Mellanox Technologies (MLNX) Q2 2018 Earnings Conference Call Transcript

Mellanox Technologies (MLNX)
Q2 2018 Earnings Conference Call
Jul. 17, 2018 2:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the Mellanox Technologies' second-quarter financial results conference call. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. [Operator instructions]. As a reminder, this conference is being recorded.

And now, I would like to turn the conference over to Mellanox. Please go ahead.

Jeffrey Schreiner -- Director of Investor Relations

Good afternoon and welcome to Mellanox Technologies' second-quarter 2018 conference call. Leading the call today will be Eyal Waldman, president and CEO of Mellanox Technologies, and Eric Johnson, vice president, corporate controller. By now you have seen our press release and associated financial information that you furnished to the SEC on Form 8-K this morning, if not, you may access them on our website at ir.mellanox.com.

As a reminder, today's discussion includes prediction, expectations, estimates and other information, all of which we consider to be forward-looking statements. Throughout today's discussion, we present important factors relating to our business that may potentially affect these forward-looking statements. These forward-looking statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements made today. As a result, we caution you against placing undue reliance on these forward-looking statements and we encourage you to review our most recent SEC reports, including our 10-K and 10-Q, for a complete discussion of these factors and other risk factors that may affect our future results or the market price of our ordinary shares.

Finally, we are not obligating ourselves to revise our results or publicly release any revisions to these forward-looking statements in light of new information or future events.

Now, I will turn the call over to Eyal for his opening remarks. Eyal?

Eyal Waldman -- Chief Executive Officer and Director

Thank you, Eric. Good afternoon, everyone, and thank you for joining us. I am proud to share with you the details of another strong quarter with you. We are again reporting record revenue and non-GAAP operating income in the second quarter of 2018.

While continuing to invest our revenue growth and operating expense discipline is returning more profit to the bottom line. We believe we are in the early stages of our transition from 10 gigabits per second to 25 gigabits per second and above and our products are well-suited to capture market share in this transition. This will be a multiyear position and we expect to remain a leader in hyperscale, artificial intelligence, cloud, high-performance computing, storage and more. With close relationships with our customers and our end-users, we believe we can deliver healthy growth in 2019 and beyond.

Now, let me give you a brief financial overview. Second-quarter revenue came in near the top of our updated guidance at $268.5 million, representing a sequential increase of 7% and an increase of 27% over the prior year. With strong revenue growth and operating expense better than our guidance, our non-GAAP operating margin was 24.7%. Second-quarter diluted non-GAAP EPS was $1.25, a 184% increase compared to the prior year.

We continued to capitalize on market opportunities for higher Ethernet speeds and again delivered strong growth and record Ethernet revenues. Ethernet revenues were up 15% sequentially and 81% year over year, driven by increased adoption of our 25-gigabit per second and above ConnectX network adapters, Spectrum switches and LinkX cables and consumers.

Customers recognized the performance efficiency, scalability and software advantages Mellanox delivers across 25, 50 and 100 gigabits per second. Independent research shows that we are capturing 67% of the network adapter market at this speed, which is forecasted to grow at a more than 50% CAGR over the next 5 years. In the second quarter, our Ethernet switch revenue was up 26% sequentially and more than doubled year over year, with 114% growth driven by a growing demand from OEMs, global hyperscale, enterprise data centers, financial services and artificial intelligence customers. Multiple Tier 1 and Tier 2 OEMs have selected our Spectrum Ethernet switch as their Ethernet switch of choice for their storage and compute platforms and Spectrum adoption among leading hyperscale and cloud users continues to increase.

We expect our switch business to continue its momentum from the first half and more than doubled for the full year of 2018 compared to 2017.

Mellanox opened Ethernet switches enable our customers to choose the best software for their Ethernet switch deployments, such as Microsoft SONiC, Cumulus Linux, Mellanox Onyx and more. Our Spectrum switches deliver superior data center return on investment with greater scalability, lower latency, lower power consumption and better price performance than our competitors. We expect our 25-gigabit per second and above Ethernet adapters, switches and cables will remain a key growth driver in 2018 and beyond.

InfiniBand revenues were flat sequentially. We remain confident InfiniBand will grow in low single-digits for the year. Mellanox InfiniBand solutions continue to deliver superior performance at a lower total cost of ownership as demonstrated by our progress in the most recent TOP500 supercomputing list. Based on the updated TOP500 data announced in June 2018, InfiniBand now connects for the first time the top three and four of the top five supercomputers in the world.

