Napatech A/S (NAPA) Earnings Call Transcript & Summary

Good morning. I'm Ray Smets, CEO of Napatech. I hope you enjoyed our opening video talking about a very important new development and opportunity for Napatech and our customers, around applying the power of our SmartNIC solution on a big problem to solve in 5G networking for the virtual user plane function. I thought it would be a good introduction to our presentation today and to whet your appetite about why we're excited about the potential of Napatech. With that I'm pleased to welcome you all to Napatech's first quarter 2022 interim management report presentation webcast. I'm joined by Heine Thorsgaard, our Chief Financial Officer here in Oslo this morning. Today's first quarter 2022 IMS was released earlier this morning on the OSE and is available on our investor relations page of our website at napatech.com. For your information, a recording of this webcast will be available on the Napatech website as soon as possible later today. As always, we will answer your questions at the end of our presentation via text, which you can submit on the webcast using the button below the presentation. We can take your questions on the phone if you prefer. If you'd like to ask a question, follow the instructions on the slide. Please note that this presentation contains forward-looking statements that are subject to a number of risks and uncertainties. Our actual results may differ from those discussed in forward-looking statements. I'm looking forward to today to giving our investors a perspective of the developments in our go-to-market strategy, why we're excited about the upcoming year. And of course, how things have started overall for Napatech in 2022. I will cover updates about our target market and the development of the server market, how we are differentiated in the consolidating group of NIC and SmartNIC makers in our industry, and some important developments in the technology space with respect to our SmartNIC and IPU technology evolution, and a new growing 5G opportunity that we are targeting. This is what excites us about how well we are positioned in a growing market opportunity. We will also review our outlook for full year 2022. To kick things off, we believe Napatech has never been in a more compelling position to take advantage of this growing opportunity. We've been executing to make all of this a reality. Clockwise, starting on the upper left of this page, our market is growing. Top industry analysts that track our market space have updated full year 2021, and are now forecasting through 2026, and they do any slowdown of market growth at all. In fact, they expect the total NIC market to keep expanding, fueled by rapid expansion of the SmartNIC segment, where Napatech is focused. By 2026, SmartNIC segment is expected to grow to $3.8 billion. This growth is being driven by server and application deployments by telcos, next wave cloud operators, hyperscale cloud operators and enterprises that are driving the need for SmartNICs, like what we make here at Napatech. Moving to the upper right, the newest, hottest tech trend in our space is the evolution of the SmartNIC to what is now being called an IPU or DPU. The goal is to offload the entire network stack, which is being done by marrying a CPU to the FPGA to boost the SmartNIC's performance dramatically. We are already participating in the SmartNIC evolution, expanding into new areas of the market that we are focus on to addressing, which we expect to grow much faster than our business does today. We are navigating Napatech to be a key player in this evolution, leveraging what we do best accelerating applications and virtual network functions on FPGA based SmartNICs. Next, we are building deeper partnerships to get access to the new and growing IPU and DPU market opportunity by bringing our best-in-class high performance software to the IPU. Moving to the lower right of the slide. I will update you on the steps that we've made in Q1 with key strategic partnership. Our strategy calls for getting into the faster growing markets, by getting access to the larger parts of the markets through these important partnerships. So we consider them important steps to growth and the value that Napatech brings to these partnerships is the rich software solution and expertise that we've created for this morning to break into several new verticals. This has shown on the lower left of this chart, where we keep penetrating and winning design wins within key areas including cybersecurity, network infrastructure, cloud and edge, mobile infrastructure and fintech. So yes, we absolutely see this as a compelling time for Napatech. So now let's dig deeper into this and underscore why we're excited. Omdia has finally published the full year 2021 market report tracking the overall NIC market