UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||
| For the Fiscal Year Ended: | December 31, | ||
| OR | |||
| 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 | 98-0233400 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
Mellanox Technologies, Ltd.
Beit Mellanox, Yokneam, Israel20692
(Address of principal executive offices, including zip code)
+972-4-909-7200972-4-909-7200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class: | Trading Symbol(s) | Name of Each Exchange on Which Registered: |
| Ordinary shares, nominal value NIS 0.0175 per share | MLNX | The |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yesx☒ No o☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o☐Nox☒
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. Yesx☒ No o☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yesx☒ 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 | ☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | Smaller reporting company | ☐ |
Emerging growth company | ☐ | ||||||
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☒
The aggregate market value of the registrant's ordinary shares, nominal value NIS 0.0175 per share, held by non-affiliates of the registrant on June 30, 2017,2019, the last business day of the registrant's most recently completed second fiscal quarter, was approximately $2.2$6.1 billion (based on the closing sales price of the registrant's ordinary shares on that date). Ordinary shares held by each director and executive officer of the registrant, as well as shares held by each holder of more than 10% of the ordinary shares known to the registrant, have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not a determination for other purposes.
The total number of shares outstanding of the registrant's ordinary shares, nominal value NIS 0.0175 per share, as of February 9, 2018,14, 2020, was 51,781,340.56,062,249.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant'sregistrant’s Definitive Proxy Statement, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the 20182020 Annual General Meeting of Shareholders of Mellanox Technologies, Ltd. (hereinafter referred to as the "Proxy Statement"“Proxy Statement”) or amendment to this Form 10-K (hereinafter referred to as the “Amendment”) are incorporated by reference in Part III of this report. Such Proxy Statement or Amendment will be filed with the Securities and Exchange Commission not later than 120 days after the conclusion of the registrant's fiscal year ended December 31, 2017.2019.
MELLANOX TECHNOLOGIES, LTD.
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PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting the financial condition of our business. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Forward-looking statements are based on information available at the time those statements are made and/or management's good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to:
the impact of worldwide economic conditions on us, our customers and our vendors;
market adoption of our Ethernet and InfiniBand solutions;
competition and competitive factors;
our ability to accurately forecast customer demand;
our dependence on a relatively small number of customers;
our ability to successfully introduce new products and enhance existing products;
our dependence on third-party subcontractors;
our ability to maintain adequate revenue growth;
our ability to carefully manage the use of "open source" software in our products;
other risk factors included under "Risk Factors" in this report.
In addition, in this report, the words "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. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements.
You should not put undue reliance on any forward-looking statements. We assume no obligation to update forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.
When used in this report, "Mellanox," the "Company," "we," "our" or "us" refers to Mellanox Technologies, Ltd. and its consolidated subsidiaries unless the context requires otherwise.
3
ITEM 1—BUSINESS
We are an integrated supplier of end-to-enda 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 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 integrated circuits ("ICs"), adapter cards, switch systems, multi-core and network processors, systems on a chip (“SOCs”), 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 high-performance computingcloud, Web 2.0, High Performance Computing ("HPC"), cloud, Web 2.0, Big Data, machine learning, storage, telecommunications, financial services, and enterprise data centers ("EDC"). 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, original design manufacturers ("ODMs"), distributors, and large end customers.vendors. Additionally, our products are used in embedded solutions.
We are a leader in high-performance Ethernet interconnects, including adapters, switches, and optical and copper cables and transceivers. We have gained significant share in the 25Gb/s and greater market segment and are the leading provider of adapters at these speeds. We work closely with key cloud, Web 2.0, server, storage, machine learning and telco customers to develop hardware and software that accelerate workloads and make data centers more efficient. This deep engagement with our customers enables us to deliver unique acceleration capabilities and thereby differentiate our products from our competitors. This provides us with the opportunity to gain share in the Ethernet market as users upgrade from 1Gb/s or 10Gb/s directly to 25/40/50, 100 or 200Gb/s.
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 also believe that we are one of the major suppliers of 25, 50, and 100Gb/s Ethernet adapters, switches, and cables to the market, and the only end-to-end supplier of these products today. We are the leading provider of adapters at the 25, 40, 50, and 100Gb/s speeds, which helps to drive demand for our switch and cable products and provides us the opportunity to gain shareleader in the Ethernet market as users upgrade from 1Gb/s or 10Gb/s directlyHPC and machine learning markets and provide the most efficient, highest bandwidth, and lowest latency end to 25, 40, 50 or 100Gb/s.
We have been shipping our InfiniBand products since 2001 and our Ethernet products since 2007. During 2008, we introduced Virtual Protocol Interconnect, ("VPI"), into our ConnectX family of adapter ICs and cards. VPI provides the ability for an adapter to automatically sense whether a communications port is connected to Ethernet or InfiniBand. In 2015, we introducedWe also offer the Spectrum family of 25, 50, and 100Gb/s Ethernet switches at speeds from 10 to 400Gb/s and the Switch-IB 2 smart InfiniBand switch.switches at speeds from 10 to 200Gb/s.
In order to accelerate the adoption of our high-performance interconnect solutions and our products, we work with leading vendors across related industries, including:
processor and accelerator vendors such as AMD, ARM, Huawei, IBM, Intel, Nvidia, Oracle,Marvell, and Qualcomm;NVIDIA;
operating system vendors such as Microsoft and Red Hat; and
software applications vendors such as Oracle, IBM and VMware.
We are a Steering Committee member of the InfiniBand Trade Association, ("IBTA"), and the OpenFabrics Alliance, ("OFA"), both of which areis an industry trade organizationsorganization that maintain and promote InfiniBand technology. Additionally, OFA supportsmaintains and promotes Ethernet solutions.InfiniBand and RoCE (RDMA over Converged Ethernet) technology. We are a founding member of the 25 Gigabit Ethernet consortium. We are also a participating member ofparticipate in the Institute of Electrical and Electronic Engineers ("IEEE"), an organization that facilitates the advancement of the Ethernet standard, EthernetStorage Networking Industry Alliance ("SNIA") and other industry organizations advancing multi-vendor interoperable ecosystems for various networking and storage related standards.
Our business headquarters are in Sunnyvale, California, and our engineering and manufacturing headquarters are in Yokneam, Israel. Our total assets as of December 31, 20172019 and 20162018 were approximately $1,401.9$2,119.8 million and $1,473.5$1,587.2 million, respectively. During the years ended December 31, 2017, 20162019, 2018 and 2015,2017, we generated approximately $863.9$1,330.6 million,
We manage our business based on one reportable segment: the development, manufacturing, marketing and sales of interconnect products. Additional information required by this item is incorporated herein by reference to our consolidated financial statements and Note 13, "Geographic information and revenues by product group," of2, "Revenue" in the Notesnotes to Consolidated Financial Statements,consolidated financial statements, included in Part IV, Item 15 of this report. The risks related to foreign operations and dependence on foreign operations are discussed under the section entitled "Risk Factors—Risks Related to Operations in Israel and Other Foreign Countries" under Part I, Item 1A of this report.
4
Industry Background
High-Performance Interconnect Market Overview and Trends
Computing and storage systems such as servers, supercomputers and storage arrays in today's data centers face a critical challenge of handling exponentially expanding volumes of transactions and data while delivering improved application performance, high scalability and reliability within economic and power constraints. High-performance interconnect solutions remove bottlenecks in communications between compute and storage resources through fast transfer of data, latency reduction, improved application processing by central processing unit ("CPU") utilization and efficient sharing of resources. The result is higher efficiency and better resource utilization, thereby delivering higher application performance with lower capital expenditures and operating expenses. Leading companies in HPC, cloud, Web 2.0, Big Data, machine learning, storage, telecommunications, financial services, and EDCEDCs utilize these technologies to develop distributed applications and services which are able to scale to serve millions of end customers.
Demand for computing power and data storage capacity continuecontinues to rise, fueled by the increasing reliance by enterprises on information technology ("IT") for everyday operations. Due to greater amounts of information to be processed, stored and retrieved, data centers rely on high-performance computing and high-capacity storage systems to optimize price/performance, minimize total cost of ownership, utilize power efficiently and simplify management. We believe that several IT trends impact the demand for interconnect solutions and the performance required from these solutions. These trends include:
Transition to clustered computing and storage using connections among multiple standard components;
Transition to multiple and multi-core processors in servers;
Use of solid state Flash memory drives for data storage;
Increasing deployments of software defined scale out storage;
Increasing deployments of mission critical, latency, or response time sensitive applications;
Increasing deployments of converged and hyperconverged infrastructure;
Increasing deployment of virtualized computing and virtualized networking resources to improve server utilization;
Requirements by cloud providers to perform system provisioning, workload migrations and support multiple users' requests faster and more efficiently;
Requirements by Web 2.0 data centers to increase their hardware utilization and to instantly scale up to large capacities;
Big Data Analytics requirements for faster data access and processing to analyze increasingly large datasets and to provide real-time analysis; and
Increasing deployment of artificial intelligence and machine learning applications that utilize massive amounts of data and compute resources and often require generating real-time results.
A number of semiconductor-based interconnect solutions have been developed to address different application requirements. These solutions include proprietary technologies as well as standard technologies, including Fibre Channel, Ethernet and InfiniBand, which was specifically created for high-performance computing, storage and embedded applications.InfiniBand.
Challenges Addressed by High-Performance Interconnect
The trends described above indicate that high-performance interconnect solutions will play an increasingly important role in IT infrastructures and will drive strong growth in unit demand. Performance requirements for interconnect solutions,
however, continue to evolve and lead to high demand for solutions that are capable of resolving the following challenges to facilitate broad adoption:
| • | Performance limitations. In clustered computing, cloud computing and storage environments, high bandwidth and low latency are key requirements to capture the full performance capabilities of a cluster. With the usage of multiple multi-core processors in server, storage and embedded systems, I/O bandwidth has not been able to keep pace with processor advances, creating performance bottlenecks. Fast data access has become a critical requirement to take advantage of the increased compute power of microprocessors. In addition, interconnect latency has become a limiting factor in a cluster's overall performance. |
| • | Increasing complexity. The increasing usage of clustered servers and storage systems as a critical IT tool has led to an increase in complexity of interconnect configurations. The number of configurations and connections has also proliferated |
| • | Interconnect inefficiency. The deployment of clustered computing and storage has created additional interconnect implementation challenges. As additional computing and storage systems, or nodes, are added to a cluster, the interconnect must be able to scale in order to provide the expected increase in cluster performance. Additionally, increased attention on data center energy efficiency is causing IT managers to look for ways to adopt more energy-efficient implementations. |
| • | Limited reliability and stability of connections. Most interconnect solutions are not designed to provide reliable connections when utilized in a large clustered environment, causing data transmission interruption. As more applications in EDCs share the same interconnect, advanced traffic management and application partitioning become necessary to maintain stability and reduce system down time. Such capabilities are not offered by most interconnect solutions. |
| • | Poor price/performance economics. In order to provide the required system bandwidth and efficiency, most high-performance interconnects are implemented with complex, multi-chip semiconductor solutions. These implementations have traditionally been extremely expensive. |
In addition to Ethernet and InfiniBand, proprietary and other standards-based interconnect solutions, including Fibre Channel, are currently used in EDC, HPC and embedded markets. Performance and usage requirements, however, continue to evolve and are now challenging the capabilities of these interconnect solutions.
Proprietary interconnect solutions have been designed for use in supercomputer applications by supporting low latency and increased reliability. These solutions are only supported by a single vendor for product and software support, and there is no standard organization maintaining and facilitating improvements and changes to the technology. The number of supercomputers that use proprietary interconnect solutions has been declining largely due to the required use of proprietary software solutions, a lack of compatible storage systems and the availability of industry standards-based interconnects that offer superior price/performance.
Fibre Channel is an industry standard interconnect solution limited to storage applications. The majority of Fibre Channel deployments support 2, 4, 8, 16, and 16Gb/32Gb/s. Fibre Channel lacks a standard software interface, does not provide server cluster capabilities and remains more expensive relative to other standards-based interconnects. There have been industry efforts to support the Fibre Channel data transmission protocol over interconnect technologies including Ethernet (Fibre Channel over Ethernet) and InfiniBand (Fibre Channel over InfiniBand). however, none of these has gained wide adoption. The Fibre Channel market is declining as legacy storage area network moves to more modern Web 2.0 and cloud architectures based on converged, software defined, and scale out storage.
Ethernet is an industry-standard interconnect solution that was initially designed to enable basic connectivity between a local area network of computers or over a wide area network, where latency, connection reliability and performance limitations due to communication processing are non-critical. While Ethernet has a broad installed base at 1/10Gb/s and lower data rates, its overall efficiency, scalability and reliability have been less optimal than other interconnect solutions in high-performance computing, storage and communication applications. An increase to 25/40/50/100Gb/s bandwidth, a significant reduction in application latency and more efficient software solutions have improved Ethernet's capabilities to address specific high-performance applications that do not demand the highest performance or scalability.
Advantages of InfiniBand
We believe that InfiniBand-based solutions have advantages compared to solutions based on alternative interconnect architectures. InfiniBand addresses the significant challenges within IT infrastructures by providing solutions for more demanding requirements of the high-performance interconnect market. More specifically, we believe that InfiniBand has the following advantages:
| • | Superior performance. Compared to other interconnect technologies that were architected to have a heavy reliance on communication processing, InfiniBand was designed for implementation in an IC that relieves the CPU of communication processing functions. InfiniBand is able to provide superior latency relative to other existing interconnect technologies and has maintained this advantage with each successive generation of products. For example, our current InfiniBand adapters and switches provide bandwidth up to 200Gb/s, with end-to-end latency lower than a microsecond. In addition, InfiniBand fully leverages the I/O capabilities of PCI Express, a high-speed system bus interface standard. |
The following table provides a bandwidth comparison of the various high-performance interconnect solutions:
| Proprietary | Fibre Channel | Ethernet | InfiniBand | ||||
| Supported bandwidth of available | 2Gb/s - 100Gb/s | 2Gb/s - | 1Gb/s - | 10Gb/s - | |||
6
Performance in terms of latency varies depending on system configurations and applications. According to independentTypical benchmark testing reports show latency of InfiniBand solutions was lessis appreciably lower than half that of tested Ethernet solutions. Fibre Channel, which is used only as a storage interconnect, is typically not benchmarked on latency performance. HPC typically demands low latency interconnect solutions. In addition, there are increasing numbers of latency-sensitive applications in the cloud, Web 2.0, storage, machine learning and embedded markets, and, therefore, there is a trend towards using industry-standard Ethernet and InfiniBand solutions of 10Gb/s and faster, which are able to deliver lower latency than 1Gb/s Ethernet.
| • | Reduced complexity. While other interconnects require use of separate cables to connect servers, storage and communications infrastructure equipment, InfiniBand allows for the consolidation of multiple I/Os on a single cable or backplane interconnect, which is critical for blade servers and embedded systems. InfiniBand also consolidates the transmission of clustering, communications, storage and management data types over a single connection. |
| • | Highest interconnect efficiency. InfiniBand was developed to provide efficient scalability of multiple systems. InfiniBand provides communication processing functions in hardware, relieving the CPU of this task, and enables the full resource utilization of each node added to the cluster. |
| • | Reliable and stable connections. InfiniBand is one of the only industry standard high-performance interconnect solutions which provides reliable end-to-end data connections within the silicon hardware. In addition, InfiniBand facilitates the deployment of virtualization solutions, which allow multiple applications to run on the same interconnect with dedicated application partitions. As a result, multiple applications run concurrently over stable connections, thereby minimizing down time. |
| • | Superior price/performance economics. In addition to providing superior performance and capabilities, standards-based InfiniBand solutions are generally available at a lower cost than other high-performance interconnects. |
Our InfiniBand Solutions
We provide comprehensive end-to-end 40/56/100Gb/100/200Gb/s InfiniBand solutions, including switch and gateway ICs, adapter cards, switch, gateway and long-haul systems, cables, modules and software. We expect to introduceintroduced our 200Gb/s solutions in fiscal 2018. InfiniBand enables us to provide products that we believe offer superior performance and meet the needs of the most compute and data demanding applications, while also offering significant improvements in total cost of ownership compared to alternative interconnect technologies. As part of our comprehensive solution, we perform validation and interoperability testing from the physical interface to the applications software. Our expertise in performing validation and testing reduces time to market for our customers and improves the reliability of the fabric solution.
Our Ethernet Solutions
Advances in server virtualization, network storage and compute clusters have driven the need for faster network throughput to address application latency and availability problems in the Enterprise. To service this need, we provide a
complete industry leading, end-to-end 10/25/40/50/100Gb/100/200Gb/s Ethernet product portfolio for use in EDC, HPC, embedded environments, hyperscale, Web 2.0, and cloud data centers. Our portfolio of advanced Ethernet switch products supports the latest generation of Ethernet speeds and deliver wire speed forwarding for telco and data center environments. In addition, we provide a full range of Ethernet adapters at these speeds which incorporate the latest in Ethernet technology, including support for virtualization and RDMA over Converged Ethernet (RoCE).RoCE. These solutions remove I/O bottlenecks in mainstream servers that limit application performance and support hardware-based I/O virtualization, providing dedicated adapter resources and guaranteed isolation and protection for virtual machines within the server.
VPI: Providing Connectivity to Ethernet and InfiniBand
Our VPI technology enables us to offer fabric-flexible products that concurrently support both Ethernet and InfiniBand with network ports having the ability to auto sense the type of switch to which it is connected and then take on the characteristics of that fabric. In addition, these products extend certain InfiniBand advantages to Ethernet fabrics, such as reduced complexity and superior price/performance, by utilizing existing, field-proven InfiniBand software solutions.