Among this, InfiniBand connects the fastest high-performance computing and artificial intelligence supercomputer in the world located in the United States and the fastest supercomputer in China and in Japan.

Mellanox connects 43% of overall TOP500 platforms across both our InfiniBand and Ethernet products. This is a 13% increase for Mellanox in just six months. InfiniBand accelerates nearly 60% of the total HPC systems on the TOP500 list, making InfiniBand the interconnect of choice for HPC and AI infrastructures. Mellanox Ethernet connects all of the 25-gigabit and faster Ethernet systems making Mellanox Ethernet the interconnect of choice for the TOP500 cloud and hyperscale platforms.

Mellanox InfiniBand solutions provide the highest performance and scalability, while also unleashing the power of multiple compute architectures, including AMD, ARM, SPGA-based, IBM Power, Intel, NVIDIA, and other compute and storage platforms. InfiniBand was selected to connect the world's fastest ARM-based supercomputer at Sandia National Lab to be deployed in the second half of 2018. We expect to see HDR 200-gigabit InfiniBand deployments in the second half of the year further expanding the performance and technology advantages between InfiniBand and alternatives.

Now, I will turn the call over to Eric for a review of our second-quarter 2018 results and discuss our updated expectations for 2018. Eric?

Eric Johnson -- Controller

Thank you, Eyal. Good afternoon, everyone. Let me now review some financial details relative to our second-quarter 2018 results. Our total revenues were $268.5 million, up 7% sequentially from $251 million in the first quarter of 2018 and up approximately 27% from $212 million in the second quarter of 2017.

The following are a few selected Q2 '18 revenue metrics for you. Revenues from our ICs represented approximately 11% of second-quarter revenues. Revenues from boards were 51% and switch system revenues accounted for 21%. Second-quarter InfiniBand revenues were $102.1 million.

Our InfiniBand revenues were roughly flat sequentially. Revenues from our InfiniBand-based products represented approximately 38% of revenues in Q2 '18 down from 41% of revenues in Q1 '18. Our EDR 100-gigabit per second InfiniBand products were up 6% sequentially and roughly flat from the second quarter of 2017 and represented 58.1% of the second-quarter InfiniBand revenues.

Quarterly Ethernet revenues were $157.5 million, up 15% sequentially and up 81% from the second quarter of 2017. Ethernet revenues represented 59% of second-quarter revenues. We had two greater than 10% customers in the second quarter. They were Dell EMC with 14% and HPE with 13% of revenues.

Our non-GAAP gross margins in the second quarter were 69.1%, up 10 basis points from the first quarter of 2018. Major reconciling items from GAAP to non-GAAP gross profit, our share-based compensation expense of approximately $415,000, amortization of acquired intangibles of $11.1 million and settlement costs of $9.2 million related to the settlement of a contingent royalty obligation.

Second-quarter non-GAAP operating expenses decreased by $1.9 million sequentially to $119.2 million and represented 44.4% of revenues, compared with $121.2 million, or 48.3% of revenues, in the first quarter of 2018. Major reconciling items from GAAP to non-GAAP operating expenses are share-based compensation of $14.5 million, amortization of acquired intangibles of $2.2 million, acquisition and other charges of $10.5 million, which include $10.1 million of expenses related to the proxy contest and restructuring charges of $1.8 million. The decrease in our non-GAAP quarterly operating expenses is primarily attributable to additional operating efficiencies realized during the quarter.

Our non-GAAP research and development expenses in the second quarter were $78.5 million, compared to $77.8 million in the first quarter of 2018, representing a sequential increase of 1%. Non-GAAP sales and marketing expenses were $29.9 million in the second quarter, compared to $33.5 million in the first quarter of 2018, representing a sequential decrease of 10.6%. In the second quarter, our non-GAAP general and administrative expenses were $10.8 million, compared to $9.9 million in the first quarter, representing a sequential increase of 8.7%. The second-quarter 2018 non-GAAP operating income was $66.2 million and represented 24.7% of revenues, compared to operating income of $52.1 million, or 20.8% of revenues, in the previous quarter.

Interest expenses associated with the term debt during the second quarter were $0.9 million. We paid off all outstanding principal and interest related to the term debt during the quarter. The second-quarter non-GAAP tax benefit was $670,000. Second-quarter non-GAAP net income was $66.6 million, or $1.25 per diluted share.

This compares to our first-quarter 2018 non-GAAP net income of $51.4 million, or $0.98 per diluted share. Cash provided by operating activities during the second quarter 2018 was $46.7 million, compared to $55.4 million in the first quarter of 2018. Our cash and investments at the end of the quarter were $282.6 million, compared to $286.3 million at March 31, 2018.

