e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2008
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
For the transition period to
Commission File No. 001-33299
MELLANOX TECHNOLOGIES, LTD.
(Exact Name of Registrant as Specified in Its Charter)
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ISRAEL
(State or Other Jurisdiction of
Incorporation or Organization)
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98-0233400
(I.R.S. Employer
Identification No.) |
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HERMON BUILDING, YOKNEAM, ISRAEL
(Address of Principal Executive Offices)
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20692
(Zip Code) |
Registrants Telephone Number, Including Area Code: +972-4-909-7200
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act) Yes o No þ
The total number of outstanding shares of the registrants Ordinary Shares, nominal value of NIS
0.0175 per share, as of March 31, 2008, was 31,172,768.
MELLANOX TECHNOLOGIES, LTD.
2
PART I. FINANCIAL INFORMATION
ITEM 1 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
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March 31, |
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December 31 |
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2008 |
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2007 |
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(In thousands) |
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ASSETS
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Current assets: |
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Cash and cash equivalents |
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$ |
61,475 |
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$ |
100,650 |
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Short-term investments |
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93,157 |
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52,231 |
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Restricted cash |
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710 |
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709 |
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Accounts receivable, net |
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18,864 |
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17,353 |
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Inventories |
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5,401 |
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5,396 |
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Deferred taxes |
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10,256 |
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12,312 |
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Prepaid expenses and other |
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1,890 |
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1,509 |
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Total current assets |
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191,753 |
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190,160 |
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Property and equipment, net |
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8,495 |
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8,449 |
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Severance assets |
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3,596 |
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3,152 |
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Intangible assets, net |
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379 |
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395 |
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Other long-term assets |
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1,756 |
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244 |
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Total assets |
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$ |
205,979 |
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$ |
202,400 |
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LIABILITIES AND SHAREHOLDERS EQUITY
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Current liabilities: |
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Accounts payable |
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$ |
4,694 |
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$ |
6,703 |
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Other accrued liabilities |
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8,944 |
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11,282 |
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Capital lease obligations, current |
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1,075 |
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1,560 |
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Total current liabilities |
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14,713 |
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19,545 |
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Accrued severance |
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4,550 |
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4,058 |
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Capital lease obligations, net of current portion |
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1,342 |
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1,609 |
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Other long-term obligations |
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583 |
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71 |
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Total liabilities |
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21,188 |
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25,283 |
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Shareholders equity |
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Ordinary shares |
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132 |
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128 |
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Additional paid-in capital |
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213,574 |
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210,618 |
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Accumulated other comprehensive income |
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131 |
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54 |
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Accumulated deficit |
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(29,046 |
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(33,683 |
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Total shareholders equity |
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184,791 |
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177,117 |
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Total liabilities and shareholders equity |
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$ |
205,979 |
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$ |
202,400 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
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Three Months Ended March 31, |
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2008 |
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2007 |
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(In thousands, except per share data) |
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Total revenues |
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$ |
25,155 |
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$ |
16,855 |
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Cost of revenues |
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(5,935 |
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(4,270 |
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Gross profit |
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19,220 |
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12,585 |
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Operating expenses: |
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Research and development |
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8,257 |
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5,944 |
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Sales and marketing |
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3,353 |
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2,791 |
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General and administrative |
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1,831 |
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1,357 |
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Total operating expenses |
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13,441 |
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10,092 |
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Income from operations |
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5,779 |
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2,493 |
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Other income, net |
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1,043 |
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957 |
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Income before taxes on income |
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6,822 |
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3,450 |
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Provision for taxes on income |
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(2,185 |
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(164 |
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Net income |
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$ |
4,637 |
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$ |
3,286 |
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Net income per share basic |
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$ |
0.15 |
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$ |
0.16 |
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Net income per share diluted |
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$ |
0.14 |
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$ |
0.15 |
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Shares used in computing income per share: |
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Basic |
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31,089 |
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20,310 |
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Diluted |
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32,790 |
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22,657 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
4
MELLANOX TECHNOLOGIES, LTD.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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Three Months Ended March 31, |
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2008 |
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2007 |
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(In thousands) |
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Cash flows from operating activities: |
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Net income |
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$ |
4,637 |
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$ |
3,286 |
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Adjustments to reconcile net income to net cash provided by operating activities: |
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Depreciation and amortization |
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816 |
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350 |
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Deferred income taxes |
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2,056 |
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Share-based compensation expense |
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1,874 |
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598 |
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Gain on sale of investments |
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(800 |
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(15 |
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Changes in assets and liabilities: |
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Accounts receivable, net |
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(1,511 |
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1,626 |
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Inventories |
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(5 |
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(258 |
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Prepaid expenses and other assets |
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(394 |
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1,341 |
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Accounts payable |
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(2,009 |
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(103 |
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Accrued liabilities and other payables |
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(1,334 |
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(131 |
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Net cash provided by operating activities |
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3,330 |
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6,694 |
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Cash flows from investing activities: |
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Purchase of severance-related insurance policies |
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(444 |
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(159 |
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Purchases of short-term investments |
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(73,544 |
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Maturities and sale of short-term investments |
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33,495 |
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Return of restricted cash deposit |
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71 |
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Purchase of property and equipment |
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(652 |
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(491 |
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Purchase of preferred stock |
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(1,500 |
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Net cash used in investing activities |
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(42,645 |
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(579 |
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Cash flows from financing activities: |
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Proceeds from initial public offering, net of issuance costs |
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106,015 |
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Principal payments on capital lease obligations |
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(946 |
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(136 |
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Proceeds from exercise of share awards and options |
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1,086 |
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222 |
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Net cash provided by financing activities |
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140 |
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106,101 |
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Net increase (decrease) in cash and cash equivalents |
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(39,175 |
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112,216 |
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Cash and cash equivalents at beginning of period |
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100,650 |
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20,570 |
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Cash and cash equivalents at end of period |
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$ |
61,475 |
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$ |
132,786 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
5
MELLANOX TECHNOLOGIES, LTD.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Company
Mellanox Technologies, Ltd., an Israeli company, and its wholly-owned subsidiary, Mellanox
Technologies, Inc., a California corporation (collectively referred to as the Company or
Mellanox), were incorporated and commenced operations in March 1999. Mellanox is a supplier of
semiconductor-based, high-performance interconnect products for computing, storage and
communications applications.
Principles of presentation
The condensed consolidated financial statements included in this quarterly report on Form 10-Q
have been prepared by the Company without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (the SEC). The year-end condensed balance sheet data was
derived from audited financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States. Certain information and footnote
disclosures normally included in consolidated financial statements prepared in accordance with U.S.
generally accepted accounting principles have been condensed or omitted pursuant to such rules and
regulations. However, the Company believes that the disclosures contained in this quarterly report
comply with the requirements of Section 13(a) of the Securities Exchange Act of 1934, as amended,
for a quarterly report on Form 10-Q and are adequate to make the information presented not
misleading. The condensed consolidated financial statements included herein reflect all adjustments
(consisting of normal recurring adjustments) which are, in the opinion of management, necessary for
a fair statement of the financial position, results of operations and cash flows for the interim
periods presented. These condensed consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto contained in the Companys 2007 annual
report on Form 10-K dated March 24, 2008. The results of operations for the three months ended
March 31, 2008 are not necessarily indicative of the results to be anticipated for the entire year
ending December 31, 2008 or thereafter.
Reverse share split
On February 1, 2007, the Company effected a 1.75-to-1.0 reverse split of the Companys
ordinary shares, mandatorily redeemable convertible preferred shares and convertible preferred
shares (the Share Split) pursuant to the filing of the Amended and Restated Articles of
Association. All references to shares in the consolidated financial statements and the accompanying
notes, including but not limited to the number of shares and per share amounts, unless otherwise
noted, have been adjusted to reflect retroactively the Share Split. Previously awarded options and
warrants to purchase the Companys ordinary shares have also been retroactively adjusted to
reflect the Share Split. On February 1, 2007, the Company also increased its authorized share
capital to NIS 2,400,000, divided into a total of 123,570,572 ordinary shares and 13,572,285
preferred shares.
Initial public offering
On February 13, 2007, the Company closed the initial public offering of its ordinary shares.
The Company sold 6,900,000 ordinary shares in the offering, which included the underwriters
exercise in full of their option to purchase up to 900,000 shares to cover over-allotments, at an
offering price of $17.00 per share. Net proceeds generated by the offering, after adjusting for
offering costs, totaled approximately $106 million. Immediately prior to the closing of the initial
public offering, all of the outstanding preferred shares converted into an aggregate of 15,035,712
ordinary shares of the Company.
Risks and uncertainties
The Company is subject to all of the risks inherent in a company which operates in the dynamic
and competitive semiconductor industry. Significant changes in any of the following areas could
have a material adverse impact on the Companys financial position and results of operations:
unpredictable volume or timing of customer orders; the sales outlook and purchasing patterns of the
Companys customers, based on consumer demands and general economic conditions; loss of one or more
of the Companys customers; decreases in the average selling prices of products or increases in the
average cost of finished goods; the availability, pricing and timeliness of delivery of components
used in the Companys products; reliance on a limited number of subcontractors to
6
manufacture, assemble, package and production test our products; the Companys ability to
successfully develop, introduce and sell new or enhanced products in a timely manner; product
obsolescence and the Companys ability to manage product transitions; and the timing of
announcements or introductions of new products by the Companys competitors.
Additionally, the Company has a significant presence in Israel, including research and
development activities, corporate facilities and sales support operations. Uncertainty surrounding
the political, economic and military conditions in Israel may directly impact the Companys
financial results.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Concentration of credit risk
Financial instruments that potentially subject the Company to a concentration of credit risk
consist of cash, cash equivalents, short-term investments and accounts receivable. The Companys
accounts receivable are derived from revenue earned from customers located in North America, Europe
and Asia. The Company performs ongoing credit evaluations of its customers financial condition and
generally requires no collateral from its customers. The Company maintains an allowance for
doubtful accounts receivable based upon the expected collectibility of accounts receivable. The
Company reviews its allowance for doubtful accounts quarterly by assessing individual accounts
receivable over a specific aging and amount, and all other balances based on historical collection
experience and an economic risk assessment. If the Company determines that a specific customer is
unable to meet its financial obligations to the Company, the Company provides an allowance for
credit losses to reduce the receivable to the amount management believes will be collected.
The following table summarizes the revenues from customers (including original equipment
manufacturers) in excess of 10% of the total revenues:
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Three Months Ended March 31, |
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2008 |
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2007 |
Hewlett-Packard |
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12 |
% |
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16 |
% |
IBM |
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12 |
% |
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* |
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QLogic |
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12 |
% |
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* |
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Cisco |
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* |
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26 |
% |
Voltaire |
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* |
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20 |
% |
At March 31, 2008, IBM accounted for 13% of the Companys total accounts receivable.
Short-term investments
The Companys short-term investments, which are classified as available-for-sale securities in
accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities, are primarily invested in marketable government agency
obligations and commercial papers.