Our Strengths
We apply our strengths to enhance our position as a leading supplier of semiconductor-based, high-performance interconnect products. We consider our key strengths to include the following:
| • | We have expertise in developing high-performance interconnect solutions. We were founded by a team with an extensive background in designing and marketing semiconductor solutions. Since our founding, we have been focused on high-performance interconnect and have successfully launched several generations of Ethernet and InfiniBand products. We believe we have developed strong competencies in integrating mixed-signal design and developing complex ICs. We also consider our software development capability as a key strength, and we believe that our software allows us to offer complete solutions. We have developed a significant portfolio of intellectual property ("IP"), and have 783 issued patents, 10 registered designs, and 255 pending patent applications. We believe our experience, competencies and IP will enable us to remain a leading supplier of high-performance interconnect solutions. |
| • | We have expertise in developing high speed analog and optical components. We have unique design expertise and manufacturing capabilities required to build state of the art optical components, modules, and cable assemblies. We have developed significant know-how related to building advanced electrical and electro-optical components and sub-assemblies which combine electrical and optical components. In addition, we have design expertise to enable advanced transceiver chipsets for driving and receiving multimode optical signals and interfacing to low cost lasers and optical sensor technologies. We have developed significant manufacturing know how and automated assembly techniques to combine these optical and electrical components and build complete optical module and cables that are high-performance, cost effective, high quality, and offer high reliability. |
| • | We believe we are the leading merchant supplier of InfiniBand ICs. We have gained in-depth knowledge of the InfiniBand standard through active participation in its development. We were first to market with InfiniBand products (in 2001) and InfiniBand products that support the latest version of the PCI Express interface standard. We have sustained our leadership position through the introduction of several generations of products. Because of our market leadership, vendors have developed and continue to optimize their software products based on our semiconductor solutions. We believe that this places us in an advantageous position to benefit from continuing market adoption of our InfiniBand products. |
| • | We believe we are a leading merchant supplier of end to end Ethernet solutions and the leading merchant supplier of high-performance Ethernet Adapters. We have gained significant expertise in Ethernet adapters and are the leading supplier of adapters with speeds of 25Gb/s and above with over 60% market share of adapters with speeds greater than 10Gb/s. We have developed significant expertise in Ethernet switch hardware and software and are gaining market share with our top of rack switch products and optical and copper cables and transceivers. Nine out of the top ten hyperscale, cloud and Web 2.0 data centers are using our products. Our engagement with these customers through several generations of designs has allowed us to understand the challenges faced by large scale deployments, and to develop features that solve these problems. We are the first to market with a complete end-to-end product portfolio of adapters, switches, and cables for the latest 25, 50, 100, and 200Gb/s speeds of Ethernet. Our leading time to market, customer engagements, advanced feature set, and rapid development cadence provides a significant competitive advantage over other vendors. We believe that this places us in an advantageous position to benefit from continuing market adoption of our Ethernet products. |
| • | We have a comprehensive set of technical capabilities to deliver innovative and reliable products. In addition to designing our ICs, we design standard and customized adapter card products, switch products, and optical cables and transceivers - providing us a deep understanding of the associated circuitry and component characteristics. We believe this knowledge enables us to develop solutions that are innovative and can be efficiently implemented in target applications. We have devoted significant resources to develop our in-house test development capabilities, which enables us to rapidly finalize our mass production test programs, thus reducing time to market. We have synchronized our test platform with our outsourced testing provider and are able to conduct quality control tests with minimal disruption. We believe that because our capabilities extend from product definition, through IC design, and ultimately management of our high-volume manufacturing partners, we have better control over our production cycle and are able to improve the quality, availability and reliability of our products. |
| • | We have extensive relationships with our key original equipment manufacturers ("OEM") and hyperscale customers and many end users. Since our inception, we have worked closely with major hyperscale customers and OEMs, including leading server, storage, communications infrastructure equipment and embedded systems vendors, to develop products that accelerate market adoption of our Ethernet and InfiniBand products. During this process, we have obtained valuable insight into the challenges and objectives of our customers, and gained visibility into their product development plans. We also have established end-user relationships with influential IT executives who allow us access to firsthand information about evolving market trends. We believe that our OEM customer and end-user relationships allow us to stay at the forefront of developments and improve our ability to provide compelling solutions to address their needs. |
Our Strategy
Our goal is to be the leading supplier of end-to-end interconnect solutions for servers and storage that optimize data center performance for computing, storage and communications applications. To accomplish this goal, we intend to:
| • | Continue to develop leading, high-performance interconnect products. We will continue to expand our technical expertise and customer relationships to develop leading interconnect products. We are focused on extending our leadership position in high-performance interconnect technology and pursuing a product development plan that addresses emerging customer and end-user demands and industry standards. Our unified software strategy is to use a single software stack to support connectivity to Ethernet and InfiniBand with the same VPI enabled hardware adapter device. |
| • | Capture Ethernet market share with our adapter, switch, and cable products. We believe we are the market leader in Ethernet adapters with performance greater than 10Gb/s and the only provider of end-to-end solutions of adapters, switches, and cables at the latest 25, 40, 50, 100, and 200Gb/s speeds. We plan to capture Ethernet market share as data centers transition from 10Gb/s to 25/40/50/100/200/400Gb/s. We believe we will be able to leverage our strength in the Ethernet adapter business to grow our Ethernet switch and cable business during the market transition to these advanced speeds. |
| • | Facilitate and increase the continued adoption of InfiniBand. We will facilitate and increase the continued adoption of InfiniBand in the high-performance interconnect marketplace by expanding our partnerships with key vendors that drive high-performance interconnect adoption, such as suppliers of processors, operating systems and other associated software. In conjunction with our OEM customers, we will expand our efforts to promote the benefits of InfiniBand and VPI directly to end users to increase demand for high-performance interconnect solutions. |
| • | Expand our presence with existing server OEM customers. We believe the leading server vendors are influential drivers of high-performance interconnect technologies to end users. We plan to continue working with and expanding our relationships with server OEMs to increase our presence in their current and future product platforms. |
| • | Broaden our customer base with storage, communications infrastructure and embedded systems OEMs. We believe there is a significant opportunity to expand our global customer base with storage, communications infrastructure and embedded systems OEMs. In storage solutions specifically, we believe our products are well suited to replace existing technologies such as Fibre Channel. We believe our adapter, SOC, and switch products are the basis of superior interconnect fabrics for unifying disparate storage interconnects, including back-end, clustering and front-end connections, primarily due to their ability to be a unified fabric and superior price/performance economics. |
| • | Leverage our fabless business model to deliver strong financial performance. We intend to continue operating as a fabless semiconductor company and consider outsourced manufacturing of our ICs, adapter cards, switches and cables to be a key element of our strategy. Our fabless business model offers flexibility to meet market demand and allows us to focus on delivering innovative solutions to our customers. We plan to continue to leverage the flexibility and efficiency offered by our business. |
Our Products
We provide complete solutions which are based on and meet the specifications of the Ethernet and InfiniBand standards. Our products include adapter ICs and cards (ConnectX®, Quantum, and Connect-IB™ product family) and switch ICs (InfiniScale®, SwitchX®, SwitchX®-2, Mellanox Spectrum®, Switch-IB® and Switch-IB™Mellanox Quantum™ product families) and systems, gateway ICs (BridgeX® product family) and gateway systems (Mellanox Skyway™), long-haul systems (MetroX®), Bluefield family SOC multicore and SmartNIC processors, software, and LinkX® cables and transceivers. Our ConnectX® family of adapters and cards support both the Ethernet and InfiniBand interconnect standards. Our SwitchX®SwitchX and SwitchX®-2SwitchX-2 family of silicon and systems supports both Ethernet and InfiniBand, and includes gateways that support bridging from InfiniBand to Ethernet. Our Spectrum®Spectrum switches support Ethernet standard and our Switch-IB and Quantum switches support InfiniBand standard. Our long-haul systems expand the reach of InfiniBand and lossless Ethernet up to 80 kilometers.
We have registered "Mellanox" and its logo, "Bluefield", "BridgeX", "Connect-IB", "ConnectX", "CoolBox", "CORE-Direct", "GPUDirect", "InfiniBridge", "InfiniHost", "InfiniScale", "Kotura" and its logo, "Mellanox Federal Systems", "Mellanox Hostdirect", "Mellanox Open Ethernet", "Mellanox Peerdirect", "Mellanox ScalableHPC", "Mellanox Technologies Connect. Accelerate. Outperform", "Mellanox Virtual Modular Switch", "MetroDX", "MetroX", "MLNX-OS", "Open Ethernet" logo, "PhyX", "SwitchX", "TestX", "The Generation of Open Ethernet" and its logo, "UFM", "Virtual Protocol Interconnect", "Quantum", "EZchip", "Tilera", and "Voltaire" and its logo as trademarks in the United States. "25 is the New 10®", "Accelio®", "CloudX®" logo, "CompustorX®"," "HPC-X®", "LinkX®", "Mellanox Care®", "Mellanox CloudX®" and its logo, "Mellanox Multi-host®", "Mellanox NEO®", "Mellanox Opencloud®" and its logo, "Mellanox OpenHPC®", "Mellanox Socket Direct®", "Mellanox Spectrum®", "Mellanox StorageX®", "Mellanox TuneX®, "Mellanox NVMEDirect®", "One Switch. A world of options®" slogan, "PlatformX®", "PSiPHY®", "SiPhy®", "Mellanox Spectrum®", "StoreX®", Switch-IB®", "TuneX®", "UCX®", "UCX Unified Communication X®" and "Unbreakable-Link®".
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We have trademark applications pending to register in the United States "25G is the New 10G"to register "FPGADirect™", "Accelio"BlueOS™, "CloudX" logo, "CompustorX"CLOUD OF THINGS™, "CYPU"DYNAMIX QSA™, "FPGADirect"ETHERNET STORAGE FABRIC™ (LOGO), "HPC-X"MELLANOX INDIGO™, "LinkX"Mellanox Innova™, "Mellanox Care"MELLANOX NVMEDIRECT™, "Mellanox CloudX" and its logo, "Mellanox Multi-host"MELLANOX ONYX™, "Mellanox NEO"MELLANOX QUANTUM™ (LOGO), "Mellanox Opencloud" and its logo, "Mellanox OpenHPC"NVMe SNAP™, "Mellanox Socket Direct"RIVERMAX™, "Mellanox Spectrum"SHIELD™, "Mellanox StorageX", "Mellanox TuneX, "NVMEDirect", "One Switch. A world of options" slogan, "PlatformX", "PSiPHY", "SiPhy", "Spectrum", "StoreX", "STPU", "Switch-EN", "Switch-IB", "TuneX", "UCX", "UCX Unified Communication X" and "Unbreakable-Link"WHAT JUST HAPPENED™ (LOGO).
We provide adapters to server, storage, communications infrastructure and embedded systems OEMs as ICs or standard card form factors with PCI Express interfaces. Adapter ICs or cards are incorporated into OEMs' server and storage systems to provide Ethernet and/or InfiniBand connectivity. All of our adapter products interoperate with standard programming interfaces and are compatible with previous generations, providing broad industry support. We support leading server operating systems including Linux, Windows AIX, HPUX, Solaris and VxWorks.VMware.
We provide our switch ICs and systems to server, storage, communications infrastructure and embedded systems OEMs to create switching equipment. To deploy an Ethernet or InfiniBand fabric, any number of server or storage systems that contain an adapter can be connected to a communications infrastructure system such as an Ethernet or InfiniBand switch. Our Spectrum family of Ethernet switch ICswitches supports 10, 25, 40, 50, and 100Gb/s Ethernet throughput while Spectrum-2 is designed to support 200 and 400Gb/s Ethernet throughput. Our 8th generationQuantum InfiniBand switch IC (Switch-IB 2) supports up to 100Gb/200Gb/s InfiniBand throughput.throughput per port. We have introduced switch systems that include 8-port, 12-port, 18-port, 36-port, 48-port, 64-port, 108-port, 216-port, 324-port, 648-port, and 648-port.800-port. Our family of multicore processors and the new Bluefield SOC device combine multiple processing cores together with advanced networking connectivity and accelerators for security, storage, and other intelligent networking applications.
Our products generally vary by the number and performance of Ethernet or InfiniBand ports, and the number of processor cores supported.
We also offer custom products that incorporate our ICs to select server and storage OEMs that meet their special system requirements. Through these custom product engagements we gain insight into the OEMs' technologies and product strategies.
We also provide our OEM customers software and tools that facilitate the use and management of our products. Our Linux, Windows, and VMware-based software enables applications to efficiently utilize the features of the interconnect. We have expertise in optimizing the performance of software that spans the entire range of upper layer protocols down through the lower level drivers that interface to our products. We provide a suite of software tools and a comprehensive management software solution, Unified Fabric Manager ("UFM"), Network Orchestration ("NEO"), and ONYX and MLNX- OS network operating systems, for managing, optimizing, testing and verifying the operation of Ethernet and InfiniBand switch fabrics. In addition, we provide a full suite of acceleration software (Messaging Accelerator ("VMA"), Fabric Collective Accelerator ("FCA"), and Unstructured Data Accelerator ("UDA")) that further reduce latency, increase throughput, and offload CPU cycles, enhancing the performance of applications in multiple markets while eliminating the need for large investments in hardware infrastructure.
We provide an extensive selection of passive and active copper and optical cables and modules to enable Ethernet and InfiniBand connectivity at speeds up to 400Gb/s.
Technology
We have technological core competencies in the design of high-performance interconnect ICs that enable us to provide a high level of integration, efficiency, flexibility and performance for our adapter and switch ICs. Our products integrate multiple complex components onto a single IC, including high-performance mixed-signal design, specialized communication processing functions and advanced interfaces.
High-performance mixed-signal design
One of the key technology differentiators of our ICs is our mixed-signal data transmission SerDes technology. SerDes I/O directly drives the interconnect interface, which provides signaling and transmission of data over copper cables or fiber optic interfaces for longer distance connections. Additionally, we are able to integrate several of these high-performance SerDes onto a single, low-power IC, enabling us to provide the highest bandwidth, merchant switch ICs based on an industry-standard specification. We have developed a 26Gb/25Gb/s SerDes I/O that is used in our ConnectX-4 adapter and Switch-IB and Spectrum switch silicon. Our 26Gb/25Gb/s SerDes enables our ConnectX adapters to support 100Gb/s bandwidth (four 26Gb/25Gb/s SerDes operating in parallel) in addition to providing a direct 10Gb/s connection to standard XFP and SFP+ fiber modules to provide long range Ethernet connectivity without the requirement of additional components, which saves power, cost and board space. We have extended our SerDes with PAM-4 technology to operate at 50G/s per lane in our ConnectX-6 adapters, Quantum-2 switches, and Spectrum-2 switches. This enables us to scale these platforms to 200 and 400Gb/s links.
Specialized communication processing and switching functions
We specialize in high-performance, low-latency design architectures that incorporate significant memory and logic areas requiring proficient synthesis and verification. Our adapter ICs are specifically designed to perform communication processing,
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effectively offloading this very intensive task from server and storage processors in a cost-effective manner. Our switch ICs are specifically designed to switch cluster interconnect data transmissions from one port to another with high bandwidth and low latency, and we have developed a packet switching engine and non-blocking crossbar switch fabric to address this.
We have developed a custom embedded Reduced Instruction Set Computer processor called InfiniRISC® that specializes in offloading network processing from the host server or storage system and adds flexibility, product differentiation and customization. We integrate a different number of these processors in a device depending on the application and feature targets of the particular product. Integration of these processors also shortens development cycles as additional features can be added by providing new programming packages after the ICs are manufactured, and even after they are deployed in the field.
Advanced interfaces
In addition to Ethernet and InfiniBand interfaces, we also support other industry-standard, high-performance advanced interfaces, such as PCI Express, which also utilize our mixed-signal SerDes I/O technology. PCI Express is a high-speed, chip-to-chip interface which provides a high-performance interface between the adapter and processor in server and storage systems. PCI Express and our high-performance interconnect interfaces are complementary technologies that facilitate optimal bandwidth for data transmissions along the entire connection starting from a processor of one system in the cluster to another processor in a different system.
System hardware technology
In addition to silicon technology, we also provide system hardware technology that enables us to build high-density, high-performance network adapters and switch systems. Our technology delivers end-to-end solutions that maximize data throughput through a given media at minimal hardware or power cost at very low Bit Error Rate.
Software technology
In addition to hardware products, we develop and provide software stacks to expose standard I/O interfaces to the consumer applications on the host and to network management applications within the network. We also provide advanced interfaces and capabilities to enable application acceleration, efficient resource management and utilization in data centers, factoring cost, power and performance into the efficiency equation.
Customers
HPC, cloud, Web 2.0 and embedded end-user markets for systems utilizing our products are mainly served by leading server, storage and communications infrastructure OEMs and ODMs.original design manufacturer ("ODMs"). In addition, our customer base includes leading embedded systems OEMs that integrate computing, storage and communication functions that use high-performance interconnect solutions contained in a chassis which has been optimized for a particular environment.
Our products have broad adoption with multiple end customers across HPC, Web 2.0, cloud, EDC, financial services and storage markets; however, these markets are mainly served by leading server, storage, communications infrastructure and embedded system OEMs and ODMs. Therefore, we have derived a substantial portion of our revenues from a relatively small
number of OEM and ODM customers. In the years ended December 31, 2017, 20162019, 2018 and 20152017, sales to Hewlett Packard Enterprise ("HPE") accounted for 13%11%, 16%12% and 14%13%, respectively, of our total revenues. In the year ended December 31, 2017,revenues and sales to Dell Technologies ("Dell") accounted for 10%, 12% and 11%, respectively, of our total revenues.
Backlog
Our sales are primarily made through standard purchase orders for delivery of products. Our manufacturing production is based on estimates and advance non-binding commitments from customers as to future purchases. We follow industry practice that allows customers to cancel, change or defer orders with limited advance notice prior to shipment. Given this practice, we do not believe that backlog is a reliable indicator of future revenue levels.
Sales and Marketing
We sell our products worldwide through multiple channels, including our direct sales force, our network of domestic and international sales representatives and independent distributors. We have strategically located marketing and sales personnel in the United States, Europe, China, Japan, India, Singapore, Taiwan and Australia. Our sales directors focus their efforts on leading OEMs and target key decision makers. We are also in frequent communication with our customers' and partners' sales organizations to jointly promote our products and partner solutions into end-user markets. We have expanded our sales and business development teams to engage directly with end users promoting the benefits of our products which we believe creates additional demand for our customers' products that incorporate our products.
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Our sales support organization is responsible for supporting our sales channels and managing the logistics from order entry to the delivery of products to our customers. In addition, our sales support organization is responsible for customer and revenue forecasts, customer agreements and program management for our large, multi-national customers.
To accelerate design and qualification of our products into our OEM customers' systems, and ultimately the deployment of our technology by our customers to end users, we have a field applications engineering ("FAE") team and a sales engineering team that provide direct technical assistance during the design-in process. In certain situations, our OEM customers will utilize our expertise to support their end-user customers jointly. Our technical support personnel have expertise in hardware and software, and have access to our development team to ensure proper technical expertise is provided to our OEM customers. Our FAE team provides OEM customers with design reviews of their systems in addition to technical training on the technology we have implemented in our products.
Our marketing team is responsible for creating and growing the brand of our company, product strategy and management, competitive analysis, marketing communications and raising the overall visibility of our company. The marketing team works closely with both the sales and research and development organizations to properly align development programs and product launches with market demands.
Our marketing team leads our efforts to promote our interconnect technology and our products to the entire industry by:
assuming leadership roles within IBTA, OFA and other industry trade organizations;
participating in tradeshows, press and analyst briefings, conference presentations and seminars for end-user education; and
building and maintaining active partnerships with industry leaders whose products are important in driving Ethernet and InfiniBand adoption, including vendors of processors, operating systems and software applications.
Research and Development
Our research and development team is composed of experienced semiconductor designers, software developers and system designers. Our semiconductor design team has extensive experience in all phases of complex, high-volume design, including product definition and architecture specification, hardware code development, mixed-signal and analog design and verification. Our software team has extensive experience in development, verification, interoperability testing and performance optimization of software for use in computing and storage applications. Our systems design team has extensive experience in all phases of high-volume adapter card, switch, and custom switchinterconnect designs including product definition and architectural specification, product design, design verification and transfer to production. Our software is driven by an open-source approach which is fundamental for achieving high quality and performance.
