THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

6 Months Ended

Jun. 30, 2019

Organization, Consolidation and Presentation of Financial Statements [Abstract]

THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Company

Mellanox Technologies, Ltd., an Israeli corporation (the "Company" or "Mellanox"), was incorporated and commenced operations in March 1999. Mellanox is a supplier of high-performance interconnect products for computing, storage and communications applications.

Pending Merger with NVIDIA Corporation

On March 10, 2019, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with NVIDIA Corporation, a Delaware corporation ("NVIDIA"), NVIDIA International Holdings Inc., a Delaware corporation and wholly owned subsidiary of NVIDIA ("Parent") and Teal Barvaz Ltd., a wholly owned subsidiary of Parent organized under the laws of the State of Israel and wholly owned subsidiary of Parent ("Merger Sub"). NVIDIA has agreed to guarantee the payment and performance obligations of Parent under the Merger Agreement. The Merger Agreement and the Merger (as defined below) have been approved by the boards of directors of the Company, NVIDIA, Parent and Merger Sub.

The Merger Agreement provides that, upon the terms and subject to the satisfaction or waiver of the conditions set forth therein, Merger Sub will be merged with and into the Company (the "Merger") in accordance with Sections 314-327 of the Companies Law 5759-1999 of the State of Israel, with the Company continuing as the surviving corporation and a wholly owned subsidiary of Parent.

At the effective time of the Merger (the "Effective Time"), each ordinary share, par value NIS 0.0175 per share, of the Company (a "Company Share") issued and outstanding immediately prior to the Effective Time, other than any shares owned by the Company, Parent and their respective subsidiaries or any shares held in the Company’s treasury, will be deemed to have been transferred to the Parent in exchange for the right to receive $125.00 in cash, without interest and subject to applicable withholding taxes.

The Merger Agreement contains customary representations, warranties and covenants. The consummation of the Merger is conditioned on the receipt of the approval of the Company’s shareholders, as well as the satisfaction of other customary closing conditions, including domestic and foreign regulatory approvals and performance in all material respects by each party of its obligations under the Merger Agreement. At the Company’s extraordinary general meeting held on June 20, 2019, the Company’s shareholders approved the consummation of the Merger. Closing of the Merger is expected by the end of calendar year 2019.

The Merger Agreement contains certain customary termination rights by either the Company or Parent, including if the Merger is not consummated by December 10, 2019, subject to two three-month extensions in order to obtain required regulatory approvals. If the Merger Agreement is terminated under certain circumstances, including termination by the Company to enter into a superior proposal, a termination by Parent following a change of the Company’s board of directors’ recommendation or a termination by Parent as a result of a willful material breach of the Merger Agreement’s no-solicitation obligations by the Company, the Company will be obligated to pay to Parent a termination fee equal to $225 million in cash. If the Merger Agreement is terminated under certain circumstances involving the failure to obtain certain regulatory approvals, Parent will be obligated to pay the Company a termination fee equal to $350 million in cash.

The Company recorded transaction-related costs of $7.8 million, principally for investment banking and legal fees associated with the pending acquisition, during the six months ended June 30, 2019. These costs are recorded in general and administrative expenses included in the condensed consolidated statement of operations for the six months ended June 30, 2019. Additional transaction-related costs are expected to be incurred through the closing of the Merger.

Principles of presentation

The unaudited condensed consolidated financial statements include the Company's accounts as well as those of its wholly owned subsidiaries after the elimination of all intercompany balances and transactions.

The unaudited 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 balance sheet data were derived from audited consolidated financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States ("GAAP"). Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP 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 unaudited 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 unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 21, 2019. The results of operations for the six months ended June 30, 2019 are not necessarily indicative of the results to be anticipated for the entire year ending December 31, 2019 or thereafter.

Certain prior year amounts have been reclassified for consistency with the current year presentation. On the balance sheet, the severance assets were reclassified to other long-term assets, and the accrued severance was reclassified to other long-term liabilities.

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 Company's financial position and results of operations: unpredictable volume or timing of customer orders; ordered product mix; the sales outlook and purchasing patterns of the Company's customers based on consumer demands and general economic conditions; loss of one or more of the Company's 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 Company's products; reliance on a limited number of subcontractors to manufacture, assemble, package and production test the Company's products; the Company's ability to successfully develop, introduce and sell new or enhanced products in a timely manner; product obsolescence and the Company's ability to manage product transitions; the timing of announcements or introductions of new products by the Company's competitors; and the Company's ability to successfully integrate acquired businesses.

Use of estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of net revenue and expenses in the reporting periods. The Company regularly evaluates estimates and assumptions related to revenue recognition, allowances for doubtful accounts, allowances for price adjustments, investment valuation, warranty reserves, inventory reserves, share-based compensation expense, long-term asset valuations, useful lives of property, equipment, and intangibles, accounting for business combinations, goodwill and purchased intangible asset valuation, investments in privately-held companies, accounting and fair value of financial instruments and derivatives, deferred income tax asset valuation, uncertain tax positions, and litigation and other loss contingencies. These estimates and assumptions are based on current facts, historical experience and various other factors that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results that the Company experiences may differ materially and adversely from the Company's original estimates. To the extent there are material differences between the estimates and actual results, the Company's future results of operations will be affected.