Short-term investments are reported at fair value at March 31, 2008 and 2007. Unrealized gains
or losses are recorded in stockholders equity and included in Accumulated other comprehensive
income. Realized gains and losses and declines in value judged to be other than temporary on
available-for-sale securities are included in interest and other income, net. In order to determine
if a decline in value on an available-for-sale security is other than temporary, we evaluate, among
other factors, general market conditions, the duration and extent to which the fair value is less
than cost, as well as the Companys intent and ability to hold the investment. Once a decline in
fair value is determined to be other than temporary, an impairment charge is recorded and a new
cost basis in the investment is established.
7
The
contractual maturities of marketable securities classified as
short-term investments at
March 31, 2008 and 2007 are due in one year or less.
Investment in preferred stock
The
Company has an investment in amount of $1.5 million in preferred stock of a privately-held company. This investment
is recorded at cost because the Company does not have the ability to exercise significant influence
over the operating and financial policies of this company. This investment is included in other
long-term assets on the accompanying balance sheets. The Company monitors this investment for
impairment by considering available evidence generally including financial, operational and
economic data and makes appropriate reductions in carrying values when an impairment is deemed to
be other than temporary.
Revenue recognition
The Company accounts for its revenue under the provisions of Staff Accounting Bulletin (SAB)
No. 104, Revenue Recognition in Financial Statements. Under SAB No. 104, revenues from sales of
products are recognized when persuasive evidence of an arrangement exists, delivery has occurred,
the price is fixed or determinable and collection is reasonably assured. The Companys standard
arrangement with its customers includes freight-on-board shipping
point, 30-60 days payment terms, no
right of return and no customer acceptance provisions. The Company generally relies upon a purchase
order as persuasive evidence of an arrangement.
Probability of collection is assessed on a customer-by-customer basis. Customers are subject
to a credit review process that evaluates the customers financial position and ultimately their
ability to pay. If it is determined at the outset of an arrangement that collection is not
probable, no product is shipped and no revenue is recognized unless cash is received in advance.
Costs incurred for shipping and handling expenses to customers are recorded as cost of
revenues. To the extent these amounts are billed to the customer in a sales transaction, the
Company records the shipping and handling fees as revenue.
Product warranty
The
Company typically offers a limited warranty on its products for periods of up to three
years. The Company accrues for estimated returns of defective products at the time revenue is
recognized based on historical activity. The determination of these accruals requires the Company
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 cost of revenues
may be required in future periods. Changes in the Companys liability for product warranty during
the three months ended March 31, 2008 and 2007, are as follows:
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Three Months Ended March 31, |
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2008 |
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2007 |
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(In thousands) |
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Balance, beginning of the period |
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$ |
704 |
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$ |
528 |
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New warranties issued during the period |
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358 |
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6 |
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Settlements during the period |
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(52 |
) |
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(35 |
) |
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Balance, end of the period |
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$ |
1,010 |
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$ |
499 |
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Net income per share
Basic and diluted net income per share is computed by dividing the net income for the period
by the weighted average number of ordinary shares outstanding during the period. The calculation of
diluted net income per share excludes potential ordinary shares if the effect is antidilutive.
Potential ordinary shares are comprised of ordinary shares subject to repurchase rights,
incremental ordinary shares issuable upon the exercise of share options or warrants and shares
issuable in accordance with employee share purchase plan.
8
The following table sets forth the computation of basic and diluted net income per share for
the periods indicated:
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Three Months Ended March 31, |
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2008 |
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2007 |
|
|
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(In thousands, except per share data) |
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Net income |
|
$ |
4,637 |
|
|
$ |
3,286 |
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Basic and diluted shares: |
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Weighted average ordinary shares outstanding |
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31,089 |
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20,313 |
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Weighted average unvested ordinary shares subject to repurchase |
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(3 |
) |
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Shares used to compute basic net income per share |
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31,089 |
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20,310 |
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Effect of dilutive securities |
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1,701 |
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|
2,347 |
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Shares used to compute diluted net income per share |
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|
32,790 |
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|
22,657 |
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Net income per share attributable to ordinary shareholders basic |
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$ |
0.15 |
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$ |
0.16 |
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Net income per share attributable to ordinary shareholders diluted |
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$ |
0.14 |
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$ |
0.15 |
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Foreign currency translation
The Company uses the U.S. dollar as its functional currency. Foreign currency assets and
liabilities are remeasured into U.S. dollars at the end-of-period exchange rates except for
non-monetary assets and liabilities, which are remeasured at historical exchange rates. Revenue and
expenses are remeasured each day at the exchange rate in effect on the day the transaction
occurred, except for those expenses related to balance sheet amounts, which are remeasured at
historical exchange rates. Gains or losses from foreign currency transactions are included in the
Consolidated Statements of Operations as part of Other income, net.
Segment reporting
Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an
Enterprise and Related Information, or SFAS No. 131, requires that companies report separately in
their financial statements certain financial and descriptive information about operating segments
profit or loss, certain specific revenue and expense items and segment assets. Additionally,
companies are required to report information about the revenues derived from their products and
service groups, about geographic areas in which they earn revenues and hold assets and about major
customers. The Company has one reportable segment: the development, manufacturing, marketing and
sales of interconnect semiconductor products.
Recent accounting pronouncements
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair
Value Measurements, or SFAS No. 157, which defines fair value, establishes a framework for
measuring fair value under generally accepted accounting principles and expands disclosures about
fair value measurements. SFAS No. 157 does not require any new fair value measurements, but
provides guidance on how to measure fair value by providing a fair value hierarchy used to classify
the source of the information. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2,
Effective Date of FASB Statement No. 157, which provides a one year deferral of the effective
date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value on a recurring basis. We adopted
SFAS 157 as of January 1, 2008, with the exception of the application of the statement to
non-recurring non-financial assets and non-financial liabilities. The adoption of this statement
did not have a material impact on the Companys consolidated results of operations, financial
condition or cash flows. Refer to Note 3 to the Condensed Consolidated Financial Statements for
additional discussion on fair value measurements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities including an amendment of FASB Statement No. 115, (SFAS 159) which is
effective for fiscal years beginning after November 15, 2007. This statement permits entities to
choose to measure many financial instruments and certain other items at fair value. This statement
also establishes presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types of assets and
liabilities. Unrealized gains and losses on items for which the fair value option is elected would
be reported in earnings. We have adopted SFAS 159 and have elected not to measure any additional
financial instruments and other items at fair value.
In June 2007 the FASB ratified EITF No. 07-3, or EITF 07-3, Accounting for Nonrefundable
Advance Payments for Goods or Services to Be Used in Future Research and Development Activities.
EITF 07-3 requires non-refundable advance payments for goods and services to be used in future
research and development activities to be recorded as an asset and the payments to be expensed when
9
the research and development activities are performed. EITF 07-3 was effective for us on
January 1, 2008. The adoption of this standard did not have a material effect on the Companys
financial statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 161). This statement is intended
to improve transparency in financial reporting by requiring enhanced disclosures of an entitys
derivative instruments and hedging activities and their effects on the entitys financial position,
financial performance, and cash flows. SFAS 161 applies to all derivative instruments within the
scope of SFAS 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133) as
well as related hedged items, bifurcated derivatives and non-derivative instruments that are
designated and qualify as hedging instruments. Entities with instruments subject to SFAS 161 must
provide more robust qualitative disclosures and expanded quantitative disclosures. SFAS 161 is
effective prospectively for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application permitted. We are currently evaluating
the disclosure implications of this statement.
NOTE 2 BALANCE SHEET COMPONENTS:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands) |
|
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
Cash |
|
$ |
13,620 |
|
|
$ |
8,028 |
|
Money market funds |
|
|
3,493 |
|
|
|
4,330 |
|
Government agency discount notes |
|
|
28,142 |
|
|
|
58,735 |
|
Commercial paper |
|
|
16,220 |
|
|
|
29,557 |
|
|
|
|
|
|
|
|
|
|
$ |
61,475 |
|
|
$ |
100,650 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments: |
|
|
|
|
|
|
|
|
Money market funds |
|
$ |
3,493 |
|
|
$ |
4,330 |
|
Commercial paper |
|
|
50,244 |
|
|
|
40,970 |
|
Government agency discount notes |
|
|
87,275 |
|
|
|
99,553 |
|
|
|
|
|
|
|
|
Total investments in marketable securities |
|
|
141,012 |
|
|
|
144,853 |
|
Less amounts classified as cash equivalents |
|
|
(47,855 |
) |
|
|
(92,622 |
) |
|
|
|
|
|
|
|
|
|
$ |
93,157 |
|
|
$ |
52,231 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable, net: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
$ |
19,062 |
|
|
$ |
17,539 |
|
Less: Allowance for doubtful accounts |
|
|
(198 |
) |
|
|
(186 |
) |
|
|
|
|
|
|
|
|
|
$ |
18,864 |
|
|
$ |
17,353 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventories: |
|
|
|
|
|
|
|
|
Raw materials |
|
$ |
781 |
|
|
$ |
642 |
|
Work-in-process |
|
|
968 |
|
|
|
1,379 |
|
Finished goods |
|
|
3,652 |
|
|
|
3,375 |
|
|
|
|
|
|
|
|
|
|
$ |
5,401 |
|
|
$ |
5,396 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid expense and other: |
|
|
|
|
|
|
|
|
Prepaid expenses |
|
$ |
1,015 |
|
|
$ |
512 |
|
Federal taxes recoverable |
|
|
787 |
|
|
|
914 |
|
Other |
|
|
88 |
|
|
|
83 |
|
|
|
|
|
|
|
|
|
|
$ |
1,890 |
|
|
$ |
1,509 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net: |
|
|
|
|
|
|
|
|
Computer equipment and software |
|
$ |
24,623 |
|
|
$ |
24,030 |
|
Furniture and fixtures |
|
|
1,150 |
|
|
|
1,146 |
|
Leasehold improvements |
|
|
693 |
|
|
|
666 |
|
|
|
|
|
|
|
|
|
|
|
26,466 |
|
|
|
25,842 |
|
Less: Accumulated depreciation and amortization |
|
|
(17,971 |
) |
|
|
(17,393 |
) |
|
|
|
|
|
|
|
|
|
$ |
8,495 |
|
|
$ |
8,449 |
|
|
|
|
|
|
|
|
10
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands) |
|
Other accrued liabilities: |
|
|
|
|
|
|
|
|
Payroll and related expenses |
|
$ |
3,870 |
|
|
$ |
5,311 |
|
Professional services |
|
|
1,517 |
|
|
|
1,418 |
|
Royalties |
|
|
402 |
|
|
|
1,233 |
|
Warranty |
|
|
1,010 |
|
|
|
704 |
|
Income tax payable |
|
|
698 |
|
|
|
997 |
|
Sales commissions |
|
|
587 |
|
|
|
888 |
|
Other |
|
|
860 |
|
|
|
731 |
|
|
|
|
|
|
|
|
|
|
$ |
8,944 |
|
|
$ |
11,282 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other long-term obligations: |
|
|
|
|
|
|
|
|
Federal income tax payable |
|
$ |
583 |
|
|
$ |
64 |
|
Other |
|
|
|
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
$ |
583 |
|
|
$ |
71 |
|
|
|
|
|
|
|
|
NOTE 3 FAIR VALUE:
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (SFAS 157), which
was effective for fiscal years beginning after November 15, 2007 and for interim periods within
those years. This statement defines fair value, establishes a framework for measuring fair value
and expands the related disclosure requirements. This statement applies under other accounting
pronouncements that require or permit fair value measurements. The statement indicates, among other
things, that a fair value measurement assumes that the transaction to sell an asset or transfer a
liability occurs in the principal market for the asset or liability or, in the absence of a
principal market, the most advantageous market for the asset or liability. SFAS 157 defines fair
value based upon an exit price model.