We design our products with careful attention to quality, reliability, cost and performance requirements. We utilize a methodology called Customer Owned Tooling ("COT"), where we control and manage a significant portion of timing, layout design and verification in-house, before sending the semiconductor design to our third-party manufacturer. Although COT requires a significant up-front investment in tools and personnel, it provides us with greater control over the quality and reliability of our IC products, better product cost and superior time to market as opposed to relying on third-party verification services.
We choose first-tier technology vendors for our design tools and continue to maintain long-term relationships with our vendors to ensure timely support and updates. We also select a mainstream silicon manufacturing process only after it has proven its production worthiness. We verify that actual silicon characterization and performance measurements strongly correlate to models that were used to simulate the device while in design, and that our products meet frequency, power and thermal targets with good margins. Furthermore, we insert Design-for-Test circuitry into our IC products which increases product quality, provides expanded debugging capabilities and ultimately enhances system-level testing and characterization capabilities once the device is integrated into our customers' products.
Frequent interaction between our silicon, software and systems design teams gives us a comprehensive view of the requirements necessary to deliver quality, high-performance products to our OEM customers. Our research and development expense was $365.9 million in 2017, $322.6 million in 2016 and $252.2 million in 2015.
Manufacturing
We depend on third-party vendors to manufacture, package, assemble and production test our products as we do not own or operate facilities for semiconductor fabrication, packaging or production testing, or for board, cable or system assembly. By outsourcing manufacturing, we are able to avoid the high cost associated with owning and operating our own facilities while managing flexible capacity. This allows us to focus our efforts on the design and marketing of our products.
We own our test infrastructure in ICs, boards and cables. To keep high utilization and flexibility, most of our equipment is common between product families. For fiber cables, we also own some of the machines in the production line.
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Manufacturing and Testing. We use Taiwan Semiconductor Manufacturing Company ("TSMC") for our CMOS process ICs and STMicroelectronics for our BiCMOS process ICs. We use Advanced Semiconductor Engineering ("ASE") and Amkor Technology Korea Inc. (“Amkor”) to assemble, package and production test our IC products. We use Flextronics International Ltd. ("Flextronics") and Universal Scientific Industrial Co., Ltd. ("USI") to manufacture our standard and custom adapter card products and switch systems. In addition, we also use Comtel Electronics to manufacture some of our switch systems. We use several sub-contractors to manufacture our cables. We maintain close relationships with our suppliers, which improves the efficiency of our supply chain. We focus on mainstream processes, materials, packaging and testing platforms, and have a continuous technology assessment program in place to choose the appropriate technologies to use for future products. We provide all of our suppliers a 6-month rolling forecast, and generally receive their confirmation that they are able to accommodate our needs on a monthly basis. We have access to online production reports that provide up-to-date status information of our products as they flow through the manufacturing process. On a quarterly basis, we generally review lead-time, yield enhancements and pricing with all of our suppliers to obtain the optimal cost for our products.
Quality Assurance. We maintain an ongoing review of product manufacturing and testing processes. Our IC products are subjected to extensive testing to assess whether their performance exceeds the design specifications. We own Teradyne IC in-house testers providing immediate test data and the ability to generate characterization reports that are made available to our customers. Our adapter cards, switch system and cable products are subject to similar levels of testing and characterization, and are additionally tested for regulatory agency certifications such as Safety and EMC (radiation test) which are made available to our customers. We only use components on these products that are qualified to be on our approved vendor list.
Employees
As of December 31, 2017,2019, we had 2,4482,660 full-time employees and 275117 part-time employees, including 1,8191,776 full-time employees in research and development, 487474 in sales and marketing, 311284 in general and administrative and 106126 in operations. 1,7281,995 of our full-time employees and 264115 of the part-time employees are located in Israel.
Certain provisions of the collective bargaining agreements between the Histadrut (General Federation of Labor in Israel) and the Coordination Bureau of Economic Organizations (including the Industrialists' Associations) are applicable to our employees in Israel by order of the Israeli Ministry of Economy and Industry, which extends such collective bargaining agreements to Israeli employers. These provisions primarily concern the length of the workweek, travel expended, and pension fund benefits for all employees. We generally provide our employees with benefits and working conditions above the required minimums.
We have never experienced any employment-related work stoppages and believe our relationship with our employees is good.
Intellectual Property
One of the key values and drivers for future growth of our high-performance interconnect IC, system hardware and software products is the IP we develop and use to improve them. We believe that the main value proposition of our high-performance interconnect products and success of our future growth will depend on our ability to protect our IP. We rely on a combination of patent, copyright, trademark, mask work, trade secret, patent, trademark, design, copyright and other IP laws, both in the United States and internationally, as well as confidentiality, non-disclosure and inventions assignment agreements with our employees, customers,
partners, suppliers and consultants to protect and otherwise seek to control access to, and distribution of, our proprietary information and processes. In addition, we have developed technical knowledge, which, although not patented, we consider to be significant in enabling us to compete. The proprietary nature of such knowledge, however, may be difficult to protect and we may be exposed to competitors who independently develop the same or similar technology or gain access to our knowledge.
The semiconductor industry is characterized by frequent claims of infringement and litigation regarding patent and other IP rights. We, like other companies in the semiconductor industry, believe it is important to aggressively protect and pursue our IP rights. Accordingly, to protect our rights, we may file suit against parties whom we believe are infringing or misappropriating our IP rights. In addition, we may engage in litigation with parties that claim that we infringed their patents or misappropriated or misused their trade secrets. Such litigations could result in substantial cost and may divert management's attention away from day-to-day operations. We may not prevail in these lawsuits. If any party infringes or misappropriates our IP rights, this infringement or misappropriation could materially adversely affect our business and competitive position.
As of December 31, 2017,2019, we had 410681 issued patents and fivesix registered designs in the United States, fivesix issued patents in Israel, and 7296 issued patents and four registered designs in other countries. We had 250175 patent applications and one design application pending in the United States one patent application pending in Israel, and 6080 patent applications pending in other countries, which cover aspects of the technology in our products. The term of any issued patent in the United States and Israel is 20 years from its priority date and if our applications are pending for a long time period, we may have a correspondingly shorter term for any patent that may be issued. In addition, the lives of acquired patents may also have a shorter term depending upon their acquisition date and the issue date of respective patent. Our present
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and future patents may provide only limited protection for our technology and may not be sufficient to provide competitive advantages to us. Furthermore, we cannot assure you that any patents will be issued to us as a result of our patent applications.
The risks associated with patents and intellectual property are more fully discussed under the section entitled "Risk Factors" under Part I, Item 1A of this report.
Competition
The markets in which we compete are highly competitive and are characterized by rapid technological change, evolving industry standards and new demands on features and performance of interconnect solutions. We compete primarily on the basis of:
price/performance;
time to market;
features and capabilities;
wide availability of complementary software solutions;
reliability;
power consumption and latency;
customer and application support;
product roadmap;
intellectual property; and
reputation.
We believe that we compete favorably with respect to each of these criteria. Many of our current and potential competitors, however, have longer operating histories, significantly greater resources, greater economies of scale, stronger name recognition and a larger base of customers than we do. This may allow them to respond more quickly to new or emerging technologies or changes in customer requirements. Many of our competitors also have significant influence in the semiconductor industry. They may be able to introduce new technologies or devote greater resources to the development, marketing and sales of their products than we can. Furthermore, in the event of a manufacturing capacity shortage, these competitors may be able to manufacture products when we are unable to do so.
We compete with other providers of semiconductor-based high-performance interconnect products based on InfiniBand, Ethernet, Fibre Channel and proprietary technologies. With respect to InfiniBand products, we compete with Intel Corporation's proprietary Omni-Path interconnects.interconnect, Cray’s (a HPE company) SlingShot interconnect, as well as high-performance Ethernet interconnects offered by many competitors. The leading IC vendors that provide Ethernet and Fibre Channel products to the marketvendors of adapters are Broadcom Limited ("Broadcom"), and Marvell Technology Group (“Marvell”). The leading Fibre Channel switch suppliers are Broadcom and Cisco Systems, Inc (“Cisco”). The leading vendors of Ethernet adapters include Intel Corporation (“Intel”), Broadcom, Limited ("Broadcom"),Cisco, Marvell, Technology Group,Chelsio, and Cavium.SolarFlare (a Xilinx company). In the SmartNIC and programmable SOC and NIC market segment we compete with Intel, Broadcom, Xilinx, Netronome, and others. Our primary Ethernet switch silicon competitor is Broadcom, Barefoot Networks (an Intel company) and Innovium as a private company. The leading Ethernet switch system vendors include Cisco Systems, Inc., Juniper Networks, Inc. and Arista Networks, Inc.Inc, and others. In the module and cable interconnect segment, we compete with II-VI, AOI, Innolight, Lumentum, and others. Across all of these market segments as well as in embedded
markets, we typicallyoften compete with interconnect technologies that are developed in-house by system OEM vendors and createdhyperscale service providers that are tailored for their specific applications.
Additional Information
We were incorporated under the laws of Israel in March 1999. Our ordinary shares began trading on The NASDAQNasdaq Global Market as of February 8, 2007 under the symbol "MLNX". Prior to February 8, 2007, our ordinary shares were not traded on any public exchange.
Our principal executive offices in the United States are located at 350 Oakmead Parkway, Suite 100, Sunnyvale, California 94085, and our principal executive offices in Israel are located at Beit Mellanox, Yokneam, Israel 20692. The majority of our assets are located in Israel. Our telephone number in Sunnyvale, California is (408) 970-3400, and our telephone number in Yokneam, Israel is +972-4-909-7200. Jacob Shulman, our Chief Financial Officer, is our agent for service of process in the United States, and is located at our principal executive offices in the United States. Our website address is www.mellanox.com. Information contained on our website is not a part of this report and the inclusion of our website address in this report is an inactive textual reference only.
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Available Information
We file reports with the Securities and Exchange Commission ("SEC"), including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any other filings required by the SEC. We post on the Investor Relations pages of our website, ir.mellanox.com, links to our filings with the SEC, our Code of Business Conduct and Ethics, our Complaint and Investigation Procedures for Accounting, Internal Accounting Controls, Fraud or Auditing Matters and the charters of our Audit, Compensation, Technology and Nominating and Corporate Governance Committees of our board of directors and the charter of our Disclosure Committee. Our filings with the SEC, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any other filings required by the SEC, are posted on our website as soon as reasonably practical after they are electronically filed with, or furnished to, the SEC. You can also obtain copies of these documents without charge to you, by writing to us at: Investor Relations, c/o Mellanox Technologies, Inc., 350 Oakmead Parkway, Suite 100, Sunnyvale, California 94085 or by emailing us at: ir@mellanox.com. All these documents and filings are available free of charge. Please note that information contained on our website is not incorporated by reference in, or considered to be a part of, this report. Further, a copy of this report on Form 10-K is located at the SEC's Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.
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ITEM 1A—RISK FACTORS
Investing in our ordinary shares involves a high degree of risk. You should carefully consider the following risk factors, in addition to the other information set forth in this report, before purchasing our ordinary shares. Each of these risk factors could harm our business, financial condition and results of operations, as well as decrease the value of an investment in our ordinary shares.
Risks Related to Our Business
The announcement and pendency of our agreement to be acquired by a wholly-owned subsidiary of NVIDIA may adversely affect our business, results of operations and share price.
Our pending acquisition by NVIDIA International Holdings Inc., a wholly-owned subsidiary of NVIDIA, could have an adverse effect on our revenue in the near term if our customers delay, defer or cancel purchases pending completion of the Merger. While we are attempting to address this risk through communications with our customers, current and prospective customers may be reluctant to purchase our products due to uncertainty about the direction of our product offerings and the support and service of our products after the Merger is consummated. Additionally, we are subject to additional risks in connection with the announcement and pendency of the Merger, including:
various conditions to the closing of the Merger, including required approval by the State Administration for Market Regulation, the China regulatory agency, may not be satisfied or waived;
the pendency and outcome of any legal proceedings that may be instituted against us, our directors and others relating to the transactions contemplated by the Merger Agreement;
potential adverse effects on our business and operations under the Merger Agreement, which may prevent us from pursuing opportunities without NVIDIA’s approval or taking other actions, whether in the form of dividend payments, share repurchases, restructurings, asset dispositions or otherwise, that we might have undertaken in the absence of this transaction;
that the Merger Agreement contains customary provisions that may limit our ability to pursue alternative sale proposals;
that we may forego opportunities we might otherwise have pursued absent the Merger Agreement;
the required regulatory approvals from governmental entities may delay the Merger or result in the imposition of conditions that could cause NVIDIA to abandon the Merger;
potential adverse effects on our ability to attract, recruit, retain and motivate current and prospective employees who may be uncertain about their future roles and relationships with us following the completion of the Merger; and
the significant diversion of our employees’ and management’s attention resulting from the transactions contemplated by the Merger Agreement.
The failure of our pending acquisition by a wholly-owned subsidiary of NVIDIA to be completed may adversely affect our business, results of operations and share price.
Each of our and NVIDIA’s obligations to consummate the Merger is subject to a number of conditions specified in the Merger Agreement, including the following: (a) approval of the Merger Agreement by the requisite affirmative vote of our shareholders, which was received at our extraordinary general meeting of shareholders held on June 20, 2019, (b) no governmental authority in any jurisdiction has by any law or order restrained, enjoined or otherwise prohibited the consummation of the Merger that remains in effect, (c) expiration or termination of the applicable Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"), waiting period, clearance or approval, as applicable, by the Anti-Monopoly Bureau of the State Administration for Market Regulation ("SAMR") in the People’s Republic of China, and clearance or affirmative approval by or expiration of the mandatory waiting period with respect to certain specified antitrust jurisdictions, (d) at least fifty (50) days shall have elapsed after the filing of the Merger proposal with the Companies Registrar of the Israeli Corporations Authority and at least thirty (30) days shall have elapsed after the approval of the Merger by our shareholders has been received, (e) with specified qualifications and exceptions, the truth and correctness of the representations and warranties of Mellanox, NVIDIA International Holdings Inc., Teal Barvaz Ltd. and NVIDIA and compliance in all material respects by Mellanox, NVIDIA International Holdings Inc. and Teal Barvaz Ltd. with their respective covenants contained in the Merger Agreement, and (f) the absence of a material adverse effect on Mellanox’s business, except any effects that, individually or in the aggregate, would prevent or materially impair Mellanox from consummating the Merger or performing any of its material obligations under the Merger Agreement. There can be no assurance that these conditions to the completion of the Merger will be satisfied in a timely manner or at all.
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If the Merger is not completed our share price could fall to the extent that our current share price reflects an assumption that the Merger will be completed. Furthermore, if the Merger is not completed, we may suffer other consequences that could adversely affect our business, results of operations and share price, including the following:
we could be required to pay a termination fee of up to $225.0 million to NVIDIA under certain circumstances as described in the Merger Agreement;
we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the Merger, and these fees and costs are payable by us regardless of whether the Merger is consummated;
the failure of the Merger to be consummated may result in adverse publicity and a negative impression of us in the investment community;
the pendency and outcome of any legal proceedings that may be instituted against us, our directors and others relating to the transactions contemplated by the Merger Agreement;
any disruptions to our business resulting from the announcement and pendency of the acquisition, including any adverse changes in our relationships with our customers, vendors and employees, may continue or intensify in the event the Merger is not consummated;
we may not be able to take advantage of alternative business opportunities or effectively respond to competitive pressures; and
we may experience employee departures.
Any delay in completing the Merger may significantly reduce the benefits expected to be obtained from the Merger.
In addition to the required regulatory clearances and approvals described above under "The failure of our pending acquisition by a wholly-owned subsidiary of NVIDIA to be completed may adversely affect our business, results of operations and share price," the Merger is subject to a number of other conditions described in the Merger Agreement that are beyond our control. We cannot predict whether and when these conditions, and the other required regulatory clearances and approvals, will be satisfied.
The semiconductor industry may be adversely impacted by worldwide economic uncertainties which may cause our revenues and profitability to decline.
We operate primarily in the semiconductor industry, which is cyclical and subject to rapid change and evolving industry standards. From time to time, the semiconductor industry has experienced significant downturns characterized by decreases in product demand and excess customer inventories. Economic volatility can cause extreme difficulties for our customers and vendors to accurately forecast and plan future business activities. This unpredictability could cause our customers to reduce spending on our products and services, which would delay and lengthen sales cycles. Furthermore, during challenging economic times our customers and vendors may face issues gaining timely access to sufficient credit, which could affect their ability to make timely payments to us. As a result, we may experience growth patterns that are different than the end demand for products, particularly during periods of high volatility.
We cannot predict the timing, strength or duration of any economic slowdown or recovery or the impact of such events on our customers, our vendors or us. The combination of our lengthy sales cycle coupled with challenging macroeconomic conditions could have a compound impact on our business. The impact of market volatility is not limited to revenue but may also affect our product gross margins and other financial metrics. Any downturn in the semiconductor industry may be severe and prolonged, and any failure of the industry to fully recover from downturns could seriously impact our revenue and harm our business, financial condition and results of operations.
The adoption of InfiniBand is largely dependent on third-party vendors and end users and InfiniBand may not be adopted at prior rates or to the extent that we anticipate.
While the usage of InfiniBand has increased since its first specifications were completed in October 2000, continued adoption of InfiniBand is dependent on continued collaboration and cooperation among IT vendors. In addition, the end users that purchase IT products and services from vendors must find InfiniBand to be a compelling solution to their IT system requirements. We cannot control third-party participation in the development of InfiniBand as an industry standard technology. We rely on server, storage, communications infrastructure equipment and embedded systems vendors to incorporate and deploy InfiniBand ICs in their systems. InfiniBand may fail to effectively compete with other technologies, which may be adopted by vendors and their customers in place of InfiniBand. The adoption of InfiniBand is also affected by the general replacement cycle of IT equipment by end users, which is dependent on factors unrelated to InfiniBand. These factors may reduce the rate at which InfiniBand is incorporated by
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our current server vendor customers and impede its adoption in the storage, communications infrastructure and embedded systems markets, which in turn would harm our ability to sell our InfiniBand products.
We face intense competition and may not be able to compete effectively, which could reduce our market share, net revenues and profit margin.
The markets in which we operate are extremely competitive and are characterized by rapid technological change, continuously evolving customer requirements and fluctuating average selling prices. We may not be able to compete successfully against current or potential competitors.
Some of our customers are also IC and switch suppliers and already have in-house expertise and internal development capabilities similar to ours. Licensing our technology and supporting such customers entails the transfer of intellectual property rights that may enable such customers to develop their own products and solutions to replace those we are currently providing to them. Consequently, these customers may become competitors to us. Further, each new design by a customer presents a competitive situation. In the past, we have lost design wins to divisions within our customers and this may occur again in the future. We cannot predict whether these customers will continue to compete with us, whether they will continue to be our customers or whether they will continue to buy products from us at the same volumes. Competition could increase pressure on us to lower our prices and could negatively affect our profit margins.