Significant accounting policies

Other than our accounting policy related to the new lease standard (see Note 14, "Leases"), there have been no changes in the Company’s significant accounting policies that were disclosed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2018, filed with the SEC on February 21, 2019.

Restricted cash

The Company maintained certain cash amounts that were restricted as to withdrawal or use over the long-term. The cash was securing bank guarantees primarily issued against long-term tenancy agreements. During the second quarter of 2019, the Company renegotiated the guarantee terms with the banks, and all restricted cash was released as of June 30, 2019. The long-term restricted cash balance of $7.9 million was reported in other long-term assets on the balance sheet as of June 30, 2018, and was included in the ending balance of cash, cash equivalents and restricted cash in the statement of cash flows for the six

months ended June 30, 2018. The following table provides a reconciliation of the cash and cash equivalents balances reported on the balance sheets and the cash, cash equivalents and restricted cash balances reported in the statements of cash flows:

	June 30,
	2019		2018
	(In thousands)
Cash and cash equivalents, as reported on the balance sheets	$	53,782	$	63,422
Restricted cash in other long-term assets, as reported on the balance sheets	—		7,931
Cash, cash equivalents, and restricted cash, as reported in the statements of cash flows	$	53,782	$	71,353

Concentration of credit risk

The following table summarizes the revenues from customers (including original equipment manufacturers) in excess of 10% of the total revenues:

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Hewlett Packard Enterprise ("HPE")	13.5	%	13.0	%	10.5	%	15.0	%
Dell Technologies Inc. ("Dell")	*		14.0	%	11.3	%	12.0	%
____________________
* Less than 10%

There was no customer with an accounts receivable balance in excess of 10% of total accounts receivable as of June 30, 2019 and December 31, 2018.

Product warranty

The following table provides changes in the product warranty accrual for the six months ended June 30, 2019 and 2018:

	Six Months Ended June 30,
	2019			2018
	(in thousands)
Balance, beginning of the period	$	1,376		$	889
New warranties issued during the period	2,397			856
Reversal of warranty reserves	(18		)	—
Settlements during the period	(1,934		)	(784		)
Balance, end of the period	1,821			961
Less: long-term portion of product warranty liability	(362		)	(173		)
Current portion, end of the period	$	1,459		$	788

Net income per share

The following table sets forth the computation of basic and diluted net income per share for the three and six months ended June 30, 2019 and 2018:

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
	(in thousands, except per share data)
Net income	$	38,429	$	16,526	$	87,049	$	54,369
Basic and diluted shares:
Weighted average ordinary shares outstanding	54,707		52,615		54,469		52,219
Effect of dilutive shares	1,773		1,851		1,711		1,930
Shares used to compute diluted net income per share	56,480		54,466		56,180		54,149
Net income per share — basic	$	0.70	$	0.31	$	1.60	$	1.04
Net income per share — diluted	$	0.68	$	0.30	$	1.55	$	1.00

There were no material amounts of potentially dilutive share options and restricted share units ("RSUs") that had an anti-dilutive effect for the computation of diluted net income per share for both the three and six months ended June 30, 2019. The Company excluded 0.2 million potentially dilutive share options and RSUs from the computation of diluted net income per share for both the three and six months ended June 30, 2018, respectively, because including them would have had an anti-dilutive effect.

Adoption of new accounting principles

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The standard requires lessees to recognize almost all leases on the balance sheet as a right-of-use asset and a lease liability and requires leases to be classified as either an operating or a finance type lease. The standard excludes leases of intangible assets or inventory.

The standard became effective for the Company on January 1, 2019. The Company elected the available practical expedients and implemented internal controls to enable the preparation of financial information on adoption. The adoption of the standard had a material impact on the Company's condensed consolidated balance sheets due to the recognition of the right-of-use ("ROU") assets and lease liabilities related to the Company's operating leases. In addition, a material portion of the Company's leases are denominated in currencies other than the U.S. Dollar, mainly in New Israeli Shekels ("NIS"). As a result, the associated lease liabilities were remeasured using the current exchange rate, which resulted in non-operating foreign exchange losses. The standard did not have a material impact on the Company's results of operations or cash flows. See Note 14, "Leases" for details about the impact from adopting the new lease standard and other required disclosures.

Recent accounting pronouncements

In August 2018, the FASB issued ASU No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU clarifies the accounting treatment for implementation costs for cloud computing arrangements (hosting arrangements) that are service contracts. This standard becomes effective for the Company beginning January 1, 2020. The Company is currently assessing the effect that this ASU will have on its condensed consolidated financial statements and related disclosures.