Court for the Northern District of California. On May 3, 2019, a purported class action suit, entitled Lewis Stein v. Mellanox Technologies, Ltd., et al., was filed in the United States District Court for the Northern District of California against the Company, the members of its board of directors, NVIDIA International Holdings Inc., Teal Barvaz Ltd., and NVIDIA Corporation.  Also on May 3, 2019, a lawsuit entitled Elaine Wang v. Mellanox Technologies, Ltd., et al., was filed in the United States District Court for the Northern District of California against the Company and the members of its board of directors. All five suits allege that the preliminary proxy statement filed by the Company on April 22, 2019 with the SEC in connection with the proposed Merger omits material information with respect to the transactions contemplated by the Merger Agreement, rendering it false and misleading in violation of Sections 14(a) and 20(a) of the Exchange Act. Each plaintiff seeks, among other things, injunctive relief, rescission, declaratory relief and unspecified monetary damages.
The Company believes that the claims asserted in these lawsuits are without merit and intends to defend vigorously against all claims asserted. The Company is currently unable to estimate the reasonably possible loss or range of loss related to these lawsuits. Additional lawsuits arising out of or relating to the Merger Agreement and the transactions contemplated thereby may be filed in the future.

ITEM 2—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition as of March 31, 2019 and results of operations for the three months ending March 31, 2019 and 2018 should be read together with our financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve risks, uncertainties and assumptions. Words such as “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “predict,” “potential” and similar expressions, as they relate to us, our business and our management, are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this report. The identification of certain statements as “forward-looking” is not intended to mean that other statements not specifically identified are not forward-looking. All statements other than statements about historical facts are statements that could be deemed forward-looking statements, including, but not limited to, statements that relate to the pending merger with NVIDIA Corporation, our future revenues, product development and introductions, customer demand, our dependence on key customers for a substantial portion of our revenue, performance of our subcontractors, growth rates, market adoption of our products, competitive factors, gross margins, levels of research, development and other related costs, expenditures, protection of our proprietary rights and patents, tax expenses and benefits, cash flows, management’s plans and objectives for current and future operations, and worldwide economic conditions.
 
Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under the section entitled “Risk Factors” in Part II, Item 1A of this report and in the section entitled “Risk Factors” in Part 1, Item 1A of our Annual Report on Form 10-K for fiscal year ended December 31, 2018. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. All forward-looking statements included in this report are based on information available to us on the date of this report, and we assume no obligation to update any forward-looking statements contained in this report. Quarterly financial results may not be indicative of the financial results of future periods.
 
Unless the context requires otherwise, references in this report to the “Company,” “we,” “us” and “our” refer to Mellanox Technologies, Ltd. and its wholly owned subsidiaries.

28


Overview
General
We are a fabless semiconductor company that designs, manufactures (through subcontractors) and sells high-performance interconnect products and solutions primarily based on the Ethernet and InfiniBand standards. Our products facilitate intelligent and efficient data transmission between servers, storage systems, communications infrastructure equipment and other embedded systems. We operate our business globally and offer products to customers at various levels of integration. The products we offer include ICs, adapter cards, switch systems, cables, modules, software, services and accessories. Together these products form a total end-to-end integrated networking solution focused on computing, storage and communication applications used in multiple markets, including HPC, cloud, Web 2.0, enterprise data center, storage, Big Data, machine learning, telecommunications, financial services, and media/entertainment markets. These solutions increase performance, application efficiency and improve return on investment. Through the successful development and implementation of multiple generations of our products, we have established significant expertise and competitive advantages.
As a leader in developing multiple generations of high-speed interconnect solutions, we have established strong relationships with our customers. Our products are incorporated in servers and associated networking solutions produced by the largest server vendors. We supply our products to leading storage and communications infrastructure equipment vendors. Additionally, our products are used in embedded solutions.
We are one of the pioneers of InfiniBand, an industry-standard architecture for high-performance interconnects. We believe InfiniBand interconnect solutions deliver industry-leading performance, efficiency and scalability for clustered computing and storage systems that incorporate our products. In addition to supporting InfiniBand, our products also support industry-standard Ethernet transmission protocols providing unique product differentiation and connectivity flexibility. Our products serve as building blocks for creating reliable and scalable Ethernet and InfiniBand solutions with leading performance. We are one of the early suppliers of 25/50/100/200Gb/s Ethernet adapters, switches, and cables to the market. This provides us with the opportunity to gain share in the Ethernet market as users upgrade from one or 10Gb/s directly to 25, 40, 50, 100, 200 and 400Gb/s.
Recent Developments - Pending Merger with NVIDIA Corporation
On March 10, 2019, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with NVIDIA Corporation, a Delaware corporation (“NVIDIA”), NVIDIA International Holdings Inc., a Delaware corporation and wholly owned subsidiary of NVIDIA (“Parent”) and Teal Barvaz Ltd., a wholly owned subsidiary of Parent organized under the laws of the State of Israel and wholly owned subsidiary of Parent (“Merger Sub”). NVIDIA has agreed to guarantee the payment and performance obligations of Parent under the Merger Agreement. The Merger Agreement and the Merger (as defined below) have been approved by our board of directors and the boards of directors of NVIDIA, Parent and Merger Sub.
The Merger Agreement provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will be merged with and into Mellanox (the “Merger”) in accordance with Sections 314-327 of the Companies Law 5759-1999 of the State of Israel, with Mellanox continuing as the surviving corporation and a wholly owned subsidiary of Parent.
At the effective time of the Merger (the “Effective Time”), each ordinary share, par value NIS 0.0175 per share, of Mellanox (a “Company Share”) issued and outstanding immediately prior to the Effective Time, other than any shares owned by Mellanox, Parent and their respective subsidiaries or any shares held in Mellanox’s treasury, will be deemed to have been transferred to the Parent in exchange for the right to receive $125.00 in cash, without interest and subject to applicable withholding taxes.
The Merger Agreement contains customary representations, warranties and covenants. The consummation of the Merger is conditioned on the receipt of the approval of our shareholders, as well as the satisfaction of other customary closing conditions, including domestic and foreign regulatory approvals and performance in all material respects by each party of its obligations under the Merger Agreement. Consummation of the Merger is not subject to a financing condition. Closing of the Merger is expected by the end of calendar year 2019.
The Merger Agreement contains certain customary termination rights by either us or Parent, including if the Merger is not consummated by December 10, 2019, subject to two three-month extensions in order to obtain required regulatory approvals. If the Merger Agreement is terminated under certain circumstances, including termination by us to enter into a superior proposal, a termination by Parent following a change of the Company’s board of directors’ recommendation or a termination by Parent as a result of a willful material breach of the Merger Agreement’s no-solicitation obligations by us, we will be obligated to pay to Parent a termination fee equal to $225 million in cash. If the Merger Agreement is terminated under certain circumstances