Many of our current and potential competitors have longer operating histories, significantly greater resources, greater economies of scale, stronger name recognition and larger customer bases than we have. This may allow them to respond more quickly to new or emerging technologies or changes in customer requirements. In addition, these competitors may have greater credibility with our existing and potential customers. If we do not compete successfully, our market share, revenues and profit margin may decline, and, as a result, our business may be adversely affected.
There has been a trend toward industry consolidation in our markets for several years, as companies attempt to improve the leverage of growing research and development costs, strengthen or hold their market positions in an evolving industry or are unable to continue operations. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in our operating results and could have a material adverse effect on our business, financial condition and results of operations.
See Part I, Item 1, "Business-Competition” for more information about our competitors.
We have limited visibility into customer and end-user demand for our products and generally have short inventory cycles, which introduce uncertainty into our revenue and production forecasts and business planning and could negatively impact our financial results.
Our sales are made on the basis of purchase orders rather than long-term purchase commitments. In addition, our customers may defer purchase orders. We place orders with the manufacturers of our products according to our estimates of customer demand. This process requires us to make multiple demand forecast assumptions with respect to both our customers' and end users' demands. It is more difficult for us to accurately forecast end-user demand because we do not sell our products directly to end users. In addition, the majority of our adapter card, switch system and cable businesses are conducted on a short order fulfillment basis, introducing more uncertainty into our forecasts. Because of the lead time associated with fabrication of our semiconductors, forecasts of demand for our products must be made in advance of customer orders. In addition, we base business decisions regarding our growth on our forecasts for customer demand. As we grow, anticipating customer demand may become increasingly difficult. If we overestimate customer demand, we may purchase products from our manufacturers that we may not be able to sell and may over-burden our operations. Conversely, if we underestimate customer demand or if sufficient manufacturing capacity were unavailable, we would forego revenue opportunities and could lose market share or damage our customer relationships.
In addition, the majority of our revenues are derived from customer orders received and fulfilled in the same quarterly period. If we overestimate customer demand, we could miss our quarterly revenue targets, which could have a material adverse effect on our financial results.
We depend on a small number of customers for a significant portion of our sales, and the loss of any one of these customers will adversely affect our revenues.
A small number of customers account for a significant portion of our revenues. For the years ended December 31, 2019, 2018 and 2017, sales to HPE accounted for 11%, 12% and 13% of our total revenues, respectively; and sales to Dell accounted for 10%, 12% and 11% of our total revenues, respectively. Sales to our top 10 customers represented 48%, 53% and 56% for the years ended December 31, 2019, 2018 and 2017, respectively. Because the majority of servers, storage, communications infrastructure equipment and embedded systems are sold by a relatively small number of vendors, we expect that we will continue
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to depend on a small number of customers to account for a significant percentage of our revenues for the foreseeable future. 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. See Part I, Item 1, "Business-Customers" for more information about our customers.
Winning business is subject to lengthy, competitive selection processes that often require us to incur significant expense, from which we may ultimately generate no revenues.
Our business is dependent on us winning competitive bid selection processes, known as “design"design wins,”" to develop semiconductors for use in our customers' products. These selection processes are typically lengthy and can require us to incur significant design and development expenditures and to dedicate scarce engineering resources in pursuit of a single customer opportunity. We may not win the competitive selection process and may never generate any revenue despite incurring such expenditures.
Furthermore, winning a product design does not guarantee sales to a customer. We may experience delays in generating revenue as a result of the lengthy development cycle typically required, or we may not realize as much revenue as anticipated. In addition, a delay or cancellation of a customer's plans could materially and adversely affect our financial results, as we may have incurred significant expense in the design process and generated little or no revenue. Customers could choose at any time
to stop using our products or may fail to successfully market and sell their products, which could reduce the demand for our products and cause us to hold excess inventory, thereby materially adversely affecting our business, financial condition and results of operations.
The timing of design wins is unpredictable and implementing production for a major design win, or multiple design wins occurring at or around the same time, may strain our resources and those of our contract manufacturers. In such instances, we may be forced to dedicate significant additional resources and incur additional, unanticipated costs and expenses, which may have a material adverse effect on our results of operations.
Finally, some customers will not purchase any products from us, other than limited numbers of evaluation units, until they qualify the products and/or the manufacturing line for the products. The qualification process can take significant time and resources and we may not always be able to satisfy the qualification requirements of these customers. Delays in qualification or failure to qualify our products may cause a customer to discontinue use of our products and result in a significant loss of revenue.
If we fail to develop new products or enhance our existing products to react to rapid technological change and market demands in a timely and cost-effective manner, our business will suffer.
We must develop new products or enhance our existing products with improved technologies to meet rapidly evolving customer requirements. We are currently engaged in the development process for our next generation of products in order to meet the demands of our customers who continually require higher performance and functionality at lower costs. The development process for these advancements is lengthy and will require us to accurately anticipate technological innovations and market trends. Developing and enhancing these products can be time-consuming, costly and complex. Our ability to fund product development and enhancements partially depends on our ability to generate revenues from our existing products.
We may be unable to successfully develop additional next generation products, new products or product enhancements. There is a risk that these developments or enhancements will be late, have technical problems, fail to meet customer or market specifications or otherwise be uncompetitive with other products using alternative technologies that offer comparable performance and functionality. Our next generation products or any new products or product enhancements may not be accepted in new or existing markets. Our business, financial condition and results of operations may be adversely affected if we fail to develop and introduce new products or product enhancements in a timely manner or on a cost-effective basis.
We rely on a limited number of subcontractors to manufacture, assemble, package and production test our products, and the failure of any of these third-party subcontractors to deliver products or otherwise perform as requested could damage our relationships with our customers, decrease our sales and limit our growth.
While we design and market our products and conduct test development in-house, we do not manufacture, assemble, package and production test the vast majority of our products, and we must rely on third-party subcontractors to perform these services. If these subcontractors do not provide us with high-quality products, services and production and production test capacity in a timely manner, or if one or more of these subcontractors terminates its relationship with us, we may be unable to obtain satisfactory replacements to fulfill customer orders on a timely basis, our relationships with our customers could suffer, our sales could decrease and our growth could be limited. In particular, there are significant challenges associated with moving our IC production from our existing manufacturer to another manufacturer with whom we do not have a pre-existing relationship.
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In addition, the consolidation of foundry subcontractors, as well as the increasing capital intensity and complexity associated with fabrication in smaller process geometries has limited the diversity of our suppliers and increased our risk of a "single point of failure." Specifically, as we move to smaller geometries, we have become increasingly reliant on IC manufacturers. The lack of diversity of suppliers could also drive increased prices and adversely affect our results of operations, including our product gross margins.
We currently do not have long-term supply contracts with any of our third-party subcontractors. Therefore, they are not obligated to perform services or supply products to us for any specific period, in any specific quantities or at any specific price, except as may be provided in a particular purchase order. None of our third-party subcontractors has provided contractual assurances to us that adequate capacity will be available to us to meet future demand for our products. Our subcontractors may allocate capacity to the production of other companies' products while reducing deliveries to us on short notice. Other customers that are larger and better financed than we are or that have long-term agreements with these subcontractors may cause these subcontractors to reallocate capacity to those customers, thereby decreasing the capacity available to us.
Other significant risks associated with relying on these third-party subcontractors include:
reduced control over product cost, delivery schedules and product quality;
potential price increases;
inability to achieve sufficient production, increase production or test capacity and achieve acceptable yields on a timely basis;
increased exposure to potential misappropriation of our intellectual property;
shortages of materials used to manufacture products;
capacity shortages;
labor shortages or labor strikes;
political instability in the regions where these subcontractors are located; and
natural disasters impacting these subcontractors.
See Part I, Item 1, "Business-Manufacturing”"Business-Manufacturing" for more information about our subcontractors.
The average selling prices of our products have decreased in the past and may do so in the future, which could harm our financial results.
The products we develop and sell are subject to declines in average selling prices. We have had to reduce our prices in the past and we may be required to reduce prices in the future. Reductions in our average selling prices to one customer could impact our average selling prices to other customers. If we are unable to reduce our associated manufacturing costs this reduction in average selling prices would cause our gross margin to decline. Our financial results will suffer if we are unable to offset any reductions in our average selling prices by increasing our sales volumes, reducing our costs or developing new or enhanced products with higher selling prices or gross margins.
We expect gross margin to vary over time, and our recent level of product gross margin may not be sustainable.
Our product gross margins vary from quarter to quarter, and our recent level of gross margins may not be sustainable and may be adversely affected in the future by numerous factors, including product mix shifts, product transitions, increased price competition in one or more of the markets in which we compete, increases in material or labor costs, excess product component or obsolescence charges from our contract manufacturers, inventory reserve levels, warranty related issues, or the introduction of new products or entry into new markets with different pricing and cost structures.
Fluctuations in our revenues and operating results on a quarterly and annual basis could cause the market price of our ordinary shares to decline.
Our quarterly and annual revenues and operating results are difficult to predict and have fluctuated in the past, and may fluctuate in the future, from quarter to quarter and year to year. It is possible that our operating results in some quarters and years will be below market expectations. This would likely cause the market price of our ordinary shares to decline. Our quarterly and annual operating results are affected by a number of factors, many of which are outside of our control, including:
unpredictable volume and timing of customer orders, which are not fixed by contract but vary on a purchase order basis;
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the loss of one or more of our customers, or a significant reduction or postponement of orders from our customers;
our customers' sales outlooks, purchasing patterns and inventory levels based on end-user demands and general economic conditions;
seasonal buying trends;
the timing of new product announcements or introductions by us or by our competitors;
our ability to successfully develop, introduce and sell new or enhanced products in a timely manner;
changes in the relative sales mix of our products;
decreases in the overall average selling prices of our products;
changes in the cost of our finished goods; and
the availability, pricing and timeliness of delivery of other components used in our customers' products.
We base our planned operating expenses in part on our expectations of future revenues, and a significant portion of our expenses is relatively fixed in the short-term. We have limited visibility into customer demand from which to predict future sales of our products. As a result, it may be difficult for us to forecast our future revenues and budget our operating expenses accordingly. Our operating results would be adversely affected to the extent customer orders are cancelled or rescheduled. If revenues for a particular quarter are lower than we expect, we may not be able to proportionately reduce our operating expenses.
We rely on our ecosystem partners to enhance and drive demand for our product offerings. Our inability to continue to develop or maintain such relationships in the future or our partners' inability to timely deliver technology or product offerings to the market may harm our revenues and ability to remain competitive.
We have developed relationships with third parties, which we refer to as ecosystem partners. Such partners provide their technology products, operating systems, tool support, reference designs and other elements necessary for the sale of our products into our markets. In addition, introduction of new products into the market by these partners may increase demand for our products. If we are unable to continue to develop or maintain these relationships, or if our ecosystem partners delay or fail to timely deliver their technology or products or other elements to the market, our revenues may be adversely impacted and we might not be able to enhance our customers' ability to commercialize their products in a timely manner and our ability to remain competitive may be harmed.
We rely primarily upon trade secret, patent, trademark, design and copyright laws and contractual restrictions to protect our proprietary rights, and, if these rights are not sufficiently protected, our ability to compete and generate revenues could suffer.
We seek to protect our proprietary manufacturing specifications, documentation and other written materials primarily under trade secret, patent, trademark, design and copyright laws. We also typically require employees and consultants with access to our proprietary information to execute confidentiality agreements. The steps taken by us to protect our proprietary information may not be adequate to prevent misappropriation of our technology. In addition, our proprietary rights may not be adequately protected because:
people may not be deterred from misappropriating our technologies despite the existence of laws or contracts prohibiting it;
policing unauthorized use of our intellectual property may be difficult, expensive and time-consuming, and we may be unable to determine the extent of any unauthorized use; and
the laws of other countries in which we market our products, such as some countries in the Asia/Pacific region, may offer little or no protection for our proprietary technologies.
Reverse engineering, unauthorized copying or other misappropriation of our proprietary technologies could enable third parties to benefit from our technologies without paying us for doing so. Any inability to adequately protect our proprietary rights could harm our ability to compete, generate revenues and grow our business.
We may not obtain sufficient patent protection on the technology embodied in our products, which could harm our competitive position and increase our expenses.
Our success and ability to compete in the future may depend to a significant degree upon obtaining sufficient patent protection for our proprietary technology. Patents that we currently own do not cover all of the products that we presently sell as we have
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patent applications pending with respect to certain products, while we have not been able to obtain, or choose not to seek, patent protection for other products. Our patent applications may not result in issued patents, and even if they result in issued patents, the patents may not have claims of the scope we seek. Furthermore, any issued patents may be challenged,
invalidated or declared unenforceable. Whether or not these patents are issued, the applications may become publicly available and the proprietary information disclosed in the applications will become available to others. The lives of acquired patents may also be of a shorter term depending upon their acquisition dates and the issue dates. The term of any issued patent in the United States and Israel is typically 20 years from its filing date, and if our applications are pending for a long time period, we may have a correspondingly shorter term for any patent that may be issued. Our present and future patents may provide only limited protection for our technology and may not be sufficient to provide competitive advantages to us. For example, competitors could be successful in challenging any issued patents or, alternatively, could develop similar or more advantageous technologies on their own or design around our patents. Also, patent protection in certain foreign countries may not be available or may be limited in scope and any patents obtained may not be as readily enforceable as in the United States and Israel, making it difficult for us to effectively protect our intellectual property from misuse or infringement by other companies in these countries. Our inability to obtain and enforce our intellectual property rights in some countries may harm our business, financial condition and results of operations. In addition, given the costs of obtaining patent protection, we may choose not to protect certain innovations that later on turn out to be important. In such cases, our lack of intellectual property rights may have a material adverse impact on our business, financial condition and results of operations.
If we fail to carefully manage the use of "open source" software in our products, we may be required to license key portions of our products on a royalty-free basis or expose key parts of source code.
Some portion of our software may be derived from "open source" software that is generally made available to the public by its authors and/or other third parties. Such open source software is often made available to us under licenses, such as the GNU General Public License, which impose certain obligations on us in the event we were to create and distribute derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public and/or license such derivative works under a particular type of license, rather than the forms of licenses customarily used to protect our intellectual property. In the event that we inadvertently use open source software without the correct license form or a copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public and/or stop distribution of that work.
Intellectual property litigation, which is common in our industry, could be costly, harm our reputation, limit our ability to sell our products and divert the attention of management and technical personnel.
The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. From time to time, we receive notices from competitors and other third parties that claim we have infringed upon, misappropriated or misused other parties' proprietary rights. We may also be required to indemnify some customers and strategic partners under our agreements if a third party alleges or if a court finds that our products or activities have infringed upon, misappropriated or misused another party's proprietary rights. We have received requests from certain customers and strategic partners to include increasingly broad indemnification provisions in our agreements with them. Additionally, our products may contain technology provided to us by other parties such as contractors, suppliers or customers. We may have little or no ability to determine in advance whether such technology infringes upon the intellectual property rights of a third party. Our contractors, suppliers and licensors may not be required to indemnify us in the event that a claim of infringement is asserted against us, or they may be required to indemnify us only up to a maximum amount, above which we would be responsible for any further costs or damages.
Questions of infringement in the markets we serve involve highly technical and subjective analyses.analysis. We are not involved in intellectual property litigation today, andbut litigation may be necessary in the future to enforce any patents we may receive and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity, and we may not prevail in any such future litigation. Litigation, whether or not determined in our favor or settled, could be costly, could harm our reputation and could divert the efforts and attention of our management and technical personnel from normal business operations. In addition, adverse determinations in litigation could result in the loss of our proprietary rights, subject us to significant liabilities, and require us to seek licenses from third parties or prevent us from licensing our technology or selling our products, any of which could seriously harm our business.
In the normal course of business, we enter into agreements with terms and conditions that require us to indemnify the other party against third-party claims alleging that one of our products infringes or misappropriates intellectual property rights, as well as against certain claims relating to property damage, personal injury or acts or omissions relating to supplied products or technologies, or acts or omissions made by us or our agents or representatives. In addition, we are obligated pursuant to indemnification undertakings with our officers and directors to indemnify them to the fullest extent permitted by law and to indemnify venture capital funds that were affiliated with or represented by such officers or directors. If we receive demands for indemnification under these agreements and terms and conditions, they will likely be very expensive to settle or defend, and we
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may incur substantial legal fees in connection with any indemnity demands. Our indemnification obligations under these agreements and terms and conditions may be unlimited in duration and amount, and could have an adverse effect on our business, financial condition and results of operations.
We depend on key and highly skilled personnel to operate our business, and if we are unable to retain our current personnel and hire additional personnel, our ability to develop and successfully market our products could be harmed.
Our business is particularly dependent on the interdisciplinary expertise of our personnel, and we believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, engineering, finance and sales and marketing personnel. The loss of any key employees or the inability to attract or retain qualified personnel could delay the development and introduction of, and harm our ability to sell our products and harm the market's perception of us. Competition for qualified engineers in the markets in which we operate is intense and accordingly, we may not be able to retain or hire all of the engineers required to meet our ongoing and future business needs. If we are unable to attract and retain the highly skilled professionals we need, we may have to forego projects for lack of resources or be unable to staff projects optimally. We believe
that our future success is highly dependent on the contributions of our president and CEO and other senior executives. We do not have long-term employment contracts with our president and CEO CFO or any other key personnel, and their knowledge of our business and industry would be extremely difficult to replace.
In an effort to retain key employees, we may modify our compensation policies by, for example, increasing cash compensation to certain employees and/or modifying existing share options. These modifications of our compensation policies and the requirement to expense the fair value of share options, restricted share units, and RSUsperformance share units awarded to employees and officers may increase our operating expenses and result in the dilution of the holders of our ordinary shares. We cannot be certain that these and any other changes in our compensation policies will or would improve our ability to attract, retain and motivate employees. Our inability to attract and retain additional key employees and the increase in share-based compensation expense could each have an adverse effect on our business, financial condition and results of operations.
We may pursue acquisitions of other companies or new or complementary products, technologies and businesses, which could harm our operating results, may disrupt our business and could result in unanticipated accounting charges.
Our growth depends upon market growth, our ability to enhance our existing products, and our ability to introduce new products on a timely basis. Consistent with the terms of the Merger Agreement, we intend to continue to address the need to develop new products and enhance existing products through acquisitions of other companies, product lines, technologies, and personnel.
Acquisitions create additional material risk factors for our business that could cause our results to differ materially and adversely from our expected or projected results. Such risk factors include:
difficulties in integrating the operations, systems, technologies, products, and personnel of the acquired companies, particularly companies with large and widespread operations and/or complex products;
the diversion of management's attention from normal daily operations of the business and the challenges of managing larger and more widespread operations resulting from acquisitions;
possible disruption to the continued expansion of our product lines;
potential changes in our customer base and changes to the total available market for our products;
reduced demand for our products;
potential difficulties in completing projects associated with in-process research and development intangibles;
the use of a substantial portion of our cash resources and incurrence of significant amounts of debt;
significantly increase our interest expense, leverage and debt service requirements as a result of incurring debt;
the impact of any such acquisition on our financial results;
internal controls may become more complex and may require significantly more resources to ensure they remain effective;
negative customer reaction to any such acquisition; and
assuming the liabilities of the acquired company.