And now on to our third-quarter 2018 outlook. We currently expect our third-quarter 2018 non-GAAP results to be as follows. Quarterly revenues at $270 million to $280 million, non-GAAP gross margin range of 68.5% to 69.5%. We expect non-GAAP operating expenses of $122 million to $124 million.

We estimate our third-quarter share compensation expense to be between $19 million and $19.5 million and non-GAAP diluted share count in the third quarter of $53.5 million to $54.0 million. We continue to manage our operating expenses. Our Q3 operating expenses will include multiple tape-out costs that are related to new products that will come out later this year and early '19. As a result, the Q3 operating expense will be slightly higher than Q2.

Now, for the full-year 2018 outlook, for the full fiscal 2018, we currently project revenues of $1.65 billion to $1.85 billion, non-GAAP gross margins of 68.5% to 69.5%, non-GAAP operating margins of 23% to 24%.

I will turn it back to Eyal now for a few closing comments. Eyal?

Eyal Waldman -- Chief Executive Officer and Director

Thank you, Eric. Our record results in the second quarter and the outlook for 2018 and beyond are providing, proving that our products outperform our peers and we are capturing market share as compute and storage systems drive to faster speeds. We are at the leading edge of a significant upgrade cycle and we are well-positioned to take advantage of the move to higher-performance networks that will continue for multiple years. With the market-leading products and a keen focus on the investments needed to maintain our competitive advantage, Mellanox is positioned to drive above market growth with expanding profitability over a multiyear period.

Our early 25, 50 and 100-gigabit per second Ethernet adapters, Spectrum switches, LinkX cables and transceivers, the new product, including Bluefield and our 200- and 400-gigabit-per-second InfiniBand and Ethernet solutions, will drive our continued revenue growth in the coming years. We expect to see multiple Bluefield design wins for storage and SmartNIC products during the second part of the year in 2019 driving further growth in '19 and beyond. We will maintain a strict focus on developing the best products and continue our growth trajectory in future years. And with financing discipline, we expect to produce greater leverage in the business model and deliver higher profitability.

Before opening the line for questions, I would like to thank Dov Baharav, Shai Cohen, and Thomas Riordan, who have recently stepped down as board members for their great contribution to the success of the company. They each have played a significant role in guiding Mellanox to where we are today. The Mellanox team has benefited greatly from the valuable insights, support and strategic contributions they have provided over the years. Mellanox has maintained the best corporate governance score for more than a year with ISS, which is a direct reflection of the board's efforts and oversight.

I would also like to welcome Jack Lazar, John Olson, and Greg Waters to our board of directors and I am looking forward to working with them and the rest of the board to ensure that Mellanox continues to build on its strong financial performance and best-in-class corporate governance practices. We remain confident that Mellanox is well-positioned to deliver the right products in the right place at the right time.

To summarize, with our updated full-year guidance, we expect to grow our revenues by about 25% in 2018 and that should result in our non-GAAP operating profit more than doubling to about $0.25 billion for the year. With that, we will open the call for questions. Operator, please?

Questions and Answers:

Operator

[Operator instructions]. Thank you. Our first question comes from Joseph Wolf with Barclays. Please go ahead.

Joseph Wolf -- Barclays -- Analyst

Thank you. Just a couple of questions. So looking at the inventory number and the sales figure right now, what should we be thinking about in terms of inventory levels that you are looking at right now? Was that a mix question or is that new products going into your customer [Inaudible] base just was driving that should it stay at this kind of growth level?

Eyal Waldman -- Chief Executive Officer and Director

First, its expectations to continue our growth in order to maintain our supply lead time. We have increased our inventory. Also in some of the products we are using in our products, we have experienced some shortage in the past. So for those two reasons, we have kind of increased our inventories.

Joseph Wolf -- Barclays -- Analyst

OK, that's helpful. And then if I look at the commentary on operating margin on an absolute dollar sense, down in sales and marketing this quarter I guess, is that I am assuming that's more marketing on sales, given sales continued to grow, how much more room is there in terms of absolute dollars of spending for that to change over the course of 2018 in the second half of the year? And then is any of that due to the strengthening of the U.S. dollar versus a shekel?

Eyal Waldman -- Chief Executive Officer and Director

No, the majority of our sales and marketing expenses are actually in the dollars, not in shekels, but we are managing our operating expenses to meet our operating margin targets and to grow our bottom line and leverage more of the top-line revenue down to the operating profit and we will continue doing that in all of the segments or multiple segments of our operating expenses.

