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Sales deflate and Mellanox swings to a small loss in Q2

A return to a different – and lower – new normal

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InfiniBand and Ethernet chip, adapter, and switch maker Mellanox Technologies sure could have used a massive server bump in its second quarter like it got last year thanks to the rollout of Intel's "Sandy Bridge" Xeon E5 processors. But instead Mellanox swung to a loss on a pretty significant revenue hit in the quarter ended in June.

This time last year, with around $30m in pent-up demand for faster adapters and switches to match Intel's Xeon E5 chips for two-socket servers, Mellanox turned in a better-than-usual quarter. And unfortunately for the top brass at the company and its investors, that looked like it might be the new normal. But in the second quarter of 2013, the situation has returned to the actual normal, and with Intel and AMD looking to integrate network adapters on future chips, and both having their own network interconnects, the expectation is that Mellanox will be under increasing pressure going forward.

In the quarter ended in June, revenues at Mellanox came in at $98.2m, down 26.5 per cent from the year-ago period. Research, development, sales, and marketing costs all rose in the quarter, with the company having only a tiny operating income. After paying its taxes, Mellanox reported a net loss of $1.7m, which is quite a swing from the $31.1m net income in Q2 2012 when the switch and adapter supplier was flying high. The company booked $11.2m in share-based compensation, which was $2.7m higher than last year, and it is this change that really pushed Mellanox into the red ink.

Mellanox has plenty of money in the bank – $126.4m in cash and $231.1m in short-term investments – so a relatively tiny loss is not a big deal. But the integration of network ports on future x86 processors, as well as the potential ramp of interconnect sales by Intel (and to a much lesser extent AMD) is giving Wall Street a case of the jitters. (Not a bad case. A drink or two should calm it down.)

In a conference call on Wednesday after the market closed, Eyal Waldman, president and CEO at Mellanox, said that 56Gb/sec InfiniBand products drove 52 per cent of revenues, or $51m, in the quarter, while 10Gb/sec and 40Gb/sec Ethernet products accounted for 14 percent of sales, or $13.7m. Slower 40Gb/sec Infiniband product sales came to $24.5m, or about a quarter of total sales, and slower still 20Gb/sec InfiniBand chips, adapters, and switches are still selling, and accounted for 5 per cent of the revenue pie, or $4.9m.

Two customers represented more than 10 per cent of sales at Mellanox during the quarter, and the US Securities and Exchange Commission makes public companies say who they are. During this quarter, it was IBM with $18.7m (19 per cent) and HP with $9.8m (10 per cent).

The 40Gb/sec Ethernet products from Mellanox are based on the converged ConnectX adapter and SwitchX switch chips, which can run either InfiniBand or Ethernet protocols, but are hard-coded to do one or the other inside of the adapters or switches. (And if you pay a little extra, Mellanox can bring in the golden screwdriver and overclock the Ethernet to run at 56Gb/sec speeds.)

At some time in the future, Mellanox has promised to make this switch between Ethernet and InfiniBand dynamically reconfigurable at the port level, and this sounds like a good way to compete with Intel, which has two distinct chips for its Ethernet and InfiniBand products from its Fulcrum Microsystems and QLogic acquisitions a few years back now. At least for now, anyway. Chipzilla could – and perhaps should – offer a converged switch and adapter as well.

Rather than worry about what Intel is doing today and in the near term, Mellanox is focusing on a faster 100Gb/sec future that will be based on silicon photonics wares, hence its recent $129.5m acquisitions of IPtronics and Kotura.

"We continue to see the increasing demand for faster interconnect solutions in the markets that we serve," explained Waldman. "The exponential growth in data, the business advantages of fast data analysis, and the challenges in research and scientific fields require higher interconnect throughput and lower latency. We believe these trends will further drive interconnect technology development and the penetration of our products into both new and traditional markets."

The plan is to get 100Gb/sec adapters and switch products out the door in 2014 or 2015, and Mellanox is not being more precise than that. Mellanox said three months ago that it was getting ready to tape out its first chip supporting the future Enhanced Data Rate (EDR) InfiniBand protocol running at 100Gb/sec using a 20-nanometer process.

By product type, switches brought in 40 per cent of revenues, or $39.3m, for Mellanox in the second quarter, while adapters and chips accounted for 44 per cent of sales, or $43.2m. The rest is cables and software for the most part.

Waldman said that more and more hyperscale cloud operators were starting to adopt Mellanox adapters, and Microsoft is using InfiniBand switches in at least some of its Azure cloud data centers.

These hyperscale data centers tend to go with 10Gb/sec network interface cards, but Waldman said that later this year and into next, the cloud operators would start moving up to 40Gb/sec adapters to the tune of hundreds of thousands of units per quarter. "Eventually," he said, "we hope to achieve a full end-to-end sale where they use both our NIC silicon, cards, and switch systems, which will increase the revenue per endpoint from those customers for our Ethernet products."

At the moment, Ethernet adapters sell in the tens to nearly hundreds of thousands of units per quarter, said Waldman, while it sells several hundred Ethernet switches per quarter. Mellanox hopes to push that to over 2,000 in future quarters, and that is still small compared to its InfiniBand switch biz. But at a 70 per cent revenue growth rate, it is getting traction. ®

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