Acquisitions present a number of other potential risks and challenges that could disrupt our business operations. For example, we may not be able to successfully negotiate or finance the acquisition on favorable terms. If an acquired company also has
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inventory that we assume, we will be required to write up the carrying value of that inventory to its fair value. When that inventory is sold, the gross margins for those products are reduced and our gross margins for that period are negatively affected. Furthermore, the purchase price of any acquired businesses may exceed the current fair values of the net tangible assets of such acquired businesses. As a result, we would be required to record material amounts of goodwill, acquired in-process research and development and other intangible assets, which could result in significant impairment and acquired in-process research and development charges and amortization expense in future periods. These charges, in addition to the results of operations of such acquired businesses and potential restructuring costs associated with an acquisition, could have a material adverse effect on our business, financial condition and results of operations. We cannot forecast the number, timing or size of future acquisitions, or the effect that any such acquisitions might have on our operating or financial results. Furthermore, potential acquisitions, whether or not consummated, will divert our management's attention and may require considerable cash outlays at the expense of our existing operations. In addition, to complete future acquisitions, we may issue equity securities, incur debt, assume contingent liabilities or have amortization expenses and write-downs of acquired assets, which could adversely affect our profitability.
We have made and may in the future pursue investments in other companies, which could harm our operating results.
We have made, and could make in the future, investments in technology companies, including privately-held companies in the development stage. Many of these private equity investments are inherently risky because these businesses may never develop, and we may incur losses related to these investments. In addition, we have written down the carrying value of these investments in the past and may be required to write down the carrying value of these investments in the future to reflect other-than-temporary declines in their value, which could have a material adverse effect on our business, financial position and results of operations.
We may not be able to manage our future growth effectively, and we may need to incur significant expenditures to address the additional operational and control requirements of our growth.
We are experiencing a period of company growth and expansion. This expansion has placed, and any future expansion will continue to place, a significant strain on our management, personnel, systems and financial resources. We plan to hire additional employees to support an increase in research and development and strengthen our sales and marketing and general and administrative efforts. To successfully manage our growth, we believe we must effectively:
manage and enhance our relationships with customers, distributors, suppliers, end users and other third parties;
implement additional, and enhance existing, administrative, financial and operations systems, procedures and controls;
address capacity shortages;
manage inventory levels;
expand and upgrade our technological capabilities;
manage the challenges of having U.S., Israeli and other foreign operations; and
hire, train, integrate and manage additional qualified engineers for research and development activities as well as additional personnel to strengthen our sales and marketing, financial and IT functions.
Managing our growth may require substantial managerial and financial resources and may increase our operating costs even though these efforts may not be successful. If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities, develop new products, satisfy customer requirements, execute our business plan or respond to competitive pressures, in which case our business, financial conditions and results of operations may be adversely affected.
We are subject to risks associated with our distributors' product inventories.
We sell many of our products to customers through distributors who maintain their own inventory of our products for sale to dealers and end customers. We allow limited price adjustments on sales to distributors. Price adjustments may be effected by way of credits for future product or by cash payments to the distributor, either in arrears or in advance, using estimates based on historical transactions. Currently we recognize revenues for sales to distributors upon sell through by the distributors, net of estimated allowances for price adjustments. Upon the adoption of the new revenue standards effective January 1, 2018, we will recognize revenue on sales to distributors upon shipment and transfer of control (known as “sell-in” revenue recognition), net of the estimated allowances for price adjustments. We have extended these programs to certain distributors in the United States, Asia and Europe and may extend them on a selective basis to some of our other distributors in these geographies. The reserves recognizedallowances for these programsdistributor price adjustments are based on judgments and estimates, using historical experience rates, inventory levels in distribution, current trends and other factors, and there could be material differences between actual amounts and our estimates. Prior to January 1, 2018, we recognized revenues for sales to distributors upon sell through by the distributors, net of estimated allowances for price adjustments. Upon the adoption of the new revenue standards effective January 1, 2018, we began recognizing revenue on sales to distributors upon shipment and transfer of control (known as "sell-in" revenue recognition), net of the estimated allowances for price adjustments.
If our distributors are unable to sell an adequate amount of their inventory of our products in a given quarter to dealers and end customers or if they decide to decrease their inventories for any reason, such as adverse global economic conditions or a downturn in technology spending, our sales to these distributors and our revenues may decline. We also face the risk that our
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distributors may purchase, or for other reasons accumulate, inventory levels of our products in any particular quarter in excess of future anticipated sales to end customers. If such sales do not occur in the time frame anticipated by these distributors for any reason, these distributors may substantially decrease the amount of product they order from us in subsequent periods until their inventory levels realign with end-customer demand, which would harm our business and could adversely affect our revenues in such subsequent periods. Our reserve estimates associated with products stocked by our distributors are based largely on reports that our distributors provide to us on a weekly or monthly basis. To date, we believe this resale and channel inventory data have been generally accurate. To the extent that these data are inaccurate or not received in a timely manner, we may not be able to make reserve estimates for future periods accurately or at all.
We do not always have a direct relationship with the end customers of our products sold through distributors. As a result, our products may be used in applications for which they were not necessarily designed or tested, and they may not perform as anticipated in such applications. In such event, failure of even a small number of parts could result in significant liabilities to us, damage our reputation and harm our business and results of operations.
Certain of our customers and suppliers require us to comply with their codes of conduct, which may include certain restrictions that may substantially increase our cost of doing business as well as have an adverse effect on our operating efficiencies, operating results and financial condition.
Certain of our customers and suppliers require us to agree to comply with the Electronic Industry Code of Conduct (“EICC”("EICC") or their own codes of conduct, which may include detailed provisions on labor, human rights, health and safety, environment, corporate ethics and management systems. Certain of these provisions are not requirements under the laws of the countries in which we operate and may be burdensome to comply with on a regular basis. Moreover, new provisions may be added or material changes may be made to any of these codes of conduct, and we may have to promptly implement such new provisions or changes, which may substantially further increase the cost of our business, be burdensome to implement and adversely affect our operational efficiencies and operating results. If we violate any such codes of conduct, we may lose further business with the customer or supplier and, in addition, we may be subject to fines from the customer or supplier. While we believe that we are currently in compliance with our customers and suppliers’suppliers' codes of conduct, there can be no assurance that, from time to time, if any one of our customers and suppliers audits our compliance with such code of conduct, we would be found to be in full compliance. A loss of business from these customers or suppliers could have a material adverse effect on our business, financial condition and results of operations.
We may experience defects in our products, unforeseen delays, higher than expected expenses or lower than expected manufacturing yields of our products, which could result in increased customer warranty claims, delays of our product shipments and prevent us from recognizing the benefits of new technologies we develop.
Our products may contain defects and errors. Product defects and errors could result in additional development costs, diversion of technical resources, delayed product shipments, increased warranty-related returns, including wide-scale product recalls, warranty expenses and product liability claims against us which may not be fully covered by insurance. Our products are complex and our quality control tests and procedures may fail to detect any such defects or errors. Delivery of products with defects or reliability, quality or compatibility problems may damage our reputation and our ability to retain existing customers and attract new customers. As a result, defects in our products could have an adverse effect on our business, financial condition and results of operations.
In addition, our production of existing and development of new products can involve multiple iterations and unforeseen manufacturing difficulties, resulting in reduced manufacturing yields, delays and increased expenses. The evolving nature of our products requires us to modify our manufacturing specifications, which may result in delays in manufacturing output and product deliveries. We rely on a limited number of third parties to manufacture our products. Our ability to offer new products depends on our manufacturers' ability to implement our revised product specifications, which is costly, time-consuming and complex.
We have significant intangible assets and goodwill. Consequently, the future impairment of our intangible assets and goodwill, if any, may significantly impact our profitability.
Our intangible assets and goodwill are significant. As of December 31, 2017,2019, we had recorded $700.6$626.0 million of intangible assets, net and goodwill primarily related to our past acquisitions. Intangible assets and goodwill are subject to an impairment analysis whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Additionally, goodwill and indefinite-lived assets are subject to an impairment test at least annually. The impairment of any goodwill and other intangible assets may have a negative impact on our consolidated results of operations.
Unanticipated changes in our tax provisions or adverse outcomes resulting from examination of our income tax returns could adversely affect our results of operations.
We are subject to income taxes in Israel, the United States and various foreign jurisdictions. Our effective income tax rate could be adversely affected by changes in tax laws or interpretations of those tax laws, by changes in the mix of earnings in countries with differing statutory tax rates, or by changes in the valuation of our deferred tax assets and liabilities. The U.S. recently enacted significant tax reform, and certain provisions of the new law may adversely affect us. See Note 12 to the consolidated financial statements for more details about the U.S. tax reform and its effects.
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Our effective income tax rates are also affected by intercompany transactions for sales, services, funding and other items. Given the increased global scope of our operations, and the complexity of global tax and transfer pricing rules and regulations, it has become increasingly difficult to estimate earnings within each tax jurisdiction. If actual earnings within a tax jurisdiction
differ materially from our estimates or new information is discovered in the course of our tax return preparation process, we may not achieve our expected effective tax rate. Additionally, our effective tax rate may be affected by the tax effects of acquisitions, restructuring activities, newly enacted tax legislation, share-based compensation and uncertain tax positions. Finally, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities which may result in the assessment of additional income taxes. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. However, unanticipated outcomes from these examinations could have a material adverse effect on our business, financial condition and results of operations.
Changes to financial accounting standards may affect our results of operations and cause us to change our business practices.
We prepare our financial statements to conform to generally accepted accounting principles ("GAAP")GAAP in the United States. These accounting principles are subject to interpretation by the Financial Accounting Standards Board ("FASB"),FASB, the American Institute of Certified Public Accountants, ("AICPA"), the SEC and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions completed before a change is announced. Changes to those rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.
We must comply with a variety of existing and future laws and regulations that could impose substantial costs on us and may adversely affect our business.
We are subject to various state, federal and international laws and regulations governing the environment, including restricting the presence of certain substances in electronic products and making producers of those products financially responsible for the collection, treatment, recycling and disposal of those products. In addition, we are also subject to various industry requirements restricting the presence of certain substances in electronic products. Although our management systems are designed to maintain compliance, we cannot assure you that we have been or will be at all times in complete compliance with such laws and regulations. If we violate or fail to comply with any of them, a range of consequences could result, including fines, import/export restrictions, sales limitations, criminal and civil liabilities or other sanctions.
We and our customers are also subject to various import and export laws and regulations. Government export regulations apply to the encryption or other features contained in some of our products. If we fail to continue to receive licenses or otherwise comply with these regulations, we may be unable to manufacture the affected products or ship these products to certain customers, or we may incur penalties or fines.
We are also subject to regulations concerning the supply of certain minerals coming from the conflict zones in and around the Democratic Republic of Congo ("DRC"). The Dodd-Frank Wall Street Reform and Consumer Protection Act includes disclosure requirements regarding the use of certain minerals mined from the DRC and adjoining countries and procedures regarding a manufacturer's efforts to identify sourcing of such conflict minerals. These requirements could affect the sourcing and availability of minerals used in the manufacture of semiconductor devices.
As a result, this could limit the pool of suppliers who can provide us confirmation that the components and parts we source are considered DRC "conflict free," and we may not be able to confirm that we have obtained products or supplies that can be confirmed as DRC "conflict free" in sufficient quantities for our operations. Also, because our supply chain is complex, we may face reputational challenges with our customers, shareholders and other stakeholders if we are unable to sufficiently verify the origins for the minerals used in our products.
The costs of complying with these laws could adversely affect our current or future business. In addition, future regulations may become more stringent or costly and our compliance costs and potential liabilities could increase, which may harm our current or future business.
If we fail to maintain an effective system of internal controls, we may not be able to report accurately our financial results or prevent material fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which could harm our business and the trading price of our ordinary shares.
Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent material fraud. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control structure and procedures for financial reporting. We have an ongoing program to perform the system and process evaluation and testing necessary to comply with these requirements. We have incurred, and expect to continue to incur significant expenses and to devote significant management resources to Section 404 compliance.
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Furthermore, as we grow our business or acquire businesses, our internal controls may become more complex and we may require significantly more resources to ensure they remain effective. Failure to implement required new or improved controls, or difficulties encountered in their implementation, either in our existing business or in businesses that we may acquire could harm our operating results or cause us to fail to meet our reporting obligations. In the event that our CEO, CFO or independent registered public accounting firm determine that our internal controls over financial reporting are not effective as defined under Section 404, investor perceptions of our company may be adversely affected and may cause a decline in the market price of our ordinary shares.
We may be subject to disruptions or failures in information technology systems and network infrastructures, including theft, misuse of our electronic data or cyber-attacks that could have a material adverse effect on us.
We rely on the efficient and uninterrupted operation of complex information technology systems and network infrastructures to operate our business. We also hold large amounts of data in various data center facilities upon which our business depends. A disruption, infiltration or failure of our information technology systems or any of our data centers as a result of software or hardware malfunctions, system implementations or upgrades, computer viruses, third-party security breaches, attempts by others that try to gain unauthorized access through the Internet to our information technology systems, employee error, theft or misuse, malfeasance, power disruptions, natural disasters or accidents could cause breaches of data security, loss of intellectual property and critical data and the release and misappropriation of sensitive competitive information and partner, customer and employee personal data. These attempts may be the result of industrial or other espionage, or actions by hackers seeking to harm us, our products, or our end users. Any of these events could harm our competitive position, result in a loss of customer confidence, cause us to incur significant costs to remedy any damages and ultimately materially adversely affect our business, financial condition and results of operations.
While we have implemented a number of protective measures, including firewalls, antivirus, patches, log monitors, routine back-ups, system audits, routine password modifications and disaster recovery procedures, such measures may not be adequate or implemented properly to prevent or fully address the adverse effect of such events, and in some cases we may be unaware of an incident or its magnitude and effects.
In addition, our third-party subcontractors, including our foundries, test and assembly houses and distributors, have access to certain portions of our sensitive data. In the event that these subcontractors do not properly safeguard our data that they hold, security breaches and loss of our data could result. Any such loss of data by our third-party service providers, or theft, unauthorized use or publication of our trade secrets and other confidential business information as a result of such cyber threats, could adversely affect our competitive position and reduce marketplace acceptance of our products; the value of our investment in research and development and marketing could be reduced; and third parties may assert against us or our customers claims related to resulting losses of confidential or proprietary information or end-user data, or system reliability. Any such event could have a material adverse effect on our business, financial condition and results of operations.
Our business is subject to the risks of earthquakes, fires, floods and other natural catastrophic events.
Our U.S. corporate offices are locatedoperations take place across the globe, including in areas such as the San Francisco Bay Area a regionand Asia Pacific nations that are known for seismic activity. A significant natural disaster, such as an earthquake, fire, or flood or tsunami, or a human health epidemic or pandemic - such as the recent strain of COVID-19 virus - affecting any location in which our operations or the operations of our customers or suppliers take place could have a material adverse impact on our business, financial condition and results of operations. To the extent that such disruptions result in delays or cancellations of customer orders, or the deployment of our products, our business, financial condition and results of operations would be adversely affected.
Risks Related to Operations in Israel and Other Foreign Countries
Regional instability in Israel may adversely affect business conditions and may disrupt our operations and negatively affect our revenues and profitability.
We have engineering facilities, corporate and sales support operations located in Israel. A significant number of our employees and a material amount of assets are located in Israel. Accordingly, political, economic and military conditions in Israel may directly affect our business. Since the establishment of the State of Israel in 1948, a number of armed conflicts have taken place between Israel and its Arab neighbors, as well as incidents of civil unrest. These conflicts negatively affected business conditions in Israel. In addition, Israel and companies doing business with Israel have, in the past, been the subject of an economic boycott. In addition, there has been recent civil unrest in certain areas in the Middle East and surrounding areas, including Egypt, Jordan, Iraq, Syria and Libya. Any future armed conflicts or political instability in the region may negatively affect business conditions and adversely affect our results of operations. Parties with whom we do business have sometimes declined to travel to Israel during periods of heightened unrest or tension, forcing us to make alternative arrangements when necessary. In addition, the political and security situation in Israel may result in parties with whom we have agreements involving performance in Israel claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions in the agreements.
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The security and political conditions may have an impact on our business in the future. Hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could adversely affect our operations and could make it more difficult for us to raise capital. Our Israeli operations are within range of Hezbollah or Hamas missiles and we or our immediate surroundings may sustain damages in a missile attack, which could adversely affect our operations.
In addition, our business insurance does not cover losses that may occur as a result of events associated with the security situation in the Middle East. Although the Israeli government currently covers the reinstatement value of direct damages that are caused by terrorist attacks or acts of war, we cannot assure you that this government coverage will be maintained. Any losses or damages incurred by us as a result of such events could have a material adverse effect on our business, financial condition and results of operations.
Our operations may be negatively affected by the obligations of our personnel to perform military service.
Generally, all non-exempt male adult citizens and permanent residents of Israel under the age of 45 (or older, for citizens with certain occupations), including some of our employees, are obligated to perform military reserve duty for Israel annually, and are subject to being called to active duty at any time under emergency circumstances. In the event of severe unrest or other conflict, individuals could be required to serve in the military for extended periods of time. In response to increases in terrorist activity, there have been periods of significant call-ups of military reservists, and some of our employees, including those in key positions, have been called upon in connection with armed conflicts. It is possible that there will be additional call-ups in the future. Our operations could be disrupted by the absence for a significant period of one or more of our officers, directors or key employees due to military service. Any such disruption could adversely affect our operations.
Our operations may be affected by labor unrest in Israel.
In the past, there have been several general strikes and work stoppages in Israel affecting all banks, airports and ports. These strikes had an adverse effect on the Israeli economy and on business, including our ability to deliver products to our customers and to receive raw materials from our suppliers in a timely manner. From time to time, the Israeli trade unions threaten strikes or work stoppages, which, if carried out, may have a material adverse effect on the Israeli economy and our business.
We are susceptible to additional risks from our international operations.
We derived 62%61%, 55%63% and 54%62% of our revenues in the years ended December 31, 2017, 20162019, 2018 and 2015,2017, respectively, from sales outside of the United States. As a result, we face additional risks from doing business internationally, including:
reduced protection of intellectual property rights in some countries;
difficulties in staffing and managing foreign operations;
longer sales and payment cycles;
greater difficulties in collecting accounts receivable;
adverse economic conditions;
seasonal reductions in business activity;
potentially adverse tax consequences;
laws and business practices favoring local competition;
costs and difficulties of customizing products for foreign countries;
compliance with a wide variety of complex foreign laws and treaties;
compliance with the United States' Foreign Corrupt Practices Act and similar anti-bribery laws in other jurisdictions;
compliance with export control and regulations;
licenses, tariffs, other trade barriers, transit restrictions and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets;markets, including the tariffs recently enacted and proposed by the U.S. government on various imports from China and by the Chinese government on certain U.S. goods, the scope and duration of which remain uncertain;
restrictive governmental actions, such as restrictions on the transfer or repatriation of funds and foreign investments;
foreign currency exchange risks;
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fluctuations in freight rates and transportation disruptions;
political and economic instability;
variance and unexpected changes in local laws and regulations;
natural disasters and public health emergencies; and
trade and travel restrictions.