Relative to SFAS 157, the FASB issued FASB Staff Positions (FSP) 157-1 and 157-2. FSP 157-1
amends SFAS 157 to exclude SFAS No. 13, Accounting for Leases, (SFAS 13) and its related
interpretive accounting pronouncements that address leasing transactions, while FSP 157-2 delays
the effective date of the application of SFAS 157 to fiscal years beginning after November 15, 2008
for all non-financial assets and non-financial liabilities that are recognized or disclosed at fair
value in the financial statements on a nonrecurring basis.
We adopted SFAS 157 as of January 1, 2008, with the exception of the application of the
statement to non-recurring non-financial assets and non-financial liabilities.
Valuation Hierarchy
SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to
measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level
1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs
that are observable for the asset or liability, either directly or indirectly through market
corroboration, for substantially the full term of the financial instrument. Level 3 inputs are
unobservable inputs based on our own assumptions used to measure assets and liabilities at fair
value. A financial asset or liabilitys classification within the hierarchy is determined based on
the lowest level input that is significant to the fair value measurement.
The following table represents the Companys fair value hierarchy for its financial assets
(cash equivalents and investments) measured at fair value on a recurring basis as of March 31, 2008
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
|
|
(In thousands) |
|
Money market funds |
|
$ |
3,493 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
3,493 |
|
Commercial paper |
|
|
|
|
|
|
50,244 |
|
|
|
|
|
|
|
50,244 |
|
Government agency discount notes |
|
|
|
|
|
|
87,275 |
|
|
|
|
|
|
|
87,275 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
3,493 |
|
|
$ |
137,519 |
|
|
$ |
|
|
|
$ |
141,012 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
NOTE 4 COMMITMENTS AND CONTINGENCIES:
Leases
As of March 31, 2008, future minimum lease payments under non-cancelable operating and capital
leases, and future minimum sublease rental receipts under non-cancelable operating leases are as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital |
|
|
Operating |
|
|
Estimated Sublease |
|
Year Ended December 31, |
|
Leases |
|
|
Leases |
|
|
Income |
|
|
|
(In thousands) |
|
2008 |
|
$ |
681 |
|
|
$ |
3,617 |
|
|
$ |
118 |
|
2009 |
|
|
756 |
|
|
|
4,028 |
|
|
|
40 |
|
2010 |
|
|
507 |
|
|
|
2,604 |
|
|
|
|
|
2011 |
|
|
316 |
|
|
|
862 |
|
|
|
|
|
2012 |
|
|
179 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total minimum lease payments and sublease income |
|
$ |
2,439 |
|
|
$ |
11,111 |
|
|
$ |
158 |
|
|
|
|
|
|
|
|
|
|
|
|
Less: Amount representing interest |
|
|
(22 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Present value of capital lease obligations |
|
|
2,417 |
|
|
|
|
|
|
|
|
|
Less: Current portion |
|
|
(1,075 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term portion of capital lease obligations |
|
$ |
1,342 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase commitments
As of March 31, 2008, the Company had no non-cancelable purchase commitments with suppliers
beyond one year.
Contingencies
The Company is not currently subject to any material legal proceedings. The Company may, from
time to time, become a party to various legal proceedings arising in the ordinary course of
business. The Company may also be indirectly affected by administrative or court proceedings or
actions in which the Company is not involved but which have general applicability to the
semiconductor industry.
NOTE 5 SHARE INCENTIVE PLANS:
The Company has four share option plans: the 1999 United States Equity Incentive Plan, 1999
Israeli Share Option Plan and 2003 Israeli Share Option Plan (collectively, the Prior Plans) and
the 2006 Global Share Incentive Plan (the Global Plan). The Global Plan was adopted by our board
of directors in October 2006, approved by our shareholders in December 2006 and became effective on
February 6, 2007. Upon the effectiveness of the Global Plan, all Prior Plans were replaced by the
Global Plan and a total of 3,554,044 of the Companys ordinary shares were reserved for the
granting under this plan. The number of ordinary shares reserved for issuance under the Global Plan
will increase automatically on the first day of each fiscal year, beginning in 2008, by a number of
ordinary shares equal to the least of: (i) 2% of ordinary shares outstanding on a fully diluted
basis on such date, (ii) 685,714 ordinary shares or (iii) a smaller number determined by our board
of directors. In any event, the maximum aggregate number of ordinary shares that may be issued or
transferred under the Global Plan during the term of the Global Plan may in no event exceed
15,474,018 ordinary shares.
The following table summarizes the activity under the Global Plan during the three months
ended March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
Shares |
|
|
Number |
|
|
Average |
|
|
|
Available |
|
|
of |
|
|
Exercise |
|
|
|
for Grant |
|
|
Shares |
|
|
Price |
|
Outstanding at December 31, 2007 |
|
|
1,510,811 |
|
|
|
6,029,526 |
|
|
$ |
9.68 |
|
Options granted |
|
|
(217,380 |
) |
|
|
217,380 |
|
|
$ |
14.80 |
|
Options exercised |
|
|
|
|
|
|
(66,291 |
) |
|
$ |
3.35 |
|
Options canceled |
|
|
48,804 |
|
|
|
(48,804 |
) |
|
$ |
13.17 |
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2008 |
|
|
1,342,235 |
|
|
|
6,131,811 |
|
|
$ |
9.90 |
|
|
|
|
|
|
|
|
|
|
|
12
The weighted average fair value of options granted was approximately $8.65 and $11.33 for the
three months ended March 31, 2008 and 2007, respectively.
The total pretax intrinsic value of options exercised in the three months ended March 31, 2008
and 2007 was $0.8 million and $0.3 million, respectively. This intrinsic value represents the
difference between the fair market value of our ordinary shares on the date of exercise and the
exercise price of each option. As of March 31, 2008, 6,131,811 options were outstanding with a
weighted-average exercise price of $9.90 per share and weighted-average remaining contractual term
of 7.33 years. Based on the closing price of our ordinary shares of $13.93 on March 31, 2008, the
total pretax intrinsic value of all outstanding options was $34.5 million. As of March 31, 2008,
3,048,897 options were exercisable, out of which 2,741,911 options were fully vested and 306,986
options were unvested but exercisable. The total pretax intrinsic value of exercisable options at
March 31, 2008 was $30.2 million.
Our Employee Share Purchase Plan, or ESPP, was adopted by our board of directors in November
2006 and approved by our shareholders in December 2006, and became effective immediately prior to
our initial public offering on February 7, 2007. The ESPP is designed to allow our eligible
employees to purchase our ordinary shares, at semi-annual intervals (offering periods), with
their accumulated payroll deductions. 571,428 shares have been initially reserved for issuance
pursuant to purchase rights under the ESPP. A participant may contribute up to 15% of his or her
compensation through payroll deductions, and the accumulated deductions will be applied to the
purchase of shares on the purchase date, which is the last trading day of the offering period. The
purchase price per share will be equal to 85% of the fair market value per share on the start date
of the offering period in which the participant is enrolled or, if lower, 85% of the fair market
value per share on the purchase date. In addition, the number of ordinary shares reserved under our
ESPP will increase automatically on the first day of each fiscal year during the term, beginning in
2008, by a number of ordinary shares equal to the least of (i) 0.5% of the total number of ordinary
shares outstanding on a fully diluted basis on the date of the increase, (ii) 171,428 shares, or
(iii) a smaller number of shares as determined by our board of directors. In any event, the maximum
aggregate number of ordinary shares that may be issued over the term of the ESPP may in no event
exceed 2,114,285 shares. In addition, no participant in our ESPP may be issued or transferred more
than $25,000 worth of ordinary shares pursuant to purchase rights under the ESPP per calendar year.
During the three months ended March 31, 2008, 66,365 shares were issued under this plan at average
per share prices of $13.01. At March 31, 2008, 442,930 shares were available for future issuance
under the ESPP.
Share-based compensation
The following weighted average assumptions are used to value share options granted in
connection with the Companys share incentive plans for the three months ended March 31, 2008 and
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Stock |
|
Employee Stock |
|
|
Options |
|
Purchase Plan |
|
|
Three Months Ended March 31, |
|
Three Months Ended March 31, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Dividend yield, % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility, % |
|
|
60.0 |
|
|
|
65.0 |
|
|
|
51.6 |
|
|
|
59.4 |
|
Risk free interest rate, % |
|
|
2.75 |
|
|
|
4.55 |
|
|
|
1.49 |
|
|
|
4.96 |
|
Expected life, years |
|
|
6.25 |
|
|
|
6.25 |
|
|
|
0.53 |
|
|
|
0.56 |
|
Estimated forfeiture rate, % |
|
|
8.18 |
|
|
|
9.43 |
|
|
|
|
|
|
|
|
|
For share options granted since January 1, 2006, the Company estimates the fair value of the
options as of the date of grant using the Black-Scholes valuation model and applies the
straight-line method to attribute share-based compensation expense. For the three months ended
March 31, 2008, the Company recorded share-based compensation expense for employees and
non-employees totaling approximately $1.87 million compared to approximately $598,000 for the three
months ended March 31, 2007.
The following table summarizes the distribution of total share-based compensation expense in
the Consolidated Statements of Operations:
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands) |
|
Cost of goods sold |
|
$ |
48 |
|
|
$ |
15 |
|
Research and development |
|
|
1,187 |
|
|
|
275 |
|
Sales and marketing |
|
|
378 |
|
|
|
211 |
|
General and administrative |
|
|
261 |
|
|
|
97 |
|
|
|
|
|
|
|
|
Total share-based compensation expense |
|
$ |
1,874 |
|
|
$ |
598 |
|
|
|
|
|
|
|
|
At March 31, 2008, there was $24.1 million of total unrecognized share-based compensation
costs related to non-vested share-based compensation arrangements. The costs are expected to be
recognized over a weighted average period of 3.08 years.
13
NOTE 6 INCOME TAXES:
Income taxes are accounted for using an asset and liability approach in accordance with
Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, which requires
the recognition of taxes payable or refundable for the current year and deferred tax liabilities
and assets for the future tax consequences of events that have been recognized in the Companys
financial statements or tax returns. The measurement of current and deferred tax liabilities and
assets are based on the provisions of enacted tax law; the effects of future changes in tax laws or
rates are not anticipated. The measurement of deferred tax assets is reduced, if necessary, by the
amount of any tax benefits that, based on available evidence, are not expected to be realized.
Deferred tax assets and liabilities are determined based on the difference between the
financial statement and tax basis of assets and liabilities using enacted tax rates in effect for
the year in which the differences are expected to affect taxable income. Valuation allowances are
provided if, based upon the weight of available evidence, it is considered more likely than not
that some or all of the deferred tax assets will not be realized.