29


involving the failure to obtain certain regulatory approvals, Parent will be obligated to pay us a termination fee equal to $350 million in cash.
The foregoing description of the Merger Agreement and the Merger does not purport to be complete and is subject to, and qualified in its entirety by, the full text of the Merger Agreement. For additional details on the transaction, please refer to the copy of the Merger Agreement attached as Exhibit 2.1 to our Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission on March 11, 2019.
We recorded transaction-related costs of $4.4 million, principally for investment banking and legal fees associated with the pending acquisition, during the three months ended March 31, 2019. These costs are recorded in general and administrative expenses included in the condensed consolidated statement of operations for the three months ended March 31, 2019. Additional transaction-related costs are expected to be incurred through the closing of the Merger.
The pending transaction with NVIDIA may have significant effects on us, including, among others, deferrals, delays or cancellations of purchase orders by our customers and the significant diversion of management and employee attention from ordinary course matters. For a more extensive discussion of those and other possible effects, please refer to “Risk Factors” in Part II, Item 1A of this report.
Our Business
Revenues. We derive revenues from sales of our ICs, boards, switch systems, cables, modules, software, accessories and other product groups. Revenues for the three months ended March 31, 2019 were $305.2 million compared to $251.0 million for the three months ended March 31, 2018, representing an increase of $54.2 million, or approximately 21.6%. Our revenues for the three months ended March 31, 2019 are not necessarily indicative of our future results. In order to increase our annual revenues, we must continue to achieve design wins over other Ethernet providers and providers of competing interconnect technologies. We consider a design win to occur when an original equipment manufacturer ("OEM"), or contract manufacturer notifies us that it has selected our products to be incorporated into a product or system under development. Because the life cycles for our customers' products can last for several years if these products have successful commercial introductions, we expect to continue to generate revenues over an extended period of time for each successful design win.
Our products have broad adoption with multiple end customers across HPC, cloud, Web 2.0, enterprise data center, storage, Big Data, machine learning, telecommunications, financial services, and media/entertainment markets. These markets are mainly served by leading server, storage and communications infrastructure OEMs. Therefore, we have derived a substantial portion of our revenues from a relatively small number of OEM customers. Sales to our top ten customers represented 55% and 57% of our total revenues for the three months ended March 31, 2019 and 2018, respectively. The loss of one or more of our principal customers, the reduction or deferral of purchases, or changes in the mix of our products ordered by any one of these customers could cause our revenues to decline materially if we are unable to increase our revenues from other customers. Our customers, including our most significant customers, are not obligated by long-term contracts to purchase our products and may cancel orders with limited potential penalties. If any of our large customers reduces or cancels its purchases from us for any reason, it could have an adverse effect on our revenues and results of operations.
Cost of revenues and gross profit. The cost of revenues consists primarily of the cost of silicon wafers purchased from our foundry supplier, costs associated with the assembly, packaging and production testing of our ICs, outside processing costs associated with the manufacture of our board and system products, royalties due to third parties, warranty costs, excess and obsolete inventory costs, depreciation and amortization, and costs of personnel associated with production management, quality assurance and services. In addition, after we purchase wafers from our foundries, we also face yield risk related to manufacturing these wafers into semiconductor devices. Manufacturing yield is the percentage of acceptable product resulting from the manufacturing process, as identified when the product is tested as a finished IC. If our manufacturing yields decrease, our cost per unit increases, which could have a significant adverse impact on our cost of revenues. We do not have long-term pricing agreements with foundry suppliers and contract manufacturers. Accordingly, our costs are subject to price fluctuations based on the overall cyclical demand for semiconductors.
We purchase our inventory pursuant to standard purchase orders. We estimate that lead times for delivery of our finished semiconductors from our foundry supplier and assembly, packaging and production testing subcontractor are approximately three to four months, lead times for delivery from our adapter card manufacturing subcontractor are approximately eight to ten weeks, lead times for delivery from our cable and transceiver manufacturing subcontractor are approximately ten to twelve weeks, and lead times for delivery from our switch systems manufacturing subcontractors are approximately twelve weeks. We build inventory based on forecasts of customer orders rather than the actual orders themselves.
We expect our cost of revenues as a percentage of sales to increase in the future as a result of a reduction in the average sales price of our products and a lower percentage of revenue deriving from sales of ICs and boards, which generally yield

30


higher gross margins than sales of switches and cables. This trend will depend on overall customer demand for our products, our product mix, competitive product offerings and related pricing and our ability to reduce manufacturing costs.
Operational expenses
Research and development expenses. Our research and development expenses consist primarily of salaries, share-based compensation and associated costs for employees engaged in research and development, depreciation, amortization of intangibles, allocable facilities related and administrative expenses and tape-out costs. Tape-out costs are expenses related to the manufacture of new ICs, including charges for mask sets, prototype wafers, mask set revisions and testing incurred before releasing new ICs into production.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries, incentive compensation, share-based compensation and associated costs for employees engaged in sales, marketing and customer support, advertising, trade shows and promotions, travel, amortization of intangibles, and allocable facilities related and administrative expenses.
General and Administrative Expenses. General and administrative expenses consist primarily of salaries, share-based compensation and associated costs for employees engaged in finance, legal, human resources and administrative activities, professional service expenses for accounting, corporate legal fees and allocable facilities related and administrative expenses.
Taxes on Income
Our operations in Israel have been granted "Approved Enterprise" status by the Investment Center of the Israeli Ministry of Economy and Industry and "Beneficiary Enterprise" status by the Israeli Income Tax Authority, which makes us eligible for tax benefits under the Encouragement Law. Under the terms of the Beneficiary Enterprise program, income that is attributable to our operations in Yokneam, Israel is exempt from income tax commencing fiscal year 2011 through 2021. Income that is attributable to our operations in Tel Aviv, Israel is subject to a reduced income tax rate (generally between 10.0% and the current corporate tax rate, depending on the percentage of foreign investment in the Company) commencing fiscal year 2013 through 2021.
On June 14, 2017, the Israeli government legislated new regulations regarding the "Preferred Technological Enterprise" regime, under which a company that complies with the terms may be entitled to certain tax benefits. The Company expects that its operation in Israel will comply with the terms of the Preferred Technological Enterprise regime. Therefore, the Company may utilize the tax benefits under this regime after the end of the benefit period of its Approved and Beneficiary Enterprise statuses (i.e., from fiscal year 2022 onwards). Under the new legislation, the majority of the Company’s income from its operations in Yokneam, Israel, will be subject to a corporate rate of 7.5%, while the majority of the income from its operations in Tel-Aviv, Israel, will be subject to a corporate rate of 12.0%.
To prepare our unaudited condensed consolidated financial statements, we estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual tax exposure together with assessing temporary differences resulting from the differing treatment of certain items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheet.
Critical Accounting Policies and Estimates
Our unaudited condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.
We believe that the assumptions and estimates associated with revenue recognition, allowances for doubtful accounts, investment valuation, warranty reserves, inventory reserves, long-term asset valuations, useful lives of property, equipment, and intangibles, accounting for business combinations, goodwill and purchased intangible asset valuation, investments in privately-held companies, accounting and fair value of financial instruments and derivatives, deferred income tax asset valuation, uncertain tax positions, and litigation and other loss contingencies have the greatest potential impact on our unaudited condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.
See our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 21, 2019, for a discussion of critical accounting policies and estimates. There have been no changes in our critical accounting policies as compared to what was disclosed in the Form 10-K for the year ended December 31, 2018.

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Results of Operations
 The following table sets forth our condensed consolidated statements of operations as a percentage of revenues for the periods indicated:
 
 
Three Months Ended
 
 
 
March 31,