We sell our products into many countries and we also source many components and materials for our products from various countries. Such global resourcing enables us to minimize or mitigate the impact of tariffs and other regulatory taxes or duties. Nonetheless, the recently imposed U.S. tariffs and other trade restrictions could have a negative impact on our business, financial condition or results of operations. Further, an increase in tariffs or the imposition of additional tariffs or other trade restrictions and the potential escalation of a trade war and retaliatory measures could adversely affect our business, financial condition or results of operations.
A significant legal risk associated with conducting business internationally is compliance with various and differing anti-corruption and anti-bribery laws and regulations of the countries in which we do business, including the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and similar laws in China. In addition, the anti-corruption laws in various countries are constantly evolving and may, in some cases, conflict with each other. Our Code of Ethics and Business Conduct and other policies prohibit us and our employees from offering or giving anything of value to a government official for the purpose of obtaining or retaining business and from engaging in unethical business practices, including kick-backs to or from purely private parties. However, there can be no assurance that all of our employees or agents will refrain from acting in violation of such laws and our related anti-corruption policies and procedures. Any violations of these anti-corruption or trade control laws, or even allegations of such violations, can lead to an investigation, which could disrupt our operations, involve significant management distraction, and lead to significant costs and expenses, including legal fees. If we, or our employees or agents acting on our behalf, are found to have engaged in practices that violate these laws and regulations, we could suffer severe fines and penalties, profit disgorgement, injunctions on future conduct, securities litigation, and other consequences that may have a material adverse effect on our business, financial condition and results of operations. In addition, our reputation, sales activities or stock price could be adversely affected if we become the subject of any negative publicity related to actual or potential violations of anti-corruption, anti-bribery, or trade control laws and regulations.
Our principal research and development facilities are located in Israel, and our directors, executive officers and other key employees are located primarily in Israel and the United States. In addition, we engage sales representatives in various countries throughout the world to market and sell our products in those countries and surrounding regions. If we encounter any of the above risks in our international operations, we could experience slower than expected revenue growth and our business could be harmed.
The United Kingdom ("U.K.") held a referendum in June 2016 in which a majority of voters approved an exit from the European Union ("Brexit"). On January 31, 2020, the UK officially left the European Union and entered into a transitional period running through December 31, 2020, during which period the UK and the European Union will attempt to negotiate their future relationship.Significant political and economic uncertainty remains about whether the terms of the relationship will differ materially from the terms before withdrawal, as well as about the possibility that a so-called “no deal” separation will occur if negotiations are locatednot completed by the end of the transition period. The laws and regulations effected could include those governing manufacturing, labor, environmental, data protection/privacy, competition and other matters applicable to the semiconductor industry.
Brexit has also given rise to calls for the governments of other European Union member states to consider withdrawal. These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global market liquidity and restrict the ability of key market participants to operate in Israel,certain financial markets. Any of these factors could depress economic activity and restrict our access to capital, which could have a significant amountmaterial adverse effect on our business, financial condition and results of operations and reduce the price of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States against us or any of the above persons in Israel.ordinary shares.
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Provisions of Israeli law may delay, prevent or make difficult an acquisition of our company, which could prevent a change of control and therefore depress the price of our shares.
The Israeli Companies Law, 1999 (the “Companies Law”"Companies Law") generally requires that a merger be approved by the board of directors and by the general meeting of the shareholders. Upon the request of any creditor of a merging company, a court may delay or prevent the merger if it concludes that there is a reasonable concern that, as a result of the merger, the surviving company will be unable to satisfy its obligations. In addition, a merger may generally not be completed unless at least (i) 50 days have passed since the filing of the merger proposal with the Israeli Registrar of Companies and (ii) 30 days have passed since the merger was approved by the shareholders of each of the merging companies.
Also, in certain circumstances, an acquisition of shares in a public company must be made by means of a tender offer if, as a result of the acquisition, the purchaser would hold 25% or more of the voting rights in the company (unless there is already a 25% or greater shareholder of the company) or more than 45% of the voting rights in the company (unless there is already a shareholder that holds more than 45% of the voting rights in the company). If, as a result of an acquisition, the acquirer would hold more than 90% of a company's shares or voting rights, the acquisition must be made by means of a tender offer for all of the shares.
In addition, the Companies Law allows us to create and issue shares having rights different from those attached to our ordinary shares, including rights that may delay or prevent a takeover or otherwise prevent our shareholders from realizing a potential premium over the market value of their ordinary shares. The authorization of a new class of shares would require an amendment to our amended and restated articles of association, which requires the prior approval of the holders of a majority of our shares at a general meeting.
These provisions could delay, prevent or impede an acquisition of us, including the planned acquisition by NVIDIA, even if such an acquisition would be considered beneficial by some of our shareholders.
Exchange rate fluctuations between the U.S. dollar and the NISNew Israeli Shekels ("NIS") may negatively affect our earnings.
We derive all of our revenues in U.S. dollars. The U.S. dollar is our functional and reporting currency in all of our foreign locations. However, a significant portion of our liabilities, as well as our operating expenses, consisting principally of salaries and related personnel costs and facilities expenses, are denominated in NIS. This foreign currency exposure gives rise to market risk associated with exchange rate movements of the U.S. dollar against the NIS. To the extent that the value of the NIS increases against the U.S. dollar, our expenses on a U.S. dollar cost basis will increase. We cannot predict any future trends in the rate of appreciation of the NIS against the U.S. dollar. If the U.S. dollar cost of our salaries and related personnel costs and facilities expenses in Israel increases, our dollar-measured results of operations will be adversely affected. Our operations also could be adversely affected if we are unable to hedge against currency fluctuations in the future. Further, because all of our international revenues are denominated in U.S. dollars, a strengthening of the dollar versus other currencies could make our products less competitive in foreign markets and the collection of our receivables more difficult. To help manage this risk we have been engaged in foreign currency hedging activities, comprised of currency derivative instruments and natural hedges.
Our cost in Israel in U.S. dollar terms will also increase if inflation in Israel exceeds the devaluation of the NIS against the U.S. dollar or if the timing of such devaluation lags behind inflation in Israel.
The government tax benefits that we currently receive require us to meet several conditions and may be terminated or reduced in the future, which would increase our costs.
According to the Israeli Law for Encouragement of Capital Investments, 1959 ("The(the "Encouragement Law"), the Company's operations in Israel were granted "Approved Enterprise" status by the Investment Center in the Israeli Ministry of Economy and Industry (formerly, the Ministry of Industry Trade and Labor) and "Beneficiary Enterprise" status by the Israeli Income Tax Authority. The Company is eligible for tax benefits under the lawEncouragement Law with respect to its income derived from its Approved and Beneficiary Enterprises. The availability of these tax benefits is subject to certain requirements, including, among other things, making specified investments in fixed assets and equipment, financing a percentage of those investments with our capital contributions, complying with our marketing program which was submitted to the Investment Center, filing of certain reports with the Investment Center, export requirements, limiting manufacturing outside of Israel and complying with Israeli intellectual property laws. If we do not meet these requirements in the future, these tax benefits may be cancelled and we could be required to refund any tax benefits that we have already received plus
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interest and penalties thereon. The tax benefits that our current "Approved Enterprise" and "Beneficiary Enterprise" program receives may not be continued in the future at their current levels or at all. If these tax benefits were reduced or eliminated, the amount of taxes that we pay would likely increase, which could adversely affect our results of operations. Additionally, if we increase our activities outside of Israel, for example, by acquisitions, our increased activities may not be eligible for inclusion in Israeli tax benefit programs.
On December 29, 2016, the Israeli government amended the Encouragement Law and legislated a new tax regime; the "Preferred Technological Enterprise" regime, under which a company that complies with the terms may be entitled to certain tax benefits. We expect that our operation in Israel will comply with the terms of the Preferred Technological Enterprise regime. Therefore, we may utilize the tax benefits under this regime after the end of the benefit period of its Approved and Beneficiary Enterprise statuses (i.e., prior to fiscal year 2022, based on our decision, and for fiscal year 2022 and onwards). The tax rates under the new regime will be higher than those under our current regime. See Note 12, "Income taxes" for more details.
If we elect to distribute dividends out ofor buy back our shares using exempt income derived from "Approved/Beneficiary Enterprise" income, we will be subject to tax on the gross amount distributed.distributed or used in a buyback. The tax rate will be the rate at which the income would have been applicablesubject to tax had weit not been granted the beneficial status.exempt. This rate is generally between 10% and the corporate tax rate in Israel, depending on the percentage of our shares held by foreign shareholders. The dividend recipient or the shareholder from whom we buy back the shares is subject to withholding tax at the source at the reduced rate applicable to dividends or buybacks from Approved Enterprises, which is 15% if the dividend is distributedwe distribute dividends or buy back shares during the tax exemption period (subject to the applicable double tax treaty) or within 12 years after the period. This 12-year limitation does not apply to foreign investment companies. The Encouragement Law has defined certain actions that are deemed as dividend distributions and would trigger the recapture of tax benefits.
The Israeli government grants that we received require us to meet severalvarious conditions and restrict our ability to manufacture and engineer products and transfer know-how outside of Israel and require us to satisfy specified conditions.
We have received grants from the Israeli NationalInnovation Authority for Technological Innovation,(the "IIA"), formerly known as the Office of the Chief Scientist of Israel's Ministry of Economy and Industry, ("OCS") for the financing of a portion of our research and development expenditures in Israel. When know-how is developed using or in connection with OCSIIA grants, we are subject to restrictions on the transfer of the know-how, including outside of Israel. Transfer of know-how outside of Israel requires pre-approval by the OCSIIA which may at its sole discretion grant such approval and impose certain conditions, and is subject to the payment to IIA of a transfer fee or license fees, calculated according to the formulaformulas provided in the RIsraeli Law for Encouragement of Research, Development and Technological Innovation in Industry, 1984 (the "R&D LawLaw") which takes into account, inter alia, the consideration for such know-how paid to us in the transaction in which the technology is transferred. In general, transfer fees are no less than the funding received plus interest less the royalties already paid for the transferred know-how and are not higher than six times the amount of the grants received by the company. In addition, any decrease of the percentage of manufacturing performed in Israel, as originally declared in the application to the OCS,IIA, requires us to obtain the approval of the OCSIIA and may result in increased amounts to be paid to the OCS.IIA as well as in increased royalty rate. Transfer of know-how to another Israeli entity requires the approval of IIA as well as full or partial assumption of the liabilities to IIA by the other entity. These restrictions may impair our ability to enter into agreements for those products or technologies without the approval of the OCS.IIA. We cannot be certain that any approval of the OCSIIA will be obtained on terms that are acceptable to us, or at all. Furthermore, in the event that we undertake a transaction involving the transfer to a non-Israeli entity of technology developed with OCSIIA funding pursuant to a merger or similar transaction, the consideration available to our shareholders may be reduced by the amounts we are required to pay to the OCS.IIA. Any approval, if given, will generally be subject to additional financial obligations. If we fail to comply with the conditions imposed by the OCS,IIA, we may be required to refund any payments previously received, together with interest and penalties as well as tax benefits. Also, failure to meet the restrictions concerning transfer of know-how outside of Israel may trigger criminal liability. The restrictions regarding the use and transfer of know-how (including for the purpose of manufacturing) apply also to any IIA programs that are under a royalty payments agreement and to non-royalty-bearing programs. Under the R&D Law and the applicable regulations, the execution and delivery of the Merger Agreement by the company requires the filing of: (i) a written notice to the IIA regarding the change in our ownership effected as a result of the Merger, which was submitted to the IIA on June 27, 2019; and (ii) a written undertaking of Parent. to the IIA, to observe the requirements of the R&D Law and the applicable regulation (including, in particular, those requirements relating to the prohibitions of the transfer of know-how and/or productions rights), which is expected to be filed to the IIA following the closing of the Merger Agreement.
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It may be difficult to enforce a U.S. judgment against us, our officers and directors or to assert U.S. securities law claims in Israel.
We are incorporated in Israel. Three of our executive officers and two of our directors, one of whom is also an executive officer, are non-residents of the United States and are located in Israel, and a significant amount of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States against us or any of the above persons in Israel.
In addition, it may be difficult for a shareholder to enforce civil liabilities under U.S. securities law claims in original actions instituted in Israel. Israeli courts may refuse to hear a claim based on a violation of U.S. securities laws because Israel is not the most appropriate forum to bring such a claim. If U.S. law is found to be applicable, the content of applicable U.S. law must be proved in an Israeli court as a fact, which can be a time-consuming and costly process. Certain matters of procedure will also be governed by Israeli law.
Your rights and responsibilities as a shareholder will be governed by Israeli law and differ in some respects from the rights and responsibilities of shareholders under U.S. law.
We are incorporated under Israeli law. The rights and responsibilities of holders of our ordinary shares are governed by our amended and restated articles of association and by Israeli law. These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in typical U.S. corporations. In particular, a shareholder of an Israeli company has a duty to act in good faith toward the company and other shareholders and to refrain from abusing his, her or its power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters.
Risks Related to Our Ordinary Shares
The price of our ordinary shares may continue to bebecome volatile, and the value of an investment in our ordinary shares may decline.
development regarding our planned Merger with NVIDIA;
quarterly variations in our results of operations or those of our competitors;
announcements by us, our competitors, our customers or rumors from sources other than our company related to acquisitions, new products, significant contracts, commercial relationships, capital commitments or changes in the competitive landscape;
our ability to develop and market new and enhanced products on a timely basis;
disruption to our operations;
geopolitical instability;
the emergence of new sales channels in which we are unable to compete effectively;
any major change in our board of directors or management;
changes in financial estimates, including our ability to meet our future revenue and operating profit or loss projections;
changes in governmental regulations or in the status of our regulatory approvals;
general economic conditions and slow or negative growth of related markets;
anticompetitive practices of our competitors;
commencement of, or our involvement in, litigation;
whether our operating results meet our guidance or the expectations of investors or securities analysts;
continuing international conflicts and acts of terrorism; and
changes in accounting rules.
We may need to raise additional capital, which might not be available or which, if available, may be on terms that are not favorable to us.
We may need to raise additional funds, and we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all. If we issue equity securities to raise additional funds, the ownership percentage of our shareholders would be diluted, and the new equity securities may have rights, preferences or privileges senior to those of existing holders of our
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ordinary shares. If we borrow money, we may incur significant interest charges, which could harm our profitability. Holders of debt may also have certain rights, preferences or privileges senior to those of existing holders of our ordinary shares. In addition, any additional funds would need to be raised consistent with the terms of the Merger Agreement. If we cannot raise needed funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could harm our business, financial condition and results of operations.
If we sell our ordinary shares in future financings, holders of ordinary shareholdersshares could experience immediate dilution and, as a result, the market price of our ordinary shares may decline.
We may from time to time issue additional ordinary shares at a discount from the current trading price of our ordinary shares. As a result, holders of our ordinary shareholdersshares would experience immediate dilution upon the purchase of any ordinary shares sold at such discount. In addition, as opportunities present themselves, we may enter into equity or debt financings or similar arrangements in the future, including the issuance of convertible debt securities, preferred shares or ordinary shares. If we issue ordinary shares or securities convertible into ordinary shares, holders of our ordinary shares could experience dilution.
If securities or industry analysts do not publish research or reports about our business, if they adversely change their recommendations regarding our ordinary shares or if our operating results do not meet their expectations, the market price of our ordinary shares could decline.
The trading market for our ordinary shares could be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause the price of our ordinary shares or trading volume in our ordinary shares to decline. Following the announcement of the Merger, some analysts suspended their coverage of our company and are no longer providing extended coverage. If we do not complete the Merger, these analysts may not resume their coverage. Moreover, if one or more of the analysts who cover our company
downgrades our ordinary shares or if our operating results do not meet their expectations, the market price of our ordinary shares could decline.
Provisions of our amended and restated articles of association could delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our shareholders, and could make it more difficult for shareholders to change management.
Provisions of our amended and restated articles of association may discourage, delay or prevent a merger, acquisition or other change in control that shareholders may consider favorable, including transactions in which shareholders might otherwise receive a premium for their shares. In addition, these provisions may frustrate or prevent any attempt by our shareholders to replace or remove our current management by making it more difficult to replace or remove our board of directors. These provisions include:
no cumulative voting;
a requirement for any merger involving the Company shall require the approval of the shareholders of at least a majority of the voting power of the Company for any merger involving the Company;
a requirement for the approval of at least 75% of the voting power represented at the general meeting of the shareholders for the removal of any director from office, and election of any director instead of the director so removed; and
an advance notice requirement for shareholder proposals and nominations.
Furthermore, Israeli tax law treats some acquisitions, particularly share-for-share swaps between an Israeli company and a foreign company, less favorably than U.S. tax law. Under certain circumstances and subject to receiving a ruling from the Israeli Income Tax Authority, Israeli tax law generally provides that a shareholder who exchanges our shares for shares that are listed for trading on an Exchangea securities exchange in a foreign corporation is treated as if the shareholder has sold the shares. In such a case, the shareholder will generally be subject to Israeli taxation on any capital gains from the sale of shares (after two years, with respect to one half of the shares, and after four years, with respect to the balance of the shares, in each case unless the shareholder sells such shares at an earlier date), unless a relevant tax treaty between Israel and the country of the shareholder's residence exempts the shareholder from Israeli tax.tax, resulting in taxation before disposition of the investment in the foreign corporation. For a further discussion of Israeli laws relating to mergers and acquisitions, please see "Risk Factors - Risks Related to Operations in Israel and Other Foreign Countries - Provisions of Israeli law may delay, prevent or make difficult an acquisition of our company, which could prevent a change of control and therefore depress the price of our shares." These provisions in our amended and restated articles of association and other provisions of Israeli law could limit the price that investors are willing to pay in the future for our ordinary shares.
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We have never paid cash dividends on our share capital, and, while the Boardour board of directors regularly reviews our cash position and uses for cash, we do not anticipate paying any cash dividends in the foreseeable future.
We currently intend to retain all available funds and any future earnings to fund the development and growth of our business. Furthermore, the Merger Agreement with NVIDIA limits our ability to pay dividends. As a result, capital appreciation, if any, of our ordinary shares will be your sole source of gain for the foreseeable future.
We may incur increased costs as a result of changes in laws and regulations relating to corporate governance matters.
Changes in the laws and regulations affecting public companies, including Israeli laws, rules adopted by the SEC, the NASDAQNasdaq Stock Market, the FASB and the Public Company Accounting Oversight Board, may result in increased costs to us as we respond to their requirements. These laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these requirements could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers. We cannot predict or estimate the amount or timing of additional costs we may incur to respond to these requirements.
ITEM 1B—UNRESOLVED STAFF COMMENTS
None.