Joseph Wolf -- Barclays -- Analyst

OK. And then just finally, and no disrespect to Eric, who was assuming this role, but is there a status on the CFO search or is it likely that Eric will become the permanent CFO?

Eyal Waldman -- Chief Executive Officer and Director

First, Eric is doing a great job as filling in. Eric will not be the full-time CFO at Mellanox, he is just filling in. We are making progress with multiple candidates and some of them already have met the board and we will continue our search. I think we have some viable candidates and hopefully, we will fill the position in the coming months.

Joseph Wolf -- Barclays -- Analyst

All right, perfect. Thank you.

Operator

Our next question comes from Kevin Cassidy with Stifel. Please go ahead.

Kevin Cassidy -- Stifel Financial Corp. -- Analyst

Thank you and congratulations on a great quarter. You mentioned multiple tape-outs in the third quarter. Can you give us an idea of where you are on the process technology?

Eyal Waldman -- Chief Executive Officer and Director

Yes, those tape-outs are at 60-nanometer technology TSMC.

Kevin Cassidy -- Stifel Financial Corp. -- Analyst

OK, great. And I guess is this, what's helping your move to 200-gigabit bandwidth and do you need to go to another processing node to get to 400 gigabit?

Eyal Waldman -- Chief Executive Officer and Director

This product will support both 200- and 400-gigabits-per-second bandwidth.

Kevin Cassidy -- Stifel Financial Corp. -- Analyst

OK. So, this is a one-time charge in the third quarter and we shouldn't expect that in the following quarters?

Eyal Waldman -- Chief Executive Officer and Director

Every time we have a tape-out, there is like a bump in our operating expenses and we just wanted to outline this for Q3.

Kevin Cassidy -- Stifel Financial Corp. -- Analyst

OK, great. Thanks for your help.

Operator

Our next question comes from Gary Mobley with Benchmark. Please go ahead.

Gary Mobley -- The Benchmark Company -- Analyst

Hi, gentlemen. I was hoping that you can quickly run through the mix between ICs, boards, and switches to start?

Eyal Waldman -- Chief Executive Officer and Director

Excuse me, go again. What was the question?

Gary Mobley -- The Benchmark Company -- Analyst

I am sorry I apologize if you can't hear me. Could you quickly run through the mix between ICs, boards, switches?

Eyal Waldman -- Chief Executive Officer and Director

So to reiterate, the mix was 11% for ICs, boards were 51%, and switch system revenues were 21%.

Gary Mobley -- The Benchmark Company -- Analyst

Thank you. As a follow-up I had a multipart question about the operating margins and so, if I'm not mistaken, your prior target was 24% to 28% to you're, I think, on record as stating your goal is to have, be at 28% operating margins for fiscal year '19, implying that you conclude 2019 with a 31% or more operating margin. And so I guess the question is, is that target out the door, what do you think the right level of spend is for the company and what is the operating margin target metrics that you have to achieve to avoid the option exercise for that fourth board seat?

Eyal Waldman -- Chief Executive Officer and Director

So I think it's specified as 23.5% operating margin for the 12 months ending 2018, 25.5% for the 12 months ending June '19, and 28% for the 12 months ending end of 2019. As we just reiterated, our operating expenses targets for '18 is 23% to 24% for the year.

Gary Mobley -- The Benchmark Company -- Analyst

OK. On the topic of capital allocation, you are generating now roughly $250 million a year in cash flow from operations, you are at a cash position of over $5 per share presumably you will be approaching $10 per share in cash in 12 months' time. And so considering that you are sort of boxed in from a capital-allocation perspective with respect to buybacks and dividends and whatnot, what is the plan looking forward to avoid some detriment to the ROE and some cash pile up here?

Eyal Waldman -- Chief Executive Officer and Director

Yes. So the best use for our cash is talking with acquisitions and bringing more to technology to accelerate our growth and we believe this is the best use of our cash moving forward.

Operator

Our next question comes from Harlan Sur with J.P.Morgan. Please go ahead.

Harlan Sur -- J.P.Morgan -- Analyst

Good afternoon and congratulations on the solid quarterly execution. You guys typically have pretty good visibility on programs with your HPC customers. So when you are going to be shipping your first production in 200-gig HDR solutions to the market? Is that going to be this quarter, Q3, and do you anticipate an HDR-powered platform in the November TOP500 List?

Eyal Waldman -- Chief Executive Officer and Director

So, we expect to ship our HDR systems in the second half of 2018 and we hope to be put in the TOP500 but we will try to ship in the second half of '18.

