BUSINESS COMBINATION:

On February 23, 2016 ("Closing Date"), the Company completed its acquisition of EZchip. Under the terms of the Merger Agreement dated as of September 30, 2015 (as amended on November 17, 2015), by and among the Company, Mondial Europe Sub Ltd. and EZchip (the "Merger Agreement") the total consideration was $782.2 million, including $1.0 million attributable to assumed RSUs. The net cash purchase price of $693.7 million consisted of a $781.2 million cash payment for all outstanding common shares of EZchip at the price of $25.50 per share and net of $87.5 million cash acquired. The Company also assumed 891,822 EZchip RSUs and converted them to 499,894 equivalent Company RSU awards. The fair value of the converted RSUs was determined based on the per share value of the underlying Mellanox ordinary shares of $46.40 per share as of the acquisition date. The 499,894 RSUs had a total aggregate value of $23.2 million, of which $1.0 million was recorded as a component of the purchase price for service rendered prior to the acquisition date and $22.2 million will be recognized as share-based compensation expense over the remaining required service period of up to 2.25 years from the acquisition date.

In connection with the acquisition, the Company entered into a $280.0 million variable interest rate Term Debt maturing February 21, 2019. For additional information on the Term Debt, see Note 15 in the notes to the consolidated financial statements.

The Company accounted for the transaction using the acquisition method, which requires, among other things, that the assets acquired and liabilities assumed in a business combination be recognized at their respective estimated fair values as of the acquisition date.

In connection with the preparation of the consolidated financial statements for the year ended December 31, 2016, the Company identified and corrected an error related to the initial purchase consideration recorded in the first quarter of 2016, resulting in a decrease in goodwill and additional paid-in capital of $4.8 million. The amount represents the cash payments related to accelerated RSUs that were paid to individuals who were terminated on the Closing Date, and was recorded as stock-based compensation expense. The Company assessed the materiality of the error and concluded that it was not material to 2016. The following summarizes the consideration paid for EZchip at the acquisition date:



	(in thousands)
Consideration:
Cash payment for all outstanding common shares of EZchip at $25.50 per share	$	781,237
Fair value of awards attributable to pre-acquisition services	972
Total consideration:	782,209
Less: cash acquired	87,545
Fair value of total consideration transferred, net of cash acquired	$	694,664

The following summarizes the Company's allocation of the total purchase price, net of cash acquired for the EZchip acquisition after consultation with third party valuation specialists:



	(in thousands)
Short-term investments	$	108,862
Other current assets	34,114
Other long-term assets	9,638
Intangible assets	288,246
Goodwill	270,485
Total assets	711,345

Current liabilities	(10,253		)
Long-term liabilities	(6,428		)
Total liabilities	(16,681		)
Total purchase price allocation	$	694,664

Acquisition-related expenses for the EZchip acquisition for the years ended December 31, 2016 and 2015 were $8.3 million and $1.6 million, respectively, and primarily consisted of investment banking, consulting and other professional fees.

Identifiable finite-lived intangible assets



	Fair value		Weighted Average Useful Life
	(in thousands)		(in years)
Purchased intangible assets:
Trade names	$	5,600	3
Customer relationships	56,400		9
Backlog	11,300		1
Developed technology	181,246		4 - 6
In process research and development ⁽¹⁾	33,700		-
Total purchased intangible assets	$	288,246

⁽¹⁾IPR&D will not be amortized until the underlying products reach technological feasibility. Upon completion, each IPR&D project will be amortized over its useful life.

Trade name represents the fair values of brand and name recognition associated with the marketing of EZchip’s products and services. The Company used the income approach and utilized a discount rate of 10.0% to determine the fair value of trade name assets.

Customer relationships represent the fair value of future projected revenues that will be derived from the sale of products to existing customers of EZchip. The Company used the comparative method ("with/without") of the income approach to determine the fair value of this intangible asset and utilized a discount rate of 10.0%.

Backlog represents the fair value of sales order backlog as of the valuation date. The Company used the income approach to determine the fair value of this intangible asset and utilized a discount rate of 8.0%.

Developed technology represents completed technology that has passed technological feasibility and/or is currently offered for sale to customers. The Company used the income approach to value the developed technology. Under the income approach, the expected future cash flows from each technology are estimated and discounted to their net present values at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return are the weighted average cost of capital and the return on assets. The Company applied a discount rate of 9.0% to value the developed technology assets taking into consideration market rates of return on debt and equity capital and the risk associated with achieving forecasted revenues related to these assets.

The IPR&D intangible asset represents the value assigned to an acquired research and development project that, as of the acquisition date, had not established technological feasibility. The fair value of IPR&D was determined using a discount rate of 12.0%. IPR&D consists of one project related to the development of two network processors. The project is expected to be completed over the next two years. The estimated remaining costs to complete the IPR&D project were $22.3 million as of the acquisition date, which are being charged to operating expense in the consolidated statements of operations as incurred. During the three months ended September 30, 2016, one component of the IPR&D project reached technological feasibility and $4.2 million was transferred to developed technology and will be amortized over three years.

Goodwill

Goodwill arising from the acquisition represents the value of the skilled assembled workforce and projected growth in overall revenues. The EZchip acquisition is a step in the Company's strategy to become a leading broad-line supplier of intelligent interconnect solutions for data centers. The addition of EZchip’s products and expertise in network processing is expected to enhance the Company's leadership position, and ability to deliver complete end-to-end, intelligent 10, 25, 40, 50, and 100Gb/s interconnect and processing solutions for advanced data center and edge platforms. The combined company will have diverse and robust solutions to enable customers to meet the growing demands of data-intensive applications used in high-performance computing, Web 2.0, cloud, secure data center, enterprise, telecom, database, financial services, and storage environments. These significant factors were the basis for the recognition of goodwill. Goodwill is not expected to be deductible for tax purposes. Goodwill will not be amortized but instead will be tested for impairment annually or more frequently if certain indicators are present.

Supplemental pro forma data

The following unaudited pro forma data have been prepared as if the EZchip acquisition had occurred on January 1, 2015, and includes adjustments for amortization of intangible assets acquired, the effect of purchase accounting adjustments including the step-up of inventory, share-based compensation expense, and interest on the Term Debt incurred to partially finance the acquisition. Pro forma results are not indicative of what would have occurred had the acquisition occurred as of January 1, 2015 or of results that may occur in the future.



	Year Ended December 31,
	2016		2015
	(in thousands, except per share amounts)
Revenues	$	867,422	$	769,290
Net income	$	40,288	$	36,130
Net income per share — basic	$	0.82	$	0.77
Net income per share — diluted	$	0.80	$	0.74

Material non-recurring adjustments included in the unaudited pro forma net income for the year ended December 31, 2016 for the effect of purchase accounting adjustments include: a reduction of acquisition-related costs of $15.3 million, composed of acquisition cost of $8.3 million incurred by the Company and $7.0 million incurred by EZchip; a reduction of amortization expense related to the acquired intangible assets and the step-up of inventory of $13.0 million; and a reduction of the stock-based compensation expense related to accelerated RSUs of $4.8 million.

Material non-recurring adjustments included in the unaudited pro forma net income for the year ended December 31, 2015 for the effect of purchase accounting adjustments include: additional amortization expense related to the acquired intangible assets and the step-up of inventory of $56.2 million; an increase of acquisition-related costs of $15.3 million; and the interest expense of term debt, including the amortization of issuance costs, of $7.6 million.

The Company immediately integrated EZchip into its ongoing operations. As a result, it is impracticable to determine EZchip's effect on revenue and earnings in the consolidated statement of operations for the reporting period.