On January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes (FIN 48). Under FIN 48, the impact of an uncertain income tax position on income
tax expense must be recognized at the amount that is more-likely-than-not of being sustained. As
of March 31, 2008, the Company has 1,185,000 of unrecognized benefits compared to $1,139,000 as of
December 31, 2007. It is the Companys policy to classify accrued interest and penalties as part
of the unrecognized tax benefits (tax contingencies) and record the expense in the provision for
income taxes. As of March 31, 2008 the amount of accrued interest and penalties totaled $11,000. As
of March 31, 2008, calendar years 2003 through 2007 are open and subject to potential examination
in one or more jurisdictions. The Company is not currently under federal, state or foreign income
tax examination..
Our effective tax rate is highly dependent upon the geographic distribution of our worldwide
earnings or losses, the tax regulations and tax holiday benefits in Israel, and the effectiveness
of our tax planning strategies. The tax provision for income taxes reported for the three months
ended March 31st, 2007 reflects the estimated annual tax rate applied to the year to
date net income, adjusted for certain discreet items which are fully recognized in the period they
occur. The application of income tax law is inherently complex. Laws and regulations in this area
are voluminous and are often ambiguous and the Company is required to make many subjective
assumptions and judgments regarding its income tax exposures. In addition, interpretations of and
guidance surrounding income tax laws and regulations are subject to change over time. Any changes
in our subjective assumptions and judgments could materially affect amounts recognized in the
consolidated balance sheets and statements of income.
14
ITEM 2 MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition as of March 31, 2008 and
results of operations for the three months ended March 31, 2008 and March 31, 2007 should be read
together with our financial statements and related notes included elsewhere in this report. This
discussion and analysis contains forward-looking statements that involve risks, uncertainties and
assumptions. Our actual results may differ materially from those anticipated in these
forward-looking statements as a result of many factors, including but not limited to those set
forth under the section entitled Risk Factors in Part II, Item 1A of this report. We urge you
not to place undue reliance on these forward-looking statements, which speak only as of the date of
this report. All forward-looking statements included in this report are based on information
available to us on the date of this report, and we assume no obligation to update any
forward-looking statements contained in this report. Quarterly financial results may not be
indicative of the financial results of future periods.
Overview
General
We are a leading supplier of semiconductor-based, high-performance interconnect products that
facilitate data transmission between servers, communications infrastructure equipment and storage
systems. Our products are an integral part of a total solution focused on computing, storage and
communication applications used in enterprise data center, high-performance computing and embedded
systems. We operate in one reportable segment: the development, manufacturing, marketing and sales
of interconnect semiconductor products.
We are a fabless semiconductor company that provides high-performance interconnect products
based on semiconductor integrated circuits, or ICs. We design, develop and market adapter and
switch ICs, both of which are silicon devices that provide high performance connectivity. We also
offer adapter cards that incorporate our ICs. Growth in our target markets is being driven by the
need to improve the efficiency and performance of clustered systems, as well as the need to
significantly reduce the total cost of ownership.
It is difficult for us to forecast the demand for our products, in part because of the highly
complex supply chain between us and the end-user markets that incorporate our products. Demand for
new features changes rapidly. Due to our lengthy product development cycle, it is critical for us
to anticipate changes in demand for our various product features and the applications they serve to
allow sufficient time for product design. Our failure to accurately forecast demand can lead to
product shortages that can impede production by our customers and harm our relationships with these
customers. Conversely, our failure to forecast declining demand or shifts in product mix can result
in excess or obsolete inventory.
Revenues. We derive revenues from sales of our ICs and cards. To date, we have derived a
substantial portion of our revenues from a relatively small number of customers. Revenues were
approximately $25.2 million for the three months ended March 31, 2008 compared to approximately
$16.9 million for the three months ended March 31, 2007, representing an increase of 49%. Total
sales to customers representing more than 10% of revenues accounted for 36% and 62% of our total
revenues for the three months ended March 31, 2008 and 2007, respectively. The loss of one or more
of our principal customers or the reduction or deferral of purchases of our products by one of
these customers could cause our revenues to decline materially if we are unable to increase our
revenues from other customers.
Cost of revenues and gross profit. The cost of revenues consists primarily of the cost of
silicon wafers purchased from our foundry supplier, Taiwan Semiconductor Manufacturing Company, or
TSMC, costs associated with the assembly, packaging and production testing of our products by
Advanced Semiconductor Engineering, or ASE, outside processing costs associated with the
manufacture of our HCA cards by Flextronics, royalties due to third parties, including the Office
of the Chief Scientist of Israels Ministry of Industry, Trade and Labor, or the OCS, the
Binational Industrial Research and Development (BIRD) Foundation and a third-party licensor,
warranty costs, excess and obsolete inventory costs and costs
of personnel associated with production management and quality assurance. In addition, after
we purchase wafers from our foundries, we also have the yield risk related with 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 TSMC and ASE. Accordingly, our costs are subject to price fluctuations based on the cyclical
demand for semiconductors.
15
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 and that lead times for
delivery from our HCA card manufacturing subcontractors are approximately eight to ten weeks. We
build inventory based on forecasts of customer orders rather than the actual orders themselves. In
addition, as customers are increasingly seeking opportunities to reduce their lead times, we may be
required to increase our inventory to meet customer demand.
We expect our cost of revenues to increase over time as a result of the expected increase in
our sales volume. Generally, our cost of revenues as a percentage of sales has decreased over time,
primarily due to manufacturing cost reductions and economies of scale related to higher unit
volumes. This trend may not continue in the future, and 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, costs associated with computer aided design software tools, depreciation expense and
tape out costs. Tape out costs are expenses related to the manufacture of new products, including
charges for mask sets, prototype wafers, mask set revisions and testing incurred before releasing
new products. We anticipate these expenses will increase in future periods based on an increase in
personnel to support our product development activities and the introduction of new products. We
anticipate that our research and development expenses may fluctuate over the course of a year based
on the timing of our product tape outs.
We received grants from the OCS for several projects. Under the terms of these grants, if
products developed from an OCS-funded project generate revenue, we are required to pay a royalty of
4-4.5% of the net sales as soon as we begin to sell such products until 120% of the dollar value of
the grant plus interest at LIBOR is repaid. All of the grants we have received from the OCS have
resulted in IC products sold by us. We received no grants from the OCS during the year ended
December 31, 2007 or the three months ended March 31, 2008. In total we have received grants from
OCS in amount of $2.8 million. As of March 31, 2008, our obligation in respect of royalties accrued
and payable to the OCS totaled approximately $261,000. All reported research and development
expenses are net of OCS and other government grants.
The terms of OCS grants generally prohibit the manufacture of products developed with OCS
funding outside of Israel without the prior consent of the OCS. The OCS has approved the
manufacture outside of Israel of our IC products, subject to an undertaking by us to pay the OCS
royalties on the sales of our OCS-supported products until such time as the total royalties paid
equal 120% of the amount of OCS grants.
Under applicable Israeli law, OCS consent is also required to transfer technologies developed
with OCS funding to third parties in Israel. Transfer of OCS-funded technologies outside of Israel
is permitted with the approval of the OCS and in accordance with the restrictions and payment
obligations set forth under Israeli law. Israeli law further specifies that both the transfer of
know-how as well as the transfer of intellectual property rights in such know-how are subject to
the same restrictions. These restrictions do not apply to exports of products from Israel or the
sale of products developed with these technologies.
Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries,
share-based compensation and associated costs for employees engaged in sales, marketing and
customer support,
commission payments to external, third party sales representatives, sales-related legal costs
for contract reviews, and charges for trade shows, promotions and travel. We expect these expenses
will increase in absolute dollars in future periods based on an increase in sales and marketing
personnel and increased commission payments on higher sales volumes.
General and administrative expenses. General and administrative expenses consist primarily of
salaries, share-based compensation and associated costs for employees engaged in finance, human
resources and administrative activities and charges for accounting and corporate legal fees. We
expect these expenses will increase in absolute dollars in future periods based on an increase in
personnel to meet the requirements associated with our anticipated growth and costs associated with
being a public company.
Taxes on Income. Our operations in Israel have been granted Approved Enterprise status by
the Investment Center of the Israeli Ministry of Industry, Trade and Labor, which makes us eligible
for tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959. Under the
terms of the Approved Enterprise program, income that is attributable to our operations in Yokneam,
Israel will be exempt from income tax for a
period of ten years commencing when we first generate
taxable income (after setting off our losses from prior years). Income that is attributable to our
operations in Tel Aviv, Israel will be exempt from income tax for a
16
period of two years commencing
when we first generate taxable income (after setting off our losses from prior years), and will be
subject to a reduced income tax rate (generally 10-25%, depending on the percentage of foreign
investment in our company) for the following five to eight years.
The change in our effective income tax rate in 2008 reflects the impact of releasing the
valuation allowance in Israel as of December 31, 2007. The 32% effective tax rate is the blend of
geographic income in the U.S. and Israel at there respective statutory rates, adjusted for
permanent differences. Management currently expects the Israeli Approved Enterprise Tax Holiday
will begin in 2009 and our effective tax rate will be materially reduced as a result.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with generally accepted
accounting principles. 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 estimates are based on historical experience and various other assumptions that we believe to
be reasonable under the circumstances. Our actual results could differ from these estimates.
We believe that the assumptions and estimates associated with revenue recognition, allowance
for doubtful accounts, inventory valuation, warranty provision, income taxes and share-based
compensation 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 of the accompanying
notes to our consolidated financial statements.
See our Annual Report on Form 10-K for the year ended December 31, 2007, filed with the
Securities and Exchange Commission, or the SEC, on March 24, 2008, for a discussion of additional
critical accounting policies and estimates. We believe there have been no significant changes in
our critical accounting policies as compared to what was previously disclosed in the Form 10-K for
the year ended December 31, 2007.
Results of Operations
The following table sets forth our consolidated statements of operations as a percentage of
revenues for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
Total Revenues |
|
|
100 |
% |
|
|
100 |
% |
Cost of revenues |
|
|
(24 |
) |
|
|
(25 |
) |
|
|
|
|
|
|
|
Gross profit |
|
|
76 |
|
|
|
75 |
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
Research and development |
|
|
33 |
|
|
|
35 |
|
Sales and marketing |
|
|
13 |
|
|
|
17 |
|
General and administrative |
|
|
7 |
|
|
|
8 |
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
53 |
|
|
|
60 |
|
|
|
|
|
|
|
|
Income from operations |
|
|
23 |
|
|
|
15 |
|
Other income, net |
|
|
4 |
|
|
|
5 |
|
Provision for taxes on income |
|
|
(9 |
) |
|
|
(1 |
) |
|
|
|
|
|
|
|
Net income |
|
|
18 |
% |
|
|
19 |
% |
|
|
|
|
|
|
|
Comparison of the Three Months Ended March 31, 2008 to the Three Months Ended March 31, 2007
Revenues. Revenues were approximately $25.2 million for the three months ended March 31, 2008
compared to approximately $16.9 million for the three months ended March 31, 2007, representing an
increase of 49%. This increase in revenues resulted from increased unit sales of approximately 26%
in addition to an increase in average sales prices of 19% primarily due do product mix changes. The
increase in unit sales was primarily due to increased purchases by Hewlett-Packard, IBM and QLogic,
each of which accounted for 12%, of our revenues for the three months ended March 31, 2008 and
increased purchases by Super Micro Computer, Dell and Network Appliance, each of which accounted
for less than 10%, of our revenue for the three months ended March 31, 2008. These increases in
unit sales were partially offset partially by reduced purchases by Cisco. Current quarter revenues
are not necessarily indicative of the results to be anticipated for the entire year ending December
31, 2008 or thereafter.