Harlan Sur -- J.P.Morgan -- Analyst

Got it, OK. And Eyal, I am hearing more and more -- you touched upon it in your commentary -- but I am hearing more and more on the usage of the smart or intelligent NIC solutions with cloud customers. Clearly, they are looking to offload more functionality from the CPU. I know some of your cloud customers seem to be doing their own custom [Inaudible] implementations.

You guys have been focused on merchant solution using Bluefield. Can you guys just give us an update on the design-win pipeline for Bluefield in intelligent NIC applications and then what types of applications are they going to be using this for?

Eyal Waldman -- Chief Executive Officer and Director

Yes. We actually have a pretty healthy momentum of design wins for Bluefield both, actually all over the world. We are now focusing on that software development with hyperscale, Web 2, and cloud customers both in the U.S. and in China.

This will be like intelligent NIC applications for both storage and compute platforms. At the same time, we are also working with storage companies to use Bluefield as the storage controller. The fact that Bluefield contains ConnectX 5 really helps our customers that they are using ConnectX family to adopt the Bluefield assisting on the chip solution into their products. So we are pretty encouraged by the momentum and traction that Bluefield products are getting.

Harlan Sur -- J.P.Morgan -- Analyst

Great. Thanks for the insight, sir. Just last question, so with 65%, 75% share of the 25-gig NIC in higher Ethernet market, you obviously have great visibility on the total opportunity ahead of you. Where do you think you and your customers are in the upgrade cycle? In other words, 10%, 15% way through the potential upgrade cycle looking at the market opportunity ahead of you, any quantification on that?

Eyal Waldman -- Chief Executive Officer and Director

So first with outside research, we are about 67% of their market. This market is expected to grow 50% CAGR over the coming years. We think we are pretty much in the very early stages of this transition. Those transitions really take about 5 years from previous experiences.

So we are definitely not even touching the mainstream, we are just the early adopters that are moving to 25 and this is again like three-, a seven-year transition that we are just starting to see the beginning of this wave when we are riding this wave with superior technology.

Operator

Thank you. Our next question comes from James Kisner with Loop Capital Markets. Please go ahead.

James Kisner -- Loop Capital Markets -- Analyst

Thank you. I am going to just ask a quick housekeeping question or two before sort of ask a bigger question, I just want to verify, I think you said that you did $101 million in revenue for InfiniBand or I guess 180.5 for Ethernet, so you add it together that's not $10 million short of your total revenue number. Just wondering what's the rest of revenue or did I miss something?

Eyal Waldman -- Chief Executive Officer and Director

Yes, the balance in the revenue primarily relates to service revenues.

James Kisner -- Loop Capital Markets -- Analyst

OK. Is that a new classification, because I don't recall you guys disclosing service revenues before?

Eyal Waldman -- Chief Executive Officer and Director

We always had it. I don't think we are spending it out but we always had it out there, it's NA.

James Kisner -- Loop Capital Markets -- Analyst

OK, that's interesting. And maybe you can answer it offline but I just noticed that the cash balance on your balance sheet and the cash balance for your end of the quarter, in your cash flow statements don't match, they are also off I think like $8 million, $9 million, so if there is an obvious reason or an accounting reason for that?

Eyal Waldman -- Chief Executive Officer and Director

It is due to restricted cash.

James Kisner -- Loop Capital Markets -- Analyst

OK.

Eyal Waldman -- Chief Executive Officer and Director

Yes, you have to put restricted cash on the cash flow statements.

James Kisner -- Loop Capital Markets -- Analyst

OK. I've seen it before.

Eyal Waldman -- Chief Executive Officer and Director

So we concluded it there. And in fact, we presented in long-term assets.

James Kisner -- Loop Capital Markets -- Analyst

OK, that's helpful. OK. So I was wondering you could also just give us an update on the competitive dynamics in Ethernet. I guess obviously you have strong share, you've maintained strong share for a while here, but what are you seeing competitively? Have you seen any changes and maybe kind of obvious gaining shares, are there any kind of people that are now active that weren't, companies that weren't active? Just you talk about the competitive dynamics there.

Eyal Waldman -- Chief Executive Officer and Director

Yes. So, I assume you are talking about that Ethernet NIC business.

James Kisner -- Loop Capital Markets -- Analyst

Yes.