ITEM 2—PROPERTIES
As of December 31, 2017,2019, our major facilities consisted of:
| Israel | United States | Other | Total | ||||
Leased facilities (in thousands of square feet) | 1,002 | 120 | 63 | 1,185 | |||
| Israel | United States | Other | Total | ||||
Leased facilities (in thousands of square feet) | 1,113 | 112 | 68 | 1,293 | |||
Our United States business headquarters are located in Sunnyvale, California, and our engineering headquarters are located in Yokneam, Israel. We believe that our existing facilities will be adequate to meet our current requirements and that suitable additional or substitute space will be available on acceptable terms to accommodate our foreseeable needs.
ITEM 3—LEGAL PROCEEDINGS
See Note 9, “Commitments and Contingencies” to the consolidated financial statements for a full description of legal proceedings and related contingencies and their effects on our consolidated financial position, results of operations and cash flows.
We may, from time to time, become a party to various other legal proceedings arising in the ordinary course of business. We may also be indirectly affected by administrative or court proceedings or actions in which we are not involved, but which have general applicability to the semiconductor industry.
ITEM 4—MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5—MARKET FOR REGISTRANT'S ORDINARY SHARES, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our ordinary shares began trading on The NASDAQNasdaq Global Market on February 8, 2007 under the symbol "MLNX". Prior to that date, our ordinary shares were not traded on any public exchange.
| 2017 | High | Low | |||||
| First quarter | $ | 52.80 | $ | 40.70 | |||
| Second quarter | $ | 52.65 | $ | 41.55 | |||
| Third quarter | $ | 47.95 | $ | 42.05 | |||
| Fourth quarter | $ | 65.90 | $ | 42.25 | |||
| 2016 | High | Low | |||||
| First quarter | $ | 55.80 | $ | 37.54 | |||
| Second quarter | $ | 55.45 | $ | 40.54 | |||
| Third quarter | $ | 52.15 | $ | 39.53 | |||
| Fourth quarter | $ | 46.20 | $ | 38.75 | |||
As of February 10, 2018,14, 2020, we had approximately 232348 holders of record of our ordinary shares. This number does not include the number of persons whose shares are in nominee or in "street name" accounts through brokers.
Share Performance Graph
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The graph below compares the five-year cumulative total shareholder return on our ordinary shares with the cumulative total return on The NASDAQNasdaq Composite Index and The Philadelphia Semiconductor Index. The period shown commences on December 31, 20122014 and ends on December 31, 2017,2019, the end date of our last fiscal year. The graph assumes an investment of $100 on December 31, 2012,2014, and the reinvestment of any dividends. No cash dividends have been declared or paid on our ordinary shares during such period. Shareholder returns over the indicated periods should not be considered indicative of future share prices or shareholder returns.
| 12/31/2012 * | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | 12/31/2014 * | 12/31/2015 | 12/31/2016 | 12/31/2017 | 12/31/2018 | 12/31/2019 | |||||||||||||||||||||||
| Mellanox Technologies | 100.00 | 67.31 | 71.96 | 70.97 | 68.88 | 108.96 | 100.00 | 98.62 | 95.72 | 151.42 | 216.19 | 274.23 | ||||||||||||||||||||||
| NASDAQ Composite Index | 100.00 | 138.32 | 156.85 | 165.84 | 178.28 | 228.63 | ||||||||||||||||||||||||||||
| Nasdaq Composite Index | 100.00 | 105.73 | 113.66 | 145.76 | 140.10 | 189.45 | ||||||||||||||||||||||||||||
| Philadelphia Semiconductor Index | 100.00 | 139.31 | 178.84 | 172.75 | 236.02 | 326.26 | 100.00 | 96.59 | 131.97 | 182.43 | 168.18 | 267.20 | ||||||||||||||||||||||
* $100 invested on December 31, 20122014 in shares or index-includingindex, including reinvestment of dividends.
Dividends
We have not declared or paid any cash dividends on our ordinary shares in the past, and we do not anticipate declaring or paying cash dividends in the foreseeable future. The Companies Law also restricts our ability to declare dividends. We can only distribute dividends from profits (the "Profit Test") (as defined in the Companies Law) and only if there is no reasonable concern that the dividend distribution will prevent us from meeting our existing and foreseeable obligations as they come due (the "Insolvency Test"); provided that, with court approval, we may distribute dividends if we do not meet the Profit Test so long as we meet the Insolvency Test.
If we elect to distribute dividends out of exempt income derived from "Approved"Approved/Beneficiary Enterprise" operations, we will be subject to tax on the gross amount distributed. The tax rate will be the rate which would have been applicable had we not been granted the beneficial status. These dividend tax rules may also apply to our acquisitions outside Israel if they are made with cash from tax benefited income.
Securities Authorized for Issuance under Equity Compensation Plans
Our equity compensation plan information required by this item is incorporated by reference to the information in Part III, Item 12 of this report. For additional information on our share incentive plans and activity, see Note 10, "Share Incentive Plans" to the consolidated financial statements.
Recent Sales of Unregistered Securities
None.
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ITEM 6—SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and related notes included elsewhere in this report. We derived the consolidated balance sheet data for the years ended December 31, 2015, 2014,2017, 2016, and 20132015 and our consolidated statements of operations data for the years ended December 31, 20142016 and 2013,2015, from our audited consolidated financial statements not included in this report. We derived the consolidated statements of operations data for each of the three years in the period ended December 31, 2017,2019, as well the consolidated balance sheet data as of December 31, 20172019 and 2016,2018, from our audited consolidated financial statements included elsewhere in this report. Our historical results are not necessarily indicative of results to be expected in any future period.
| Year ended December 31, | |||||||||||||||||||
| 2017 | 2016 (1) | 2015 | 2014 | 2013 | |||||||||||||||
| (In thousands, except per share data) | |||||||||||||||||||
| Consolidated Statement of Operations Data: | |||||||||||||||||||
| Total revenues | $ | 863,893 | $ | 857,498 | $ | 658,140 | $ | 463,649 | $ | 390,436 | |||||||||
| Cost of revenues | 300,450 | 301,986 | 189,209 | 148,672 | 134,282 | ||||||||||||||
| Gross profit | 563,443 | 555,512 | 468,931 | 314,977 | 256,154 | ||||||||||||||
| Operating expenses: | |||||||||||||||||||
| Research and development | 365,878 | 322,620 | 252,175 | 208,877 | 169,382 | ||||||||||||||
| Sales and marketing | 150,457 | 133,780 | 97,438 | 76,860 | 70,544 | ||||||||||||||
| General and administrative | 52,170 | 68,522 | 44,212 | 36,431 | 37,046 | ||||||||||||||
| Impairment of long-lived assets | 12,019 | — | — | — | — | ||||||||||||||
| Total operating expenses | 580,524 | 524,922 | 393,825 | 322,168 | 276,972 | ||||||||||||||
| Income (loss) from operations | (17,081 | ) | 30,590 | 75,106 | (7,191 | ) | (20,818 | ) | |||||||||||
| Interest expense | (7,937 | ) | (7,352 | ) | — | — | — | ||||||||||||
| Other income (loss), net | 3,115 | 1,090 | (524 | ) | 1,449 | 1,228 | |||||||||||||
| Interest and other, net | (4,822 | ) | (6,262 | ) | (524 | ) | 1,449 | 1,228 | |||||||||||
| Income (loss) before taxes on income | (21,903 | ) | 24,328 | 74,582 | (5,742 | ) | (19,590 | ) | |||||||||||
| Provision for (benefit from) taxes on income | (2,478 | ) | 5,810 | (18,312 | ) | 18,267 | 3,752 | ||||||||||||
| Net income (loss) | $ | (19,425 | ) | $ | 18,518 | $ | 92,894 | $ | (24,009 | ) | $ | (23,342 | ) | ||||||
| Net income (loss) per share — basic | $ | (0.39 | ) | $ | 0.38 | $ | 2.00 | $ | (0.54 | ) | $ | (0.54 | ) | ||||||
| Net income (loss) per share — diluted | $ | (0.39 | ) | $ | 0.37 | $ | 1.94 | $ | (0.54 | ) | $ | (0.54 | ) | ||||||
| Shares used in computing net income (loss) per share: | |||||||||||||||||||
| Basic | 50,310 | 48,145 | 46,365 | 44,831 | 43,421 | ||||||||||||||
| Diluted | 50,310 | 49,526 | 47,778 | 44,831 | 43,421 | ||||||||||||||
| Year ended December 31, | |||||||||||||||||||
| 2019 (1) | 2018 (2) | 2017 | 2016 (3) | 2015 | |||||||||||||||
| (In thousands, except per share data) | |||||||||||||||||||
| Consolidated Statement of Operations Data: | |||||||||||||||||||
| Total revenues | $ | 1,330,576 | $ | 1,088,743 | $ | 863,893 | $ | 857,498 | $ | 658,140 | |||||||||
| Income (loss) from operations | $ | 207,920 | $ | 112,074 | $ | (17,081 | ) | $ | 30,590 | $ | 75,106 | ||||||||
| Net income (loss) | $ | 205,095 | $ | 134,258 | $ | (19,425 | ) | $ | 18,518 | $ | 92,894 | ||||||||
| Net income (loss) per share — basic | $ | 3.73 | $ | 2.54 | $ | (0.39 | ) | $ | 0.38 | $ | 2.00 | ||||||||
| Net income (loss) per share — diluted | $ | 3.62 | $ | 2.46 | $ | (0.39 | ) | $ | 0.37 | $ | 1.94 | ||||||||
| December 31, | December 31, | |||||||||||||||||||||||||||||||||||||
| 2017 | 2016 (1) | 2015 | 2014 (2) | 2013 (2) | 2019 (1) | 2018 (2) | 2017 | 2016 (3) | 2015 | |||||||||||||||||||||||||||||
| (In thousands) | (In thousands) | |||||||||||||||||||||||||||||||||||||
| Consolidated Balance Sheet Data: | ||||||||||||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 62,473 | $ | 56,780 | $ | 263,199 | $ | 51,326 | $ | 63,164 | ||||||||||||||||||||||||||||
| Short-term investments | 211,281 | 271,661 | 247,314 | 334,038 | 263,528 | |||||||||||||||||||||||||||||||||
| Working capital | 310,286 | 340,511 | 540,108 | 396,591 | 344,825 | $ | 894,413 | $ | 497,666 | $ | 310,286 | $ | 340,511 | $ | 540,108 | |||||||||||||||||||||||
| Long-term assets | 895,015 | 920,427 | 376,144 | 348,982 | 363,939 | |||||||||||||||||||||||||||||||||
| Total assets | 1,401,934 | 1,473,505 | 1,053,382 | 863,218 | 806,826 | $ | 2,119,789 | $ | 1,587,198 | $ | 1,401,934 | $ | 1,473,505 | $ | 1,053,382 | |||||||||||||||||||||||
| Current liabilities | 196,633 | 212,567 | 137,130 | 117,645 | 98,062 | |||||||||||||||||||||||||||||||||
| Long-term liabilities | 147,853 | 285,208 | 49,571 | 43,821 | 41,953 | $ | 137,127 | $ | 72,778 | $ | 147,853 | $ | 285,208 | $ | 49,571 | |||||||||||||||||||||||
| Total liabilities | 344,486 | 497,775 | 186,701 | 161,466 | 140,015 | |||||||||||||||||||||||||||||||||
| Total shareholders' equity | $ | 1,057,448 | $ | 975,730 | $ | 866,681 | $ | 701,752 | $ | 666,811 | $ | 1,655,845 | $ | 1,301,648 | $ | 1,057,448 | $ | 975,730 | $ | 866,681 | ||||||||||||||||||
(1) On January 1, 2019, we adopted the new lease standard (Topic 842). The consolidated financial statements for the year ended December 31, 2018 and prior years are reported under Topic 840. See Note 15, "Leases" to the consolidated financial statements for more details.
(2) On January 1, 2018, we adopted the new revenue standards (Topic 606) using a modified retrospective method with the cumulative effect recognized in the beginning retained earnings. The consolidated financial statements for the year ended December 31, 2017 and prior years are reported under Topic 605. See Note 2, "Revenue" to the consolidated financial statements for more details.
(3) On February 23, 2016, we acquired EZchip. EZchip's results of operations and estimated fair value of assets acquired and liabilities assumed were included in our consolidated financial statements beginning February 23, 2016.
| Year ended December 31, | |||||||
| 2014 | 2013 | ||||||
| (in thousands) | |||||||
| Working capital decrease | $ | (2,271 | ) | $ | (7,336 | ) | |
| Long-term assets increase | 2,271 | 7,336 | |||||
ITEM 7—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in the section entitled "Risk Factors".
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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 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, Big Data, machine learning, storage, telecommunications, financial services, and EDC. 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 also believe that we are one of the early suppliers of 25/50/100Gb/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 or 100Gb/s.
Our revenues for the years ended December 31, 2019, 2018 and 2017 2016 and 2015 were $863.9$1,330.6 million, $857.5$1,088.7 million, and $658.1$863.9 million, respectively. 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.
On February 23, 2016,March 10, 2019, we completed our acquisitionentered into an Agreement and Plan of EZchip,Merger (the "Merger Agreement") with NVIDIA Corporation, a public company formedDelaware 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 at which time EZchip became ourand wholly owned subsidiary. Undersubsidiary 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. In June 2019, our shareholders approved the consummation of the Merger, and we received regulatory approvals for the Merger from Mexico in July 2019 and from the European Commission in December 2019. In addition, the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, in connection with the proposed acquisition expired in May 2019. Discussions with State Administration for Market Regulation, the China regulatory agency, are progressing and we believe the closing will likely occur in the early part of calendar 2020.
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The Merger Agreement contains certain customary termination rights by either us or Parent, including if the Merger is not consummated by December 10, 2019 (the "Outside Date"), subject to two three-month extensions in order to obtain required regulatory approvals. Pursuant to the first of those three-month extensions, the Outside Date has been extended to March 10, 2020. 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 our 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 $225.0 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 us a termination fee equal to $350.0 million in cash.
The foregoing description of the Merger Agreement and the net cash purchase price of $693.7 million consisted of a $781.2 million cash payment for all outstanding common shares of EZchip atMerger does not purport to be complete and is subject to, and qualified in its entirety by, the price of $25.50 per share, net of $87.5 million of cash acquired. We also assumed 891,822 EZchip RSUs and converted them to 499,894 equivalent Mellanox RSU awards. The fair valuefull text of the converted RSUs was determined basedMerger Agreement. For additional details on the per share valuetransaction, please refer to the copy of the underlying Mellanox ordinary shares of $46.40 per shareMerger Agreement attached as of the acquisition date. The 499,894 RSUs had a total aggregate value of $23.2 million, of which $1.0 million was recorded as a component of the purchase price for service rendered priorExhibit 2.1 to the acquisition date and $22.2 million will be recognized as share-based compensation expense over the remaining required service period of up to 2.25 years from the acquisition date.
During the Term Debt, see Note 15 to the consolidated financial statements.
Our Business
Revenues. We derive revenues from sales of our ICs, boards, switch systems, cables, modules, software, accessories and other product groups. Our products have broad adoption with multiple end customers across HPC, machine learning, Web 2.0, cloud, EDC, financial services and storage markets; however, 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 56%48%, 55%53% and 57%56% of our total revenues for the years ended December 31, 2017, 20162019, 2018 and 2015,2017, respectively. Sales to customers representing 10% or more of revenues accounted for 24%21%, 16%24% and 14%24% of our total revenues for the years ended December 31, 2017, 20162019, 2018 and 2015,2017, 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 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 eightten to tentwelve weeks, lead times for delivery from our cable and transceiver manufacturing subcontractor are approximately tentwelve to twelvesixteen weeks, and lead times for delivery from our switch systems manufacturing subcontractors are approximately twelve to sixteen 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 sale price of our products and a lower percentage of revenue deriving from sales of ICs and boards, which generally yield 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,
38
allocable facilities 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. We expect these expenses will increase in absolute dollars in the upcoming year as our business expands.
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 and marketing, field applications engineering and sales engineering, advertising, trade shows and promotions, travel, amortization of intangibles, and allocable facilities and administrative expenses. We expect these expenses will increase in absolute dollars in the upcoming year as our business expands.
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 expenses. We expect these expenses will increase in absolute dollars in the upcoming year as our business expands.
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 (formerly, the Ministry of Industry, Trade and Labor) and "Beneficiary Enterprise" status by the Israeli Income Tax Authority, which makes us eligible for tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959.Law. Under the terms of the Approved and Beneficiary Enterprise programs, 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% 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,December 29, 2016, the Israeli government amended the Encouragement Law and legislated a new regulations regarding thetax regime - "Preferred Technological Enterprise" regime, under which a company that complies with the terms may be entitled to certain tax benefits. On June 14, 2017, the Israeli government legislated new regulations, stipulating the calculation method of the tax benefits under the Preferred Technological Enterprise regime. We expect that our operations in Israel will comply with the terms of the Preferred Technological Enterprise regime. Therefore, we may utilize the tax benefits under this regime after the end of the benefit period of our Approved and Beneficiary Enterprise statuses (i.e. fromprior to fiscal year 2022, based on our decision, and for fiscal year 2022 and onwards). Under the new legislation, the majority of our income from our operations in Yokneam, Israel, will be subject to a corporate rate of 7.5%, while the majority of the income from our operations in Tel-Aviv, Israel, will be subject to a corporate rate of 12%. As a result of the lower tax rates mentioned above, we recorded a decrease of approximately $0.2 million in deferred tax assets and a corresponding increase in tax expense during the second quarter of 2017.
To prepare our 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 consolidated balance sheet.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these 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
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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 the following areas would have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, please see Note 1, "The Company and Summary of Significant Accounting Policies" to the consolidated financial statements.
Revenue recognition
We recognize revenue fromwhen (or as) we satisfy performance obligations by transferring promised products or services to our customers in an amount that reflects the sales of products when all ofconsideration we expect to receive. We apply the following criteriafive steps: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when a performance obligation is satisfied.
We consider customer purchase orders, which in some cases are met: (1) persuasive evidencegoverned by master sales agreements, to be the contracts with a customer. For each contract, we consider the promise to transfer tangible products, extended warranty and post-contract customer support, each of an arrangement exists; (2) delivery has occurred; (3)which are distinct, to be the identified performance obligations. In determining the transaction price, we evaluate whether the price is fixed or determinable;subject to rebates and (4) collectionadjustments to determine the net consideration which we expect to receive. As our standard payment terms are less than one year, the contracts have no significant financing component. We allocate the transaction price to each distinct performance obligation based on its relative standalone selling price. Revenue from tangible products is reasonably assured. We use a binding purchase order or a signed agreement as evidencerecognized when control of an arrangement. Delivery occurs when goods are shipped and title and risk of loss transferthe product is transferred to the customer. Our standard arrangement withcustomer (i.e., when our customersperformance obligation is satisfied), which typically includes freight-on-board shipping point, no right of return and no customer acceptance provisions.occurs at shipment. The revenues from fixed-price support or maintenance contracts, including extended warranty contracts and software post-contract customer support agreements, are recognized ratably over the contract period and the costs associated with these contracts are recognized as incurred. The customer's obligation to pay and the payment terms are set at the timeOur standard arrangements with our customers do not allow for rights of shipment and are not dependent on the subsequent resale of the product. The Company determines whether collectability is reasonably assured on a customer-by-customer basis. We determine whether collectability is reasonably assured on a customer-by-customer basis. When assessing the probability of collection, we consider the number of years the customer has been in business and the history of our collections. Customers are subject to a credit review process that evaluates the customers' financial positions and ultimately their ability to pay. If it is determined at the outset of an arrangement that collection is not reasonably assured, no product is shipped and no revenue is recognized unless cash is received in advance.return.