17
Gross Profit and Margin. Gross profit was approximately $19.2 million for the three months
ended March 31, 2008 compared to $12.6 million for the three months ended March 31, 2007,
representing an increase of 53%. As a percentage of revenues, gross margin increased to 76% in the
three months ended March 31, 2008 from 75% in the three months ended March 31, 2007. This increase
in gross margin was primarily due to a reduction in production costs associated with outsourced
labor, raw materials and volume discounts, and conclusion of our OCS obligation, partially offset
by higher warranty and inventory costs. In addition, part of the gross margin improvement was due
to increased sales of next generation double-data rate (DDR) products for which we receive higher
margins. Revenues attributable to DDR products were 84% and 45% of total revenues for the three
months ended March 31, 2008 and 2007, respectively. This trend may or may not continue in the near
term.
Research and Development. Research and development expenses were approximately $8.3 million in
the three months ended March 31, 2008 compared to approximately $5.9 million in the three months
ended March 31, 2007, representing an increase of 39%. The increase consisted of approximately $1.9
million in higher employee related expenses associated with increased headcount, an increase in
share based compensation of $912,000 primarily due to new option grants, higher depreciation and
amortization expenses of approximately $387,000 related to purchases of equipment and technology
licenses, offset by a decrease in new product expenses of $1.1 million. We expect that research and
development expense will increase in absolute dollars in future periods as we continue to devote
resources to develop new products, meet the changing requirements of our customers, expand into new
markets and technologies, and hire additional personnel.
For a further discussion of share-based compensation included in research and development
expense, see Share-based compensation expense below.
Sales and Marketing. Sales and marketing expenses were approximately $3.4 million for the
three months ended March 31, 2008 compared to approximately $2.8 million for the three months ended
March 31, 2007, representing an approximate increase of 20%. The increase was primarily
attributable to higher employee related expenses of $226,000 associated with increased headcount,
an increase in share based
compensation of $167,000 primarily due to new option grants, an increase in external sales
commissions of $145,000 due to increase in sales, offset by a decrease in expensed equipment of
$135,000.
For a further discussion of share-based compensation included in sales and marketing expense,
see Share-based compensation expense below.
General and Administrative. General and administrative expenses were approximately $1.8
million for the three months ended March 31, 2008 compared to approximately $1.4 million for the
three months ended March 31, 2007, representing an increase of 35%. The increase was primarily due
to increase in employee related expenses of $179,000 associated with increased headcount, higher
share based compensation of $164,000 due to new option grants, and an increase in other
professional services of $126,000 associated primarily with consulting fees.
Share-based compensation expense. The following table presents details of total share-based
compensation expense that is included in each functional line item in our consolidated statements
of operations:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2008 |
|
|
2007 |
|
|
|
(In thousands) |
|
Cost of goods sold |
|
$ |
48 |
|
|
$ |
15 |
|
Research and development |
|
|
1,187 |
|
|
|
275 |
|
Sales and marketing |
|
|
378 |
|
|
|
211 |
|
General and administrative |
|
|
261 |
|
|
|
97 |
|
|
|
|
|
|
|
|
Total |
|
$ |
1,874 |
|
|
$ |
598 |
|
|
|
|
|
|
|
|
At March 31, 2008, there was $24.1 million of total unrecognized share-based compensation
costs related to non-vested share-based compensation arrangements. The costs are expected to be
recognized over a weighted average period of 3.08 years.
Other Income, net. Other income, net consists of interest earned on cash and cash equivalents
and short-term investments, and foreign currency exchange gains and losses. Other income, net was
approximately $1,043,000 for the three months ended March 31, 2008 compared to approximately
$957,000 for the three months ended March 31, 2007. The increase consisted of approximately
$450,000 of higher interest income associated with higher average invested cash balances during the
three months ended March 31,
18
2008 compared to the three months ended March 31, 2007, partially
offset by higher foreign currency exchange losses of approximately $300,000.
Provision for Taxes on Income. Provision for taxes on income was approximately $2.2 million
for the three months ended March 31, 2008 compared to approximately $164,000 for the three months
ended March 31, 2007. The increase in the effective tax rate was primarily a result of reversing the Israeli valuation
allowance as of December 31, 2007 and realizing certain deferred tax assets related to net
operating losses in Israel expected to be utilized before the Approved Enterprise Tax Holiday is
expected to begin in 2009.
Liquidity and Capital Resources
Since our inception until our initial public offering in February 2007, we financed our
operations primarily through private placements of our convertible preferred shares totaling
approximately $89.3 million. We incurred net losses from operations since inception until the
second quarter of 2005. On February 13, 2007, we closed the initial public offering of our ordinary
shares. We sold 6,900,000 ordinary shares in the offering, which number of shares included the
underwriters exercise in full of their option to purchase up to 900,000 shares to cover
over-allotments, at an offering price of $17.00 per share. Net proceeds generated by the offering,
after adjusting for offering costs, totaled approximately $106 million.
As of March 31, 2008, our principal source of liquidity consisted of cash and cash equivalents
of approximately $61.5 million and short-term investments of approximately $93.2 million. We
currently anticipate that our current cash and cash equivalents and short-term investments and our
cash flows from
operating activities will be sufficient to fund our operations over the next 12 months after
taking into account potential business and technology acquisitions, if any, and expected increases
in research and development expenses, including tape out costs, sales and marketing expenses,
general and administrative expenses, primarily for increased headcount, and capital expenditures to
support our infrastructure and growth.
Operating Activities
Net cash generated by our operating activities amounted to approximately $3.3 million in the
three months ended March 31, 2008. Net cash generated by operating activities was primarily
attributable to net income of approximately $4.6 million adjusted for non-cash items of
approximately $2.1 million for the realization of deferred taxes, $1.9 million for share-based
compensation and $0.8 million for depreciation and amortization, partially offset by gains on
investments of $0.8 million. Furthermore, net cash generated by operating activities was reduced by
a decrease of approximately $2.0 million in accounts payable, an increase in accounts receivables,
net of approximately $1.5 million due to an increase in the percentage of sales shipped later in
the quarter and a decrease of approximately $1.3 million in accrued liabilities primarily
associated with payroll.
Net cash generated by our operating activities amounted to approximately $6.7 million in the
three months ended March 31, 2007. Net cash generated by operating activities was primarily
attributable to net income of approximately $3.3 million, a decrease in accounts receivable, net of
approximately $1.6 million due a higher percentage of sales shipped earlier in the quarter, and a
decrease in prepaid expenses and other assets of approximately $1.4 million due to the
reclassification of deferred equity offering costs against the proceeds of our initial public
offering.
Investing Activities
Net cash used in investment activities amounted to approximately $42.6 million in the three
months ended March 31, 2008, and approximately $0.6 million in the three months ended March 31,
2007. Net cash used in investment activities was primarily attributable to purchases of short term
investments of $73.5 million, an investment in preferred stock of a privately-held company of $1.5
million, partially offset by the maturities and sales of short term investments of $33.5 million.
Financing Activities
Our financing activities generated approximately $140,000 in the three months ended March 31,
2008, primarily due to proceeds from stock option exercises of $1.1 million offset by principal
payments on capital lease obligations of $946,000. Financing activities generated approximately
$106 million in the three months ended March 31, 2007, primarily due to proceeds from our initial
public offering.
19
Contractual Obligations
The following table summarizes our contractual obligations at March 31, 2008, and the effect
those obligations are expected to have on our liquidity and cash flows in future periods:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
|
Less Than |
|
|
|
|
|
|
Beyond |
|
|
|
Total |
|
|
1 Year |
|
|
1-3 Years |
|
|
3 Years |
|
|
|
(In thousands) |
|
Commitments under capital lease |
|
$ |
2,417 |
|
|
$ |
1,075 |
|
|
$ |
947 |
|
|
$ |
395 |
|
Non-cancelable operating lease commitments |
|
|
2,895 |
|
|
|
1,168 |
|
|
|
1,541 |
|
|
|
186 |
|
Purchase commitments |
|
|
5,648 |
|
|
|
5,401 |
|
|
|
172 |
|
|
|
75 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
10,960 |
|
|
$ |
7,644 |
|
|
$ |
2,660 |
|
|
$ |
656 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For purposes of this table, purchase obligations for the purchase of goods or services are
defined as agreements that are enforceable and legally binding and that specify all significant
terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price
provisions; and the approximate timing of the transaction. Our purchase orders are based on our
current manufacturing needs and are fulfilled by our vendors within short time horizons. In
addition, we have purchase orders that represent authorizations to purchase rather than binding
agreements. We do not have significant agreements for the purchase of raw materials or other goods
specifying minimum quantities or set prices that exceed our expected requirements.
Recent Accounting Standards
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair
Value Measurements, or SFAS No. 157, which defines fair value, establishes a framework for
measuring fair value under generally accepted accounting principles and expands disclosures about
fair value measurements. SFAS No. 157 does not require any new fair value measurements, but
provides guidance on how to measure fair value by providing a fair value hierarchy used to classify
the source of the information. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2,
Effective Date of FASB Statement No. 157, which provides a one year deferral of the effective
date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value on a recurring basis. We adopted
SFAS 157 as of January 1, 2008, with the exception of the application of the statement to
non-recurring non-financial assets and non-financial liabilities. The adoption of this statement
did not have a material impact on the Companys consolidated results of operations and financial
condition. Refer to Note 3 to the Condensed Consolidated Financial Statements for additional
discussion on fair value measurements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities including an amendment of FASB Statement No. 115, (SFAS 159) which is
effective for fiscal years beginning after November 15, 2007. This statement permits entities to
choose to measure many financial instruments and certain other items at fair value. This statement
also establishes presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types of assets and
liabilities. Unrealized gains and losses on items for which the fair value option is elected would
be reported in earnings. We have adopted SFAS 159 and have elected not to measure any additional
financial instruments and other items at fair value.
In June 2007, the FASB ratified EITF No. 07-3, or EITF 07-3, Accounting for Nonrefundable
Advance Payments for Goods or Services to Be Used in Future Research and Development Activities.
EITF 07-3 requires non-refundable advance payments for goods and services to be used in future
research and development activities to be recorded as an asset and the payments to be expensed when
the research and development activities are performed. EITF 07-3 is effective for us on January 1,
2008. The adoption of this standard did not have a material effect on the Companys financial
statements.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 161). This statement is intended
to improve transparency in financial reporting by requiring enhanced disclosures of an entitys
derivative instruments and hedging activities and their effects on the entitys financial position,
financial performance, and cash flows. SFAS 161 applies to all derivative instruments within the
scope of SFAS 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133) as
well as related hedged items, bifurcated derivatives, and non-derivative instruments that are
designated and qualify as hedging instruments. Entities with instruments subject to SFAS 161 must
provide more robust qualitative disclosures and expanded quantitative disclosures. SFAS 161 is
effective prospectively for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008, with early application permitted. We are currently evaluating
the disclosure implications of this statement.
20
ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The recent decline in the market value of certain securities backed by residential mortgage
loans has led to a large liquidity crisis effecting the broader U.S. housing market, the financial
services industry and global financial markets. Investors in many industry sectors have experienced
substantial decreases in asset valuations and uncertain market liquidity. Furthermore, credit
rating authorities have, in many cases, been slow to respond to the rapid changes in the underlying
value of certain securities and pervasive market illiquidity, regarding these securities.
As a result, this credit crisis may have a potential impact on the determination of the fair
value of financial instruments or may result in impairments in the future should the value of
certain investments suffer a decline which is determined to be other than temporary. We do not
currently believe that the impact of this credit crisis on the value of our marketable securities
would be material or warrant a determination of other than a temporary write down.
Interest rate fluctuation risk
We do not have any long-term borrowings. Our investments consist of cash and cash equivalents,
short-term deposits and interest bearing investments in marketable securities with maturities of
one year or less, consisting of commercial paper, government and non-government debt securities.
The primary objective of our investment activities is to preserve principal while maximizing income
without significantly increasing risk. We do not enter into investments for trading or speculative
purposes. Our investments are exposed to market risk due to a fluctuation in interest rates, which
may affect our interest income and the fair market value of our investments. Due to the short term
nature of our investment portfolio, we do not believe an immediate 5% change in interest rates
would have a material effect on the fair market value of our portfolio, and therefore we do not
expect our operating results or cash flows to be materially affected to any degree by a sudden
change in market interest rates.
Foreign currency exchange risk
We derive all of our revenues in U.S. dollars. The U.S. dollar is our functional and reporting
currency. However, a significant portion of our headcount related expenses, consisting principally
of salaries and related personnel expenses, are denominated in new Israeli shekels, or NIS. This
foreign currency exposure gives rise to market risk associated with exchange rate movements of the
U.S. dollar against the NIS. Furthermore, we anticipate that a material portion of our expenses
will continue to be denominated in NIS. To the extent the U.S. dollar weakens against the NIS, we
will experience a negative impact on our profit margins. To manage this risk, we have on occasion
converted U.S. dollars into NIS within two to three weeks of monthly pay dates in Israel to lock in
the related salary expense given the different currencies. We do not currently engage in currency
hedging activities but we may choose to do so in the future. These measures, however, may not
adequately protect us from material adverse effects due to the impact of inflation in Israel. At
March 31, 2008, approximately $1.7 million of our monthly operating expenses were denominated in
NIS. This amount may increase in the future due to hiring additional employees in Israel and
expanding our facilities there.
Inflation related risk
We believe that the rate of inflation in Israel has not had a material impact on our business
to date. Our cost in Israel in U.S. dollar terms will 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.
ITEM 4 CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that information
required to be disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange Commissions rules and
forms and that such information is accumulated and communicated to our management, including our
chief executive officer and chief financial officer, as appropriate, to allow for timely decisions
regarding required disclosure. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.
As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and
with the participation of our management, including our chief executive officer and chief financial
officer, of the effectiveness of the design and operation of our disclosure controls and procedures
as of the end of the period covered by this quarterly report on Form 10-Q. Based on the foregoing,
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our chief executive officer and chief financial officer concluded that our disclosure controls
and procedures were effective at the reasonable assurance level.
There has been no change in our internal control over financial reporting during our most
recent quarter that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
We provided a management report on internal control over financial reporting, in connection with
our Annual Report on Form 10-K for the year ending December 31, 2007. In addition, we will be
required to provide both a management report and an independent registered public accounting firm
attestation report on internal control over financial reporting in connection with our Annual
Report on Form 10-K for the year ending December 31, 2008.
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
We are not currently party to any material legal proceedings.
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 or operating results, as well as decrease the value of an investment in our ordinary
shares.
Risks Related to Our Business
We have a history of losses, have only recently become profitable and may not sustain or increase
profitability in the future.
We have only recently become profitable, and we first recorded a profit in the year ended
December 31, 2005. We incurred net losses prior to the quarter ended June 30, 2005 and incurred a
net loss during the quarter ended March 31, 2006. Although we recorded a profit in the three months
ended March 31, 2008, we had an accumulated deficit as of March 31, 2008 of approximately $29.0
million. We may not be able to sustain or increase profitability on a quarterly or an annual basis.
This may, in turn, cause the price of our ordinary shares to decline. To sustain or increase our
profitability, we will need to generate and sustain substantially higher revenues while maintaining
reasonable cost and expense levels. We expect to increase expense levels in each of the next
several quarters to support increased research and development, sales and marketing and general and
administrative efforts. These expenditures may not result in increased revenues or customer growth,
and we may not remain profitable.
We do not expect to sustain our recent revenue growth rate, which may reduce our share price.
Our revenues have grown rapidly over the last four years, approximately doubling in size from
each of 2003 to 2004 and 2005, and increasing by 15% and 73% in 2006 and 2007, respectively. Our
revenues increased from $10.2 million to $20.3 million to $42.1 million to $48.5 million and to
$84.1 million for the years ended December 31, 2003, 2004, 2005, 2006 and 2007, respectively. We do
not expect to sustain our recent growth rate in future periods. You should not rely on the revenue
growth of any prior quarterly or annual periods as an indication of our future performance. If we
are unable to maintain adequate revenue growth, we may not have adequate resources to execute our
business objectives and our share price may decline.
InfiniBand may not be adopted at the rate or extent that we anticipate, and adoption of InfiniBand
is largely dependent on third-party vendors and end users.
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 information technology, or 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 integrated circuits, or
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 impacted by the general
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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 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 have limited visibility into end-user demand for our products, which introduces uncertainty
into our 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 business is 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 demands. 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-budget company 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.
We depend on a small number of customers for a significant portion of our sales, and the loss of
any of these customers will adversely affect our revenues.
A small number of customers account for a significant portion of our revenues. For the three
months ended March 31, 2008, sales to Hewlett-Packard, IBM and QLogic Corporation accounted for
12%, each, of our total revenues. For the year ended December 31, 2007, sales to Hewlett-Packard
accounted for 19% of our total revenues, sales to Voltaire accounted for 15% of our total revenues,
and sales to Cisco Systems and QLogic Corporation accounted for 11%, each, of our total revenues.
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 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.
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 declining average selling
prices. We may not be able to compete successfully against current or potential competitors. With
respect to InfiniBand products, we compete with QLogic Corporation, which acquired SilverStorm
Technologies in October 2006. We also compete with providers of alternative technologies, including
Ethernet, Fibre Channel and proprietary interconnects. The companies that provide IC products for
these alternative technologies include Marvell Technology Group, Broadcom Corporation, Emulex
Corporation, QLogic Corporation and Myricom. 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 than we are able to respond 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.
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 next generation products, and we need to successfully design our next generation and other
products successfully for 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. For
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example, we recently introduced our next generation of products that also support the industry
standard Ethernet interconnect specification.
There is a risk that these developments or enhancements, such as migrating our next generation
products from 130nm to 90nm technology, will be late, fail to meet customer or market
specifications and will not be competitive with other products using alternative technologies that
offer comparable performance and functionality. We may be unable to successfully develop additional
next generation products, new products or product enhancements. Our next generation products that
include Ethernet support or any new products or product enhancements may not be accepted in new or
existing markets. Our business will suffer if we fail to continue 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 our products, and we must rely on third-party
subcontractors to perform these services. We currently rely on Taiwan Semiconductor Manufacturing
Company, or TSMC, to produce our silicon wafers, and Flextronics International Ltd. to manufacture
and production test our adapter cards. We also rely on Advanced Semiconductor Engineering, or ASE,
to assemble, package and production test our ICs. 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.
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:
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reduced control over product cost, delivery schedules and product quality; |
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potential price increases; |
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inability to achieve sufficient production, increase production or test capacity and
achieve acceptable yields on a timely basis; |
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increased exposure to potential misappropriation of our intellectual property; |
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shortages of materials used to manufacture products; |
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capacity shortages; |
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labor shortages or labor strikes; |
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political instability in the regions where these subcontractors are located; and |
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natural disasters impacting these subcontractors. |
Our sales cycle can be lengthy, which could result in uncertainty and delays in generating
revenues.
We have occasionally experienced a lengthy sales cycle for some of our products, due in part
to the constantly evolving nature of the technologies on which our products are based. Some of our
products must be custom designed to operate in our customers
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products, resulting in a lengthy process between the initial design stage and the ultimate
sale. We also compete for design wins prior to selling products, which may increase the length of
the sales process. We may experience a delay between the time we increase expenditures for research
and development, sales and marketing efforts and inventory and the time we generate revenues, if
any, from these expenditures. In addition, because we do not have long-term supply contracts with
our customers and the majority of our sales are on a purchase order basis, we must repeat our sales
process on a continual basis, including sales of new products to existing customers. As a result,
our business could be harmed if a customer reduces or delays its orders.
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. This 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 margin.
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:
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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; |
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our customers sales outlooks, purchasing patterns and inventory levels based on end-user
demands and general economic conditions; |
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seasonal buying trends; |
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the timing of new product announcements or introductions by us or by our competitors; |
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our ability to successfully develop, introduce and sell new or enhanced products in a
timely manner; |
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product obsolescence and our ability to manage product transitions; |
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changes in the relative sales mix of our products; |
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decreases in the overall average selling prices of our products; |
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changes in our cost of finished goods; and |
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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
is 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 likely would not
proportionately be able to reduce our operating expenses.
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We rely on our ecosystem partners to enhance our product offerings and our inability to continue
to develop or maintain such relationships in the future would harm our ability to remain
competitive.
We have developed relationships with third parties, which we refer to as ecosystem partners,
which provide operating systems, tool support, reference designs and other services designed for
specific uses of our products. We believe that these relationships enhance our customers ability
to get their products to market quickly. If we are unable to continue to develop or maintain these
relationships, we might not be able to enhance our customers ability to commercialize their
products in a timely manner and our ability to remain competitive would be harmed.
We rely primarily upon trade secret, patent 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 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:
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people may not be deterred from misappropriating our technologies despite the existence
of laws or contracts prohibiting it; |
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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 |
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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. As of March 31, 2008, we had
15 issued patents and 21 patent applications pending in the United States, 5 issued patents in
Taiwan and 6 applications pending in Israel, each of which covers aspects of the technology in our
products. Patents that we currently own do not cover all of the products that we presently sell.
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. Even in the event that these patents
are not issued, the applications may become publicly available and proprietary information
disclosed in the applications will become available to others. In addition, any issued patents may
be challenged, invalidated or declared unenforceable. The term of any issued patent in the United
States would be 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. In addition, given the costs of obtaining patent protection, we may choose
not to protect certain innovations that later turn out to be important.
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. We have indemnification obligations with most of our customers with
respect to infringement of third-party patents and intellectual property rights by our products. If
litigation were to be filed against these customers in connection with our technology, we may be
required to defend and indemnify such customers.
Questions of infringement in the markets we serve involve highly technical and subjective
analyses. Although we have not been involved in intellectual property litigation to date,
litigation may be necessary in the future to enforce any patents we may receive and
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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, 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.