Eyal Waldman -- Chief Executive Officer and Director

So what we are seeing there are Intel and Broadcom obviously trying to come up with the network interface card to the products out there into the market. The advantage we have is we are just in the silicon. So we have multiple offload engines in the ConnectX family like RDMA. And then we have a fabric, SROV and more storage and networking virtualization offload functions but what's even similar or even more important is that now in the kernel, there is the call to support those offload engines, so we have actually put there that caused you to support those mechanisms and this is a very heavy lifting task for someone else to put upstream, the drivers for the right mix.

So, first, our silicon has great performance, power consumption, and cost and second, the software that we put upstream into the kernel is a huge advantage for us and helps everybody use this for Lennox, Windows, VMware, and all of the other higher providers out there. So we expect this leadership position to be maintained for quite some time.

James Kisner -- Loop Capital Markets -- Analyst

That's really helpful. One last one to sneak in here just on switching. Great progress there and just wondering, you talk about kind of customer concentration there -- is it fair to say that more than half revenues of that switch business are coming from one major Tier 1 customer, Tier 1 hyperscale customer? Is that fair or just maybe you can comment on your progress with the Tier 1s to the extent that you can? And I guess relatedly, obviously there was an announcement or there is an article on Friday reporting that Amazon was exploring entering the switching business. I wonder if you had any comments on that? Thanks.

Eyal Waldman -- Chief Executive Officer and Director

So, there is no concentration in our Ethernet switch business and it's very diversified across the whole geographies and we try to see more and more design wins with our Ethernet NIC and cables business worldwide. The second question was regarding the Amazon switch business.

James Kisner -- Loop Capital Markets -- Analyst

Enterprise switches, just felt that was an interesting article. Just wonder if you had any comments on it?

Eyal Waldman -- Chief Executive Officer and Director

So yes, I mean, don't have much details about this. We have to look into this. Obviously other hyperscale guys will probably not use this technology. And we see the enterprise want to use OEMs but yes, still to be seen like what the real products are and what the advantages and how do we compare to that.

James Kisner -- Loop Capital Markets -- Analyst

Thank you.

Operator

Our next question comes from John Pitzer with Credit Suisse. Please go ahead.

John Pitzer -- Credit Suisse -- Analyst

Yes, good afternoon guys. Congratulations on the strong results, Eyal. I just want to go back to the opex in the September quarter. I'm sorry if I missed it, did you quantify what the tape-out costs would be? I am just trying to figure out kind of what's the right base level to think about opex in Q3 as we start modeling Q4 and beyond?

Eyal Waldman -- Chief Executive Officer and Director

Yes. So, first, we said it's going to be multiple tape-outs, just wasn't strong. And I guess I'd say it's around I don't know $3 million, $4 million.

John Pitzer -- Credit Suisse -- Analyst

That's helpful. And then when you look at the op margin targets that you have sort of signed up for, remind me again, are those non-GAAP targets and how are you guys thinking about stock-based comp and managing stock-based comp from there?

Eyal Waldman -- Chief Executive Officer and Director

Yes, those are non-GAAP targets that we are targeting there. On the compensation side, we are definitely winning the ISS guidance in terms of our brand rate and we are in that competitive situation with our employees being very attractive to multiple companies. So we definitely think they are incentivized to say whereas our shareholders by running them equity so well. We are complying with the ISS guidelines and work that way.

John Pitzer -- Credit Suisse -- Analyst

And then my last question, Eyal, more fundamental, good to see EDR doing well, I think this is the third consecutive quarter of sequential growth but when you look at the InfiniBand segment overall, you are some about 13% below kind of level you saw back at the end of 2016. And I am just kind of curious -- it sounds like you are planning for growth going forward. I that because of the addition of HDR? Do you think the core business today can support getting back to that $130ish million level? And to the extent that maybe you are kind of converting what was InfiniBand customers to Ethernet customers, can you help me understand if that's a positive economic dynamic for you or how do I think about ASPs in gross margins if that's what's going on?

Eyal Waldman -- Chief Executive Officer and Director

Yes. So first we believe InfiniBand will grow single digits in 2018 and this is our bottoms-up forecast that's based on projects, customers, and our predictions, our forecasts. What we are seeing is that's simply growth in HPC, storage is coming back with some of the customers such as EMC, AI is growing and we are seeing more people in hyperscale opportunities to a cloud goes AI clouds with InfiniBand, so that's why we expect to have a single-digit growth this year and maybe even better growth in 2019 due to more HPC and the drive through hyperscale programs that we expected in the future will also drive InfiniBand growth.

John Pitzer -- Credit Suisse -- Analyst

But Eyal, is usual subs in Ethernet at all a headwind to growth in InfiniBand and if it is well, what's the economic trade-off of the customer choosing Ethernet over your Ethernet over years?

Eyal Waldman -- Chief Executive Officer and Director

Yes. So for us, InfiniBand and Ethernet are kind of in similar speeds pretty comparable, assuming that you take full end-to-end Ethernet for Mellanox. We also expect when HDR kicks in to have an ASP expansion due to moving from EDR to HDR. We think that InfiniBand will the stay the main interconnect for HPC, artificial intelligence and back-end storage, sometimes, it's the front-end storage, so that we believe those segments will continue to grow for us.

John Pitzer -- Credit Suisse -- Analyst

Perfect, thanks. Appreciate it.

Operator

Our next question comes from Mark Kelleher with D.A. Davidson. Please go ahead.

Mark Kelleher -- D.A. Davidson -- Analyst

Great, thanks for taking the questions. Congratulations on the strong operating margin results. I want to go back to the sales and marketing, because you got some nice leverage there, increase sequentially revenue but down in absolute dollars on sales and marketing. Can you just give a little more detail on how you did that and whether that's sustainable, what we should look for, for that number going forward, can we keep that leverage going forward?

Eyal Waldman -- Chief Executive Officer and Director

Obviously, we don't give guidance for kind of operating expense segment. I mean, we are trying to manage our opex in the best way we can. I don't think there were major events that took place in 2000 in that second quarter. We have obviously continued to manage and try to trim down our operating expenses.

At the same time, we want to meet our goals. So that's where we are heading forward, is managing our operating expenses to meet our operating margin commitments and try to exceed them.

Mark Kelleher -- D.A. Davidson -- Analyst

Yes. On the gross margin line, Ethernet has been having a nice ramp here and kind of thought it might be more of a headwind than it's turning out to be on the gross margin line. What are your expectations on Ethernet gross margins as a headwind to overall gross margins going forward?

Eyal Waldman -- Chief Executive Officer and Director

Like we guided, we expect that our gross margins to stay at the same levels for Q3 and probably the full year as we guided for the full year. We are in the higher end of the Ethernet market, 25 and above and thus I think our gross margins are still going to stay in the high 60s.

Mark Kelleher -- D.A. Davidson -- Analyst

All right. And the last question just a clarification you have talked in the past about a second cloud customer coming on board for Ethernet switches toward the second half of the year, is that still true?

Eyal Waldman -- Chief Executive Officer and Director

Yes. We are still working on it. I think it's going to be true, yes.

Mark Kelleher -- D.A. Davidson -- Analyst

OK, great. Thanks.

Operator

Our next question comes from James Fish with Piper Jaffray. Please go ahead.

James Fish -- Piper Jaffray -- Analyst

Hi, thanks for the question and congrats on an even stronger quarter than expected. I guess first is, last quarter you talked about most of the Ethernet adapter growth essentially being replacements but not just upgrading your own installed base, was that the case this quarter as well and if so any sense to what percentage of the installed base has already upgraded to 25-gig and what percentage is essentially left?

Eyal Waldman -- Chief Executive Officer and Director

I don't think there were upgrades, I think most of it, if not all of 25-gigabit and above are being new deployments. I don't think they were upgrades. The vast majority is definitely new deployments.

James Fish -- Piper Jaffray -- Analyst

New deployments meaning you are replacing Broadcom or Intel there or just net new footprint adding an existing customer?

Eyal Waldman -- Chief Executive Officer and Director

I have a hard time hearing you.

James Fish -- Piper Jaffray -- Analyst

Is it more so meaning net new being for a footprint or is it for replacing net new, replacing Broadcom or Intel?

Eyal Waldman -- Chief Executive Officer and Director

It's when people buy new compute platforms and/or storage platforms they decide which interconnect will connect those platforms to their local area network. And then before as they decide what bandwidth whether it's that 1-gigabit and 25, 50, or 100, and then they decide if they want to control it, who the vendor for those NICs are. The options, the majority of the markets is using Mellanox. We have more than 67% at 25-gigabit and above and then there is Intel, Broadcom, and some of, Marvell, I guess now.

So we actually grow our market share and continue to grow with this very attractive product in the market.

James Fish -- Piper Jaffray -- Analyst

OK. Well, I guess moving on, what was the impact this quarter from the change to ASC 606? I think last quarter it was roughly $7 million?

Eyal Waldman -- Chief Executive Officer and Director

About $2 million, something like that.

James Fish -- Piper Jaffray -- Analyst

OK. And then one final one for me. Collections look pretty good this quarter -- was that primarily due to the strong demand you saw in the first half of the quarter? Just trying to gauge how the first half of Q2 played out compared to the second half.

Eyal Waldman -- Chief Executive Officer and Director

Well, I don't think there is anything special. I think it was ordering, probably more spread even in terms of revenue across the quarter. I don't think there is anything significant.

James Fish -- Piper Jaffray -- Analyst

OK, thank you.

Operator

Our next question comes from Hans Mosesmann with Rosenblatt Securities. Please go ahead.

Hans Mosesmann -- Rosenblatt Securities -- Analyst

Thank you. Congratulations. A couple of questions. The first one is on InfiniBand, can you give us an update, Eyal, on the competitive dynamic with Intel, how is that progressed? And then the second question would just be on the tax rate -- how should we look for the non-GAAP tax rate to be for the rest of the year and next year?

Eyal Waldman -- Chief Executive Officer and Director

Yes. So let me take the Omni-Path question first, so I think Intel made it public they expect Omni-Path 2 to be somewhere out there in 2019. Regarding Omni-Path, the current generation, we are seeing people moving back to InfiniBand and people that were considering to use Omni-Path, I think are again coming back to InfiniBand, not the stores that have deployed Omni-Path coming back but those that were considering that. So I think InfiniBand is the choice for high-performance interconnect and I think this will continue.

Now we are coming out with HDR, which would increase the gap between the Omni-Path and InfiniBand, so we expect to get an even larger share of the market. Regarding the tax rate ...

Hans Mosesmann -- Rosenblatt Securities -- Analyst

Will the tax rate be in the low single digits for next year as well?

Eyal Waldman -- Chief Executive Officer and Director

For 2018 and '19.

Hans Mosesmann -- Rosenblatt Securities -- Analyst

OK, thank you.

Operator

Our next question comes from Christopher Rolland with Susquehanna International Group. Please go ahead.

Christopher Rolland -- Susquehanna International Group -- Analyst

Hi, guys. Nice quarter. In your latest investor presentation, I think you maybe added a new guidance, at least I missed it the first time. It was Ethernet NICs plus, plus was written there and it seems like you guys had another great quarter for next year.

It seems like you can easily hurdle that 25%, I was wondering if you could elaborate on the plus and perhaps give us an update for what you think NICs can do year on year?

Eyal Waldman -- Chief Executive Officer and Director

Yes. What we meant is that we expected to continue growing faster and we said adding the class was saying we are going to grow significantly more than 25% is what we are seeing. And we expect to continue growing at a very nice rate.

Christopher Rolland -- Susquehanna International Group -- Analyst

OK. And then on the InfiniBand side of things, EDR was nice up in the quarter but that also kind of implies, if I'm doing the math right, a pretty sizable decline for FDR and QDR, perhaps you could talk about the moving parts there and how that weakness kind of matched your expectations?

Eyal Waldman -- Chief Executive Officer and Director

To the new technologies with InfiniBand, sometimes it takes lower, it takes more time, but I think this is part of what we are seeing. Also, some of the embedded solutions are moving from FDR to EDR and then some of them embedded our plans as we are going through Ethernet. So this is the combination of a decline in the FDR, InfiniBand as a percent of our InfiniBand revenues.

Christopher Rolland -- Susquehanna International Group -- Analyst

Great. Thanks and congrats again.

Eyal Waldman -- Chief Executive Officer and Director

Thank you.

Operator

It appears we have no further questions at this time. I will turn the floor back over to Eyal Waldman for any additional or closing remarks.

Eyal Waldman -- Chief Executive Officer and Director

So thank you, everybody, for your interest in Mellanox and we look forward to seeing you in the near future. Thank you very much, everybody.

Operator

[Operator signoff]

Duration: 48 minutes

Call Participants:

Jeffrey Schreiner -- Director of Investor Relations

Eyal Waldman -- Chief Executive Officer and Director

Eric Johnson -- Controller

Joseph Wolf -- Barclays -- Analyst

Kevin Cassidy -- Stifel Financial Corp. -- Analyst

Gary Mobley -- The Benchmark Company -- Analyst

Harlan Sur -- J.P.Morgan -- Analyst

James Kisner -- Loop Capital Markets -- Analyst

John Pitzer -- Credit Suisse -- Analyst

Mark Kelleher -- D.A. Davidson -- Analyst

James Fish -- Piper Jaffray -- Analyst

Hans Mosesmann -- Rosenblatt Securities -- Analyst

Christopher Rolland -- Susquehanna International Group -- Analyst

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