We maintain inventory, or hub arrangements with certain customers. Pursuant to these arrangements, we deliver products to a customer or a designated third partythird-party warehouse based upon the customer's projected needs, but do not recognize product revenue unless and until the customer reports it has removed our product from the warehouse to be incorporated into its end products.
A portion of our sales are made to distributors under agreements which contain price protection provisions. Currently, we recognize revenuesRevenue from sales to distributors based on the sell-through method using inventory and point of sale information provided by the distributors, net of estimated allowances for price adjustments. Upon the adoption of the new revenue standards effective January 1, 2018, we will recognize revenues from sales to distributorsis recognized upon shipment and transfer of control, (known as “sell-in” revenue recognition), net of estimated distribution price adjustments (“DPAs”). We calculate the estimated allowances for price adjustments.
Most of our distributors are entitled to a currentlimited right of return related to stock rotation. Distributors have the right to return a limited amount of product not to exceed a percentage of the distributor’s prior quarter's net purchases. However, a simultaneous, compensating order of equal or future salegreater value must be placed by the distributor within the same quarter of these assets.the return.
Derivatives
We enter 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 future cash flows and certain existing assets and liabilities. We account for our derivative instruments as either assets or liabilities and carry 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. For derivative instruments that hedge the exposure to variability in expected future cash flows that are designated as cash flow hedges, the effective portion of the gains or losses on the derivative instruments is reported as a component of accumulated other comprehensive income ("AOCI") in shareholders’ equity and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of the gains or losses on the derivative instruments, if any, is recognized in earnings in the current period. Our derivative instruments that hedge the exposure to variability in the fair value of assets or liabilities are not currently designated as hedges for financial reporting purposes, and thus the gains or losses on such derivative instruments are recognized in earnings in the current period.
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Inventory valuation
Inventory includes finished goods, work-in-process and raw materials. Inventory is stated at the lower of cost (principally standard cost which approximates actual cost on a first-in, first-out basis) or net realizable value. Reserves for potentially excess and obsolete inventory are made based on management's analysis of inventory levels, future sales forecasts and market conditions. Once established, the original cost of our inventory less the related inventory reserve represents the new cost basis of such products.
Business combinations
We account for business combinations using the acquisition method of accounting. We determine the recognition of intangible assets based on the following criteria: (i) the intangible asset arises from contractual or other rights; or (ii) the intangible asset is separable or divisible from the acquired entity and capable of being sold, transferred, licensed, returned or exchanged. We allocate the purchase price of business combinations to the tangible assets, liabilities and intangible assets acquired, including in-process research and development ("IPR&D"), based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill. The process of estimating the fair values requires significant estimates, especially with respect to intangible assets. Critical estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from customer contracts, customer lists and distribution agreements, acquired developed technologies, expected costs to develop IPR&D into commercially viable products, estimated cash flows from projects when completed and discount rates. We estimate fair value based upon assumptions that are believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Other estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed.
Goodwill and intangible assets
Goodwill represents the excess of the cost of acquired businesses over the fair market value of their identifiable net assets. We conduct a goodwill impairment qualitative assessment during the fourth quarter of each fiscal year or more frequently if facts and circumstances indicate that goodwill may be impaired. The goodwill impairment qualitative assessment requires us to perform an assessment to determine if it is more likely than not that the fair value of the business is less than its carrying amount. The qualitative assessment considers various factors, including the macroeconomic environment, industry and market specific conditions, market capitalization, stock price, financial performance, earnings multiples, budgeted-to-actual revenue performance from the prior year, gross margin and cash flow from operating activities and issues or events specific to the business. If adverse qualitative trends are identified that could negatively impact the fair value of the business, we perform a "two step" goodwill impairment test. "Step one" is the identification of potential impairment. This involves comparing the fair value of each reporting unit, which we have determined to be the entity itself, with its carrying amount including goodwill. If the fair value of a reporting unit exceeds its carrying amount, the goodwill of the reporting unit is considered not impaired and "Step two" of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, "Step two" is performed and it involves comparing the carrying amount of goodwill to its implied fair value, which is determined to be the excess of the reporting unit's fair value over the fair value of its identifiable net assets other than goodwill. If the carrying amount of goodwill exceeds its implied fair value, an impairment exists and is recorded. As of December 31, 2017,2019, our qualitative assessment of goodwill impairment indicated that goodwill was not impaired.
Intangible assets represent acquired intangible assets including developed technology, customer relationships and IPR&D, as well as licensed technology. We amortize the finite lived intangible assets over their useful lives using a method that reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used, or, if that pattern cannot be reliably determined, using a straight-line amortization method. We capitalize IPR&D projects acquired as part of a business combination as intangible assets with indefinite lives. On completion of each project, IPR&D assets are reclassified to developed technology and amortized over their estimated useful lives. If any of the IPR&D projects are abandoned, we impair the related IPR&D asset.
Indefinite-lived intangible assets are tested for impairment annually or more frequently when indicators of impairment exist. We first assess qualitative factors to determine if it is more likely than not that an indefinite-lived intangible asset is impaired and whether it is necessary to perform a quantitative impairment test. The qualitative assessment considers various factors, including reductions in demand, the abandonment of IPR&D projects or significant economic slowdowns in the semiconductor industry and macroeconomic environment. If adverse qualitative trends are identified that could negatively impact the fair value of the asset, then quantitative impairment tests are performed to compare the carrying value of the asset to its undiscounted expected future cash flows. If this test indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using: (i) quoted
market prices or (ii) discounted expected future cash flows utilizing an appropriate discount rate. Impairment is based on the excess of the carrying amount over the fair value of those assets. As of December 31, 2017,2019, there were no indicators that impairment existed or assets were not recoverable. Intangible assets with finite lives are tested for impairment in accordance with our policy for long-lived assets.
Equity investments in privately-held companies
We account forhave made equity investments in privately-held companies. We measure these equity investments at cost, less impairments, adjusted by observable price changes. We record gains or losses on the sale of these investments underwhen the proceeds are greater than or
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less than cost, method, reduced by any impairment write-downs, because we do not have the ability to exercise significant influence over the operating and financial policies of these companies.respectively. To determine if an investment is recoverable, we monitor the investments and if facts and circumstances indicate the investment may be impaired, conduct an impairment test. The impairment test considers multiple factors including a review of the privately-held company's revenue and earnings trends relative to pre-defined milestones and overall business prospects, the general market conditions in its industry and other factors related to its ability to remain in business, such as liquidity and receipt of additional funding.
While performing our review for impairment for the first quarter of 2019, we noted an observable price change related to one of our investments in a privately-held company. As a result, we recorded an impairment charge of $1.8 million in the first quarter of 2019.
While performing our review for impairment for the fourth quarter of 2018, we noted an observable price change related to one of our investments in a privately-held company. As a result, we recorded an impairment charge of $1.5 million in the first quarter of 2018.
Impairment of long-lived assets
Long-lived assets include equipment, and furniture and fixtures,right-of-use ("ROU") assets, and finite-lived intangible assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. If the sum of the expected future cash flows (undiscounted and without interest charges) from the long-lived assets is less than the carrying amount of such assets, an impairment loss would be recognized, and the assets would be written down to their estimated fair values. We review for possible impairment on a regular basis.
In January 1, 2019, we adopted the new lease standard ASU No. 2016-02, Leases (Topic 842) and recognized ROU assets and lease liabilities on the balance sheet. The leases are mainly for impairment foroffice buildings. Establishing ROU assets and lease liabilities requires judgments and estimates related to the fourth quarter of 2017, we noted an impairment indicator associated withdiscount rate to be applied to the potential sale or discontinuation of the 1550nm silicon photonics line of business. As a result, we recorded impairment charges totaling $12.0 millionfuture lease payments and, if applicable, renewal options. Renewal options are included in the fourth quarter of 2017, of which $7.7 million were related to propertyROU and equipment and $4.3 million were related to intangible assets. See Note 16 toliability calculations when we are reasonably assured that we will exercise the consolidated financial statements for more details about the impairment charges.option.
Warranty provision
We typically offer a limited warranty for our products for periods up to three years. We accrue for estimated returns of defective products at the time revenue is recognized based on historical activity. The determination of these accruals requires us to make estimates of the frequency and extent of warranty activity and estimated future costs to either replace or repair the products under warranty. If the actual warranty activity and/or repair and replacement costs differ significantly from these estimates, adjustments to record additional cost of revenues may be required in future periods.
Income taxes
To prepare our 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 calculated using tax rates expected to be in effect during the period these temporary differences would reverse, and are included within our consolidated balance sheet.
We must also make judgments regarding the realizability of deferred tax assets. The carrying value of our net deferred tax assets is based on our belief that it is more likely than not that we will generate sufficient future taxable income in certain jurisdictions to realize these deferred tax assets. A valuation allowance has been established for deferred tax assets which we do not believe meet the "more likely than not" criteria. Our judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws, tax planning strategies or other factors. If our assumptions and consequently our estimates change in the future, the valuation allowances we have established may be increased or decreased, resulting in a respective increase or decrease in income tax expense. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses, the tax regulations and tax holidays in each geographic region, the availability of tax credits and carryforwards, and the effectiveness of our tax planning strategies.
We use a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with the guidance on judgments regarding the realizability of deferred taxes. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. We recognize potential accrued interest and penalties related to unrecognized tax benefits within the consolidated statements of income as income tax expense.
Results of Operations
The following table sets forth our consolidated statements of operations as a percentage of revenues for the periods indicated:
| Year ended December 31, | Year ended December 31, | |||||||||||||||||||||
| 2017 | 2016 | 2015 | 2019 | 2018 | 2017 | |||||||||||||||||
| Total revenues | 100 | % | 100 | % | 100 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||
| Cost of revenues | (35 | ) | (35 | ) | (29 | ) | 34.9 | 35.7 | 34.8 | |||||||||||||
| Gross profit | 65 | 65 | 71 | 65.1 | 64.3 | 65.2 | ||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||
| Research and development | 42 | 38 | 38 | 31.2 | 33.1 | 42.4 | ||||||||||||||||
| Sales and marketing | 17 | 16 | 15 | 12.2 | 13.6 | 17.4 | ||||||||||||||||
| General and administrative | 6 | 7 | 7 | 6.0 | 6.3 | 6.0 | ||||||||||||||||
| Impairment of long-lived assets | 2 | — | — | |||||||||||||||||||
| Restructuring and impairment charges | 0.1 | 1.0 | 1.4 | |||||||||||||||||||
| Total operating expenses | 67 | 61 | 60 | 49.5 | 54.0 | 67.2 | ||||||||||||||||
| Income (loss) from operations | (2 | ) | 4 | 11 | 15.6 | 10.3 | (2.0 | ) | ||||||||||||||
| Interest expense | (1 | ) | (1 | ) | — | |||||||||||||||||
| Other income (loss), net | — | — | — | |||||||||||||||||||
| Interest and other, net | (1 | ) | (1 | ) | — | 1.2 | — | (0.5 | ) | |||||||||||||
| Income (loss) before taxes on income | (3 | ) | 3 | 11 | 16.8 | 10.3 | (2.5 | ) | ||||||||||||||
| Provision for (benefit from) taxes on income | (1 | ) | 1 | (3 | ) | 1.4 | (2.0 | ) | (0.3 | ) | ||||||||||||
| Net income (loss) | (2 | ) | % | 2 | % | 14 | % | 15.4 | % | 12.3 | % | (2.2 | ) | % | ||||||||
Comparison of the Year Ended December 31, 20172019 to the Year Ended December 31, 2016 and the Year Ended December 31, 2016 to the Year Ended December 31, 20152018
Revenues.
The following tables represent our total revenues for the years ended December 31, 20172019 and 20162018 by product type and interconnect protocol:
| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||||
| 2017 | % of Revenues | 2016 | % of Revenues | 2019 | % of Revenues | 2018 | % of Revenues | |||||||||||||||||||
| (In thousands) | (In thousands) | (In thousands) | ||||||||||||||||||||||||
| ICs | $ | 161,216 | 18.7 | % | $ | 170,641 | 19.9 | % | $ | 216,726 | 16.3 | % | $ | 149,180 | 13.7 | % | ||||||||||
| Boards | 325,845 | 37.7 | % | 337,304 | 39.3 | % | 532,584 | 40.0 | % | 495,753 | 45.5 | % | ||||||||||||||
| Switch systems | 222,836 | 25.8 | % | 204,083 | 23.8 | % | 329,529 | 24.8 | % | 247,478 | 22.7 | % | ||||||||||||||
| Cables, accessories and other | 153,996 | 17.8 | % | 145,470 | 17.0 | % | 251,737 | 18.9 | % | 196,332 | 18.1 | % | ||||||||||||||
| Total Revenue | $ | 863,893 | 100.0 | % | $ | 857,498 | 100.0 | % | $ | 1,330,576 | 100.0 | % | $ | 1,088,743 | 100.0 | % | ||||||||||
| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||||
| 2017 | % of Revenues | 2016 | % of Revenues | 2019 | % of Revenues | 2018 | % of Revenues | |||||||||||||||||||
| (In thousands) | (In thousands) | (In thousands) | ||||||||||||||||||||||||
| InfiniBand: | ||||||||||||||||||||||||||
| HDR | $ | 142,127 | 10.7 | % | $ | 10,177 | 0.9 | % | ||||||||||||||||||
| EDR | $ | 194,261 | 22.5 | % | $ | 125,249 | 14.6 | % | 273,045 | 20.5 | % | 234,655 | 21.6 | % | ||||||||||||
| FDR | 181,465 | 21.0 | % | 302,093 | 35.2 | % | 125,530 | 9.4 | % | 149,168 | 13.7 | % | ||||||||||||||
| QDR/DDR/SDR | 31,599 | 3.6 | % | 49,987 | 5.9 | % | 25,228 | 1.9 | % | 44,359 | 4.1 | % | ||||||||||||||
| Total | 407,325 | 47.1 | % | 477,329 | 55.7 | % | 565,930 | 42.5 | % | 438,359 | 40.3 | % | ||||||||||||||
| Ethernet | 401,005 | 46.4 | % | 317,241 | 37.0 | % | 743,899 | 55.9 | % | 618,471 | 56.8 | % | ||||||||||||||
| Other | 55,563 | 6.5 | % | 62,928 | 7.3 | % | 20,747 | 1.6 | % | 31,913 | 2.9 | % | ||||||||||||||
| Total revenue | $ | 863,893 | 100.0 | % | $ | 857,498 | 100.0 | % | $ | 1,330,576 | 100.0 | % | $ | 1,088,743 | 100.0 | % | ||||||||||
Revenues were $863.9$1,330.6 million for the year ended December 31, 20172019 compared to $857.5$1,088.7 million for the year ended December 31, 2016,2018, representing an increase of $6.4$241.9 million, or approximately 0.7%22.2%. The year-over-year revenue increaseInfiniBand product sales increased by $127.6 million, which was mainly due to the strong adoption of our 200Gb/s HDR InfiniBand solutions in 2017 from 2016the high-performance computing, artificial intelligence, cloud, and storage market segments. Ethernet product sales increased by $125.4 million primarily due to the increased
| Year Ended December 31, | |||||||||||||
| 2016 | % of Revenues | 2015 | % of Revenues | ||||||||||
| (In thousands) | (In thousands) | ||||||||||||
| ICs | $ | 170,641 | 19.9 | % | $ | 92,214 | 14.0 | % | |||||
| Boards | 337,304 | 39.3 | % | 265,249 | 40.3 | % | |||||||
| Switch systems | 204,083 | 23.8 | % | 179,977 | 27.3 | % | |||||||
| Cables, accessories and other | 145,470 | 17.0 | % | 120,700 | 18.4 | % | |||||||
| Total Revenue | $ | 857,498 | 100.0 | % | $ | 658,140 | 100.0 | % | |||||
| Year Ended December 31, | |||||||||||||
| 2016 | % of Revenues | 2015 | % of Revenues | ||||||||||
| (In thousands) | (In thousands) | ||||||||||||
| InfiniBand: | |||||||||||||
| EDR | $ | 125,249 | 14.6 | % | $ | 39,009 | 5.9 | % | |||||
| FDR | 302,093 | 35.2 | % | 347,760 | 52.8 | % | |||||||
| QDR/DDR/SDR | 49,987 | 5.9 | % | 63,745 | 9.8 | % | |||||||
| Total | 477,329 | 55.7 | % | 450,514 | 68.5 | % | |||||||
| Ethernet | 317,241 | 37.0 | % | 155,221 | 23.6 | % | |||||||
| Other | 62,928 | 7.3 | % | 52,405 | 7.9 | % | |||||||
| Total revenue | $ | 857,498 | 100.0 | % | $ | 658,140 | 100.0 | % | |||||
Research and Development.
The following table presents details of our research and development expenses for the periods indicated:
| Year ended December 31, | Year ended December 31, | ||||||||||||||||||||||||||||||||
| 2017 | % of Revenues | 2016 | % of Revenues | 2015 | % of Revenues | 2019 | % of Revenues | 2018 | % of Revenues | ||||||||||||||||||||||||
| (In thousands) | (In thousands) | (In thousands) | (In thousands) | ||||||||||||||||||||||||||||||
| Salaries and benefits | $ | 200,125 | 23.2 | % | $ | 174,462 | 20.3 | % | $ | 130,255 | 19.8 | % | $ | 227,232 | 17.1 | % | $ | 207,041 | 19.0 | % | |||||||||||||
| Share-based compensation | 40,278 | 4.7 | % | 40,475 | 4.7 | % | 28,821 | 4.4 | % | 61,315 | 4.6 | % | 38,922 | 3.6 | % | ||||||||||||||||||
| Development and tape-out costs | 39,001 | 4.5 | % | 36,091 | 4.2 | % | 36,305 | 5.5 | % | 37,438 | 2.8 | % | 32,968 | 3.0 | % | ||||||||||||||||||
| Other | 86,474 | 10.0 | % | 71,592 | 8.4 | % | 56,794 | 8.6 | % | 88,890 | 6.7 | % | 81,413 | 7.5 | % | ||||||||||||||||||
| Total Research and development | $ | 365,878 | 42.4 | % | $ | 322,620 | 37.6 | % | $ | 252,175 | 38.3 | % | $ | 414,875 | 31.2 | % | $ | 360,344 | 33.1 | % | |||||||||||||