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 markets perception of
us. Competition for qualified engineers in the markets in which we operate, primarily in Israel
where our engineering operations are based, 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 Eyal Waldman, our president and chief executive
officer. We do not have long-term employment contracts with Mr. Waldman or any other key personnel,
and their knowledge of our business and industry would be extremely difficult to replace.
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 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, as well as increases in our sales and marketing and general and administrative
efforts. To successfully manage our growth and handle the responsibilities of being a public
company, we believe we must effectively:
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continue to enhance our customer relationship and supply chain management and supporting
systems; |
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implement additional and improve existing administrative, financial and operations
systems, procedures and controls; |
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expand and upgrade our technological capabilities; |
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manage multiple relationships with our customers, distributors, suppliers, end users and
other third parties; |
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manage the mix of our U.S., Israeli and other foreign operations; and |
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hire, train, integrate and manage additional qualified engineers for research and
development activities, sales and marketing personnel and financial and IT personnel. |
Our efforts 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.
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, delay our product shipments and prevent us from recognizing the benefits of new
technologies we develop.
Although we test our products, they are complex and may contain defects and errors. In the
past we have encountered defects and errors in our products. 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. In addition, product defects and errors could result
in additional development costs, diversion of technical resources, delayed product shipments,
increased product returns, warranty expenses and product liability claims against us which may not
be fully covered by insurance. Any of these could harm our business.
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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 third parties to manufacture our products and currently rely on one
manufacturer for our ICs and one manufacturer for our cards. Our ability to offer new products
depends on our manufacturers ability to implement our revised product specifications, which is
costly, time-consuming and complex.
If we fail to maintain an effective system of internal controls, we may not be able to report
accurately our financial results or prevent 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 fraud. We have in the past discovered, and may in the future discover, areas of
our internal controls that need improvement. In addition, Section 404 of the Sarbanes-Oxley Act of
2002, or Sarbanes-Oxley, requires us to evaluate and report on our internal control over financial
reporting and have our independent registered public accounting firm annually attest to our
internal control over financial reporting. The Section 404 internal control reporting requirements
will be implemented according to the regulatory phase-in schedule of the Securities and Exchange
Commission. The SEC recently adopted rules to delay the implementation of Section 404 compliance
for new public companies. Under the SECs new rules, we provided a management report on internal
control over financial reporting for the first time in connection with our Annual Report on Form
10-K for the year ending December 31, 2007 filed with SEC on March 24, 2008. As required by the
Section 404, we will provide both a management report and an independent registered public
accounting firm attestation report on internal controls over financial reporting in connection with
our Annual Report on Form 10-K for the year ending December 31, 2008. The continuous process of
strengthening our internal controls over financial reporting and complying with Section 404 is
expensive and time-consuming and requires significant management attention. We cannot be certain
that these measures will ensure that we will maintain adequate control over our financial processes
and reporting. Furthermore, as we grow our business, our internal controls will become more complex
and will require significantly more resources to ensure our internal controls remain effective
overall. Failure to implement new or improved controls, or difficulties encountered in their
implementation, could harm our operating results or cause us to fail to meet our reporting
obligations. If we or our independent registered public accounting firm identify a material
weakness, the disclosure of that fact, even if quickly remedied, could reduce the markets
confidence in our financial statements and harm our share price. In addition, future non-compliance
with Section 404 could subject us to a variety of administrative sanctions, including the
suspension or delisting of our ordinary shares from The NASDAQ Global Market, which could reduce
our share price.
We may pursue acquisitions or investments in complementary products, technologies and businesses,
which could harm our operating results and may disrupt our business.
In the future, we may pursue acquisitions of, or investments in, complementary products,
technologies and businesses. Acquisitions present a number of potential risks and challenges that
could, if not met, disrupt our business operations, increase our operating costs and reduce the
value to us of the acquisition. For example, if we identify an acquisition candidate, we may not be
able to successfully negotiate or finance the acquisition on favorable terms. Even if we are
successful, we may not be able to integrate the acquired businesses, products or technologies into
our existing business and products. Furthermore, potential acquisitions and investments, whether or
not consummated, may divert our managements attention and 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.
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 with generally accepted accounting principles,
or GAAP, in the United States. These accounting principles are subject to interpretation by the
Financial Accounting Standards Board, or FASB, 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. For example, accounting policies
affecting many aspects of our business, including rules relating to employee share option grants,
have recently been revised. The FASB and other standard setters have made changes to GAAP that
required us, as of our first quarter of 2006, to record a charge to earnings for the estimated fair
value of employee share option grants and other equity incentives, whereas under previous
accounting rules charges were required only for the intrinsic value, if any, of such awards to
employees. We may have significant and ongoing accounting charges under the new rules resulting
from option grants and other equity incentive expensing that could reduce our net income. In
addition, since historically we have used equity-related compensation as a component of our total
28
employee compensation program, the accounting change could make the use of equity-related
compensation less attractive to us and therefore make it more difficult for us to attract and
retain employees.
Our business is subject to the risks of earthquakes, fires, floods and other natural catastrophic
events, and to interruption by manmade problems such as computer viruses or terrorism.
Our U.S. corporate offices are located in the San Francisco Bay Area, a region known for
seismic activity. A significant natural disaster, such as an earthquake, fire or flood, could have
a material adverse impact on our business, operating results and financial condition. In addition,
our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized
tampering with our computer systems. In addition, acts of terrorism could cause disruptions in our
or our customers businesses or the economy as a whole. To the extent that such disruptions result
in delays or cancellations of customer orders, or the deployment of our products, our business,
operating results and financial condition would be adversely affected.
Risks Related to Our Industry
Due to the cyclical nature of the semiconductor industry, our operating results may fluctuate
significantly, which could adversely affect the market price of our ordinary shares.
The semiconductor industry is highly cyclical and subject to rapid change and evolving
industry standards and, from time to time, has experienced significant downturns. These downturns
are characterized by decreases in product demand, excess customer inventories and accelerated
erosion of prices. These factors could cause substantial fluctuations in our net revenues and in
our operating results. Any downturns in the semiconductor industry may be severe and prolonged, and
any failure of this industry to fully recover from downturns could harm our business. The
semiconductor industry also periodically experiences increased demand and production capacity
constraints, which may affect our ability to ship products. Accordingly, our operating results may
vary significantly as a result of the general conditions in the industry, which could cause our
share price to decline.
The demand for semiconductors is affected by general economic conditions, which could impact our
business.
The semiconductor industry is affected by general economic conditions, and a downturn may
result in decreased demand for our products and adversely affect our operating results. Our
business has been adversely affected by previous economic downturns. For example, during the global
economic downturn in 2002 to 2003, demand for many computer and consumer electronics products
suffered as consumers delayed purchasing decisions or changed or reduced their discretionary
spending. As a result, demand for our products suffered and we had to implement restructuring
initiatives to align our corporate spending with a slower than anticipated revenue growth during
that timeframe.
The semiconductor industry is highly competitive, and we cannot assure you that we will be able to
compete successfully against our competitors.
The semiconductor industry is highly competitive. Increased competition may result in price
pressure, reduced profitability and loss of market share, any of which could seriously harm our
revenues and results of operations. Competition principally occurs at the design stage, where a
customer evaluates alternative design solutions. We continually face intense competition from
semiconductor interconnect solutions companies. Some of our competitors have greater financial and
other resources than we have with which to pursue engineering, manufacturing, marketing and
distribution of their products. As a result, they may be able to respond more quickly to changing
customer demands or devote greater resources to the development, promotion and sales of their
products than we can. We cannot assure you that we will be able to increase or maintain our
revenues and market share, or compete successfully against our current or future competitors in the
semiconductor industry.
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 and corporate and sales support operations and, as of March 31,
2008, 191 full-time and 39 part-time employees located in Israel. A significant amount of our
assets is 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. During the summer of 2006, Israel was engaged in an armed conflict with Hezbollah, a
Lebanese Islamist Shiite militia group and political party. This conflict involved missile strikes
against civilian targets in northern Israel, and negatively affected business conditions in Israel.
In addition,
29
Israel and companies doing business with Israel have, in the past, been the subject of an
economic boycott. Although Israel has entered into various agreements with Egypt, Jordan and the
Palestinian Authority, Israel has been and is subject to civil unrest and terrorist activity, with
varying levels of severity, since September 2000. The election in early 2006 of representatives of
the Hamas movement to a majority of seats in the Palestinian Legislative Council and the tension
among the different Palestinian factions may create additional unrest and uncertainty. 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.
We can give no assurance that security and political conditions will have no 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. While we did not sustain damages from the recent
conflict with Hezbollah referred to above, our Israeli operations, which are located in northern
Israel, are within range of Hezbollah 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 could have a material adverse effect on our business.
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 officers, directors
and employees, are obligated to perform military reserve duty 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 recently some of our employees, including those in key
positions, have been called up 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 negative economic conditions or labor unrest in Israel.
Due to significant economic measures adopted by the Israeli government, there were several
general strikes and work stoppages in Israel in 2003 and 2004, 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 derived42% and 45% of our revenues in the three months ended March 31, 2008 and 2007,
respectively, from sales outside North America. As a result, we face additional risks from doing
business internationally, including:
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reduced protection of intellectual property rights in some countries; |
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licenses, tariffs and other trade barriers; |
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difficulties in staffing and managing foreign operations; |
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longer sales and payment cycles; |
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greater difficulties in collecting accounts receivable; |
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seasonal reductions in business activity; |
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potentially adverse tax consequences; |
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laws and business practices favoring local competition; |
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costs and difficulties of customizing products for foreign countries; |
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compliance with a wide variety of complex foreign laws and treaties; |
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tariffs, trade barriers, transit restrictions and other regulatory or contractual
limitations on our ability to sell or develop our products in certain foreign markets; |
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fluctuations in freight rates and transportation disruptions; |
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political and economic instability; and |
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variance and unexpected changes in local 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 these challenges
in our international operations, we could experience slower than expected revenue growth and our
business could be harmed.
It may be difficult to enforce a U.S. judgment against us, our officers and directors and some of
the experts named in the prospectus relating to the initial public offering of our ordinary shares
or to assert U.S. securities law claims in Israel.
We are incorporated in Israel. Four of our executive officers and one of our directors, who is
also an executive officer, and some of our accountants and attorneys are non-residents of the
United States and are located in Israel, and substantially all of our assets and the assets of
these persons are located outside the United States. Three of our executive officers and five of
our directors are located in the United States. Therefore, it may be difficult to enforce a
judgment obtained in the United States against us or any of these persons in U.S. or Israeli courts
based on the civil liability provisions of the U.S. federal securities laws.
In addition, we have been informed by our legal counsel in Israel, Yigal Arnon & Co., that 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. In addition, even if an Israeli court agrees to hear a claim, it may determine that Israeli
law, and not U.S. law, is applicable to the claim. If U.S. law is found to be applicable, the
content of applicable U.S. law must be proved in court as a fact, which can be a time-consuming and
costly process. Certain matters of procedure will also be governed by Israeli law. There is little
binding case law in Israel addressing the matters described above.
Provisions of Israeli law may delay, prevent or make difficult an acquisition of us, which could
prevent a change of control and therefore depress the price of our shares.
Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares
above specified thresholds, requires special approvals for transactions involving directors,
officers or significant shareholders and regulates other matters that may be relevant to these
types of transactions. For example, a merger may not be completed unless at least 50 days have
passed from the date that a merger proposal was filed by each merging company with the Israel
Registrar of Companies and at least 30 days from the date that the shareholders of both merging
companies approved the merger. In addition, the approval of a majority of each class of securities
of the target company is required to approve a merger. Israeli corporate law further requires that
any person who wishes to acquire more than a specified percentage of the companys share capital
complies with certain tender offer procedures. In addition, Israeli corporate 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 articles of association, which requires the
prior approval of the holders of a majority of our shares at a general meeting.
31
These provisions could delay, prevent or impede an acquisition of us, even if such an
acquisition would be considered beneficial by some of our shareholders. See Risk Factors
Provisions of Israeli law 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 for a further discussion of this risk factor.
Exchange rate fluctuations between the U.S. dollar and the NIS may negatively affect our earnings.
Although all of our revenues and a majority of our expenses are denominated in U.S. dollars, a
significant portion of our research and development expenses are incurred in new Israeli shekels,
or NIS. As a result, we are exposed to risk to the extent that the inflation rate in Israel exceeds
the rate of devaluation of the NIS in relation to the U.S. dollar or if the timing of these
devaluations lags behind inflation in Israel. In that event, the U.S. dollar cost of our research
and development operations in Israel will increase and our U.S. dollar-measured results of
operations will be adversely affected. To the extent that the value of the NIS increases against
the U.S. dollar, our expenses on a U.S. dollar cost basis increase. We cannot predict any future
trends in the rate of inflation in Israel or the rate of devaluation of the NIS against the U.S.
dollar. The Israeli rate of inflation (deflation) amounted to 2.4%, (0.1)% and 3.4% for the years
ended December 31, 2005, 2006 and 2007, respectively. The increase in value of the NIS against the
U.S. dollar amounted to 8.2% and 8.9% in the years ended December 31, 2006 and 2007, respectively.
In three months ended March 31, 2007 and 2008 the increase in value of the NIS against the U.S.
dollar amounted to 1.7% and 7.6%, respectively. If the U.S. dollar cost of our research and
development operations 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 guard
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 collection of receivables more difficult. We do
not currently engage in currency hedging activities but we may choose to do so in the future. These
measures, however, may not adequately protect us from material adverse effects due to the impact of
inflation in Israel and changes in value of NIS against the U.S. dollar.
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.
Some of our operations in Israel have been granted Approved Enterprise status by the
Investment Center in the Israeli Ministry of Industry Trade and Labor, which makes us eligible for
tax benefits under the Israeli Law for Encouragement of Capital Investments, 1959. 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 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 interest and penalties thereon. The tax benefits that our current Approved 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.
The Israeli government grants that we received require us to meet several conditions, and may be
reduced or eliminated due to government budget cut, 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, and may receive in the future, grants from the government of Israel through
the Office of the Chief Scientist of Israels Ministry of Industry, Trade and Labor, or the OCS,
for the financing of a portion of our research and development expenditures in Israel. When
know-how or products are developed using OCS grants, the terms of these grants restrict the
transfer of the know-how out of Israel. Transfer of know-how abroad is subject to various
conditions, including payment of a percentage of the consideration paid to us or our shareholders
in the transaction in which the technology is transferred. In addition, any decrease of the
percentage of manufacturing performed locally, as originally declared in the application to the
OCS, may require us to notify, or to obtain the approval of the OCS, and may result in increased
royalty payments to the OCS. These restrictions may impair our ability to enter into agreements for
those products or technologies without the approval of the OCS. We cannot be certain that any
approval of the OCS 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 OCS 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. Any approval, if given, will generally be subject to additional financial obligations. If
we fail to comply with the conditions imposed by the OCS, including the payment of royalties with
respect to grants received, we may be required to refund any payments previously received,
32
together with interest and penalties. In total we have received grants from OCS in amount of
$2.8 million. We received no grants from the OCS during the year ended December 31, 2007 or the
three months ended March 31, 2008. Our royalty obligation to the OCS was completed during the first
quarter of 2008 and our outstanding payable to the OCS as of March 31, 2008, was approximately
$261,000.
We may be classified as a passive foreign investment company, which could result in adverse U.S.
federal income tax consequences to U.S. holders of our ordinary shares.
We do not expect to be considered a passive foreign investment company, or PFIC, for U.S.
federal income tax purposes for our current taxable year ending December 31, 2008. However, the
application of the PFIC rules is subject to ambiguity in several respects, and, in addition, we
must make a separate determination each taxable year as to whether we are a PFIC (after the close
of each taxable year). Accordingly, we cannot assure you that we will not be a PFIC for our current
taxable year or any future taxable year. A non-U.S. corporation will be considered a PFIC for any
taxable year if either (i) at least 75% of its gross income is passive income or (ii) at least 50%
of the value of its assets is attributable to assets that produce or are held for the production of
passive income. The market value of our assets generally will be determined based on the market
price of our ordinary shares, which has fluctuated since our ordinary shares began trading on the
NASDAQ Global Market on February 8, 2007 and is likely to fluctuate in the future. In addition, the
composition of our income and assets will be affected by how, and how quickly, we spend the cash we
raised in our initial public offering. If we were treated as a PFIC for any taxable year during
which a U.S. person held an ordinary share, certain adverse U.S. federal income tax consequences
could apply to such U.S. person, including:
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having gains realized on the sale of our ordinary shares treated as ordinary income,
rather than capital gain; |
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the loss of the preferential rate applicable to dividends received on our ordinary shares
by individuals who are U.S. holders; and |
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having interest charges apply to the proceeds of share sales. |
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 be volatile, and the value of an investment in
our ordinary shares may decline.
We sold ordinary shares in our initial public offering in February 2007 at a price of $17.00
per share, and our shares have subsequently traded as low as $11.05 per share. An active and liquid
trading market for our ordinary shares may not develop or be sustained. Factors that could cause
volatility in the market price of our ordinary shares include, but are not limited to:
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quarterly variations in our results of operations or those of our competitors; |
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announcements by us or our customers of acquisitions, new products, significant
contracts, commercial relationships or capital commitments; |
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our ability to develop and market new and enhanced products on a timely basis; |
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disruption to our operations; |
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geopolitical instability; |
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the emergence of new sales channels in which we are unable to compete effectively; |
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any major change in our board of directors or management; |
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changes in financial estimates, including our ability to meet our future revenue and
operating profit or loss projections; |
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changes in governmental regulations or in the status of our regulatory approvals; |
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general economic conditions and slow or negative growth of related markets; |
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commencement of, or our involvement in, litigation; and |
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changes in earnings estimates or recommendations by securities analysts. |
In addition, the stock markets in general, and the markets for semiconductor stocks in
particular, have experienced extreme volatility that often has been unrelated to the operating
performance of the issuer. These broad market fluctuations may adversely affect the trading price
or liquidity of our ordinary shares. In the past, when the market price of a stock has been
volatile and declined, holders of that stock have sometimes instituted securities class action
litigation against the issuer. If any of our shareholders were to bring such a lawsuit against us,
we could incur substantial costs defending the lawsuit and the attention of our management would be
diverted from the operation of our business.
The ownership of our ordinary shares will continue to be highly concentrated, and your interests
may conflict with the interests of our existing shareholders.
Our executive officers and directors and their affiliates, together with our current
significant shareholders, beneficially owned approximately 16% of our outstanding ordinary shares
as of March 31, 2008. Moreover, three of our shareholders, Fidelity Management and Research,
Sequoia Capital Partners and Fred Alger Management, beneficially owned approximately 31% of our
outstanding ordinary shares as of March 31, 2008. Accordingly, these shareholders, acting as a
group, have significant influence over the outcome of corporate actions requiring shareholder
approval, including the election of directors, any merger, consolidation or sale of all or
substantially all of our assets or any other significant corporate transaction. These shareholders
could delay or prevent a change of control of our company, even if such a change of control would
benefit our other shareholders. The significant concentration of share ownership may adversely
affect the trading price of our ordinary shares due to investors perception that conflicts of
interest may exist or arise.
If we sell our ordinary shares in future financings, ordinary shareholders will experience
immediate dilution and, as a result, our share price may go down.
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, our ordinary shareholders 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 financings or similar arrangements in
the future, including the issuance of debt securities, preferred shares or ordinary shares. If we
issue ordinary shares or securities convertible into ordinary shares, our ordinary shareholders
could experience dilution.
Provisions of Israeli law 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:
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no cumulative voting; and |
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an advance notice requirement for shareholder proposals and nominations. |
Furthermore, Israeli tax law treats some acquisitions, particularly stock-for-stock swaps
between an Israeli company and a foreign company, less favorably than U.S. tax law. Israeli tax law
generally provides that a shareholder who exchanges our shares for shares 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
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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 shareholders residence exempts the shareholder from Israeli
tax. Please see Risk Factors Provisions of Israeli law may delay, prevent or make difficult an
acquisition of us, which could prevent a change of control and therefore depress the price of our
shares for a further discussion of Israeli laws relating to mergers and acquisitions. 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.
We have never paid cash dividends on our share capital, and we do not anticipate paying any cash
dividends in the foreseeable future.
We have never declared or paid cash dividends on our share capital, nor do we anticipate
paying any cash dividends on our share capital 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. 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 the provisions of
Sarbanes-Oxley and rules adopted by the SEC and by The NASDAQ Stock Market, will 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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Unregistered Sales of Equity Securities
None
(b) Use of Proceeds
Our initial public offering of 6,900,000 ordinary shares was effected through a Registration
Statement on Form S-1 (File No. 333-137659) that was declared effective by the Securities and
Exchange Commission on February 7, 2007. We issued all 6,900,000 shares on February 13, 2007 for
gross proceeds of $117,300,000. The underwriters of the offering were Credit Suisse Securities
(USA) LLC, J.P. Morgan Securities Inc., Thomas Weisel Partners LLC and Jefferies & Company, Inc. We
paid the underwriters a commission of $8,211,000 and incurred additional offering expenses of
approximately $3,136,000. After deducting the underwriters commission and the offering expenses,
we received net proceeds of approximately $105,953,000. No payments for such expenses were made
directly or indirectly to (i) any of our directors, officers or their associates, (ii) any
person(s) owning 10% or more of any class of our equity securities or (iii) any of our affiliates.
The net proceeds from our initial public offering have been invested into short-term marketable
government agency obligations and commercial paper. There has been no material change in the
planned use of proceeds from our initial public offering as described in our final prospectus filed
with the SEC pursuant to Rule 424(b).
(c) Repurchases of Equity Securities
None.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
ITEM 5 OTHER INFORMATION
Not applicable.
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ITEM 6 EXHIBITS
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31.1 |
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Certification of the Companys Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 |
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Certification of the Companys Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1 |
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Certification of the Companys Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 |
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Certification of the Companys Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized as of
the 5th day of May, 2008.
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Mellanox Technologies, Ltd.
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/s/ Michael Gray
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Michael Gray |
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Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer) |
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Exhibit Index
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31.1 |
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Certification of the Companys Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 |
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Certification of the Companys Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1 |
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Certification of the Companys Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 |
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Certification of the Companys Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |