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Mellanox profits explode even as sales slip in Q4

Breaks a half billion bucks for all of 2012

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Networking chip, switch, and adapter supplier Mellanox Technologies gave Wall Street a bit of a start earlier this month when faulty InfiniBand FDR cables caused it to miss its revenue estimates for the fourth quarter. But the company still turned in a record year and has squeezed a lot more profit out of its InfiniBand and Ethernet businesses.

In the quarter ended in December, Mellanox had $122.1m in sales, up 68 per cent from the year ago period but significantly lower than the $145m to $150m in guidance that the company had given to Wall Street three months ago. Eyal Waldman, CEO at Mellanox, said that this was the first time that the switch maker has missed its guidance since it went public in February 2007.

The fault with the FDR InfiniBand cables that caused issues during the fourth quarter and which Mellanox warned investors about earlier in the month, had already been fixed when it made its announcement. At the time, Mellanox had said this faulty cable issue had delayed about $20m in revenues.

What was not clear at the time, however, was that some big deals that were expected to close in the fourth quarter did not, and that left one of the big OEM customers that buy chips, switches, and server adapters from Mellanox, with a lot of inventory to burn off. In this case, Waldman explained, it was $30m in inventory, which that vendor (who was not named) will sell out through the first quarter. At that point, this OEM will start buying up again.

In the meantime, Mellanox is now saying to expect revenues of between $78m and $83m in the first quarter of this year, which does not compare well to the $88.7m in sales the company booked in the first quarter of 2012. That's about a 9 per cent decline at the midpoint, and you can bet that Mellanox is not happy about that.

But the fact remains that Mellanox is part of the HPC server racket, which is always choppy, and is expanding out into the hyperscale cloud market as InfiniBand gets a foothold among some cloud operators, and this business is also choppy. Projecting sales is tough, and it is impossible to even it all out over the course of the year. That's just the way it is.

Jacob Shulman, CFO at Mellanox, said on a call with Wall Street analysts that a chip tape out that was expected to hit in the fourth quarter was pushed out, which is one of the reasons why net income was $18.4m in the quarter.

This tape out – exactly what it was Mellanox did not say, but it could be related to the next-generation converged InfiniBand-Ethernet SwitchX chips – is now going to hit in the first quarter. Despite the revenue and FDR cable issues, Mellanox was able to boost profits by a factor of four.

Mellanox will do another tape out in 2013, and perhaps a total of three if things go right, according to Waldman.

During Q4, Mellanox boosted its InfiniBand and Ethernet chip sales to OEM customers by 95 per cent, to 1.1 million units. FDR InfiniBand products (56Gb/sec) drove 39 per cent of revenues, down sequentially from the 57 per cent that FDR chips, adapters, switches, and cables pushed in the third quarter. QDR InfiniBand (40Gb/sec) products drove 37 per cent of sales, while DDR InfiniBand (20Gb/sec) accounted for 7 per cent.

The combined 10Gb/sec and 40Gb/sec Ethernet products brought in 11 per cent of revenues. Mellanox had two customers who drove more than 10 per cent of sales, which the US Securities and Exchange Commission says you have to be specific about.

IBM accounted for 17 per cent of revenues for Mellanox in the fourth quarter, while Hewlett-Packard represented 14 percent. Oracle, which is a stakeholder in Mellanox and which also buys a lot of Mellanox stuff, was not a big customer this time around. Draw your own conclusions about Exadata, Exalogic, and Sparc SuperCluster as you see fit. Maybe Oracle bought lots of stuff already?

For the full year, Mellanox had $500.8m in revenues, up 93.2 per cent, and net income was $119.6m, up by more than a factor of eleven over the prior year.

There's very little doubt that financials for Mellanox benefited from pent-up demand for Xeon E5-based servers, which started shipping in the spring and which are necessary to drive FDR InfiniBand adapters at full speed thanks to the PCI-Express 3.0 slots that the Xeon E5 processors support.

It is hard to figure how much of the demand for Xeon E5s was from backlog and how much was just because of the new capabilities of the combination of Xeon E5 and FDR InfiniBand adapters and switches. But it looks like there was a bit of a bubble and that baseline revenues will be a bit lower than the run rates that Mellanox averaged in the second and third quarters, when both Intel chips and Mellanox FDR InfiniBand gear were shipping.

Mellanox is not saying whether or not it will grow in 2013, and the most it has said is to expect a dip in revenues in Q1 and that it will see sequential growth in Q2 from that point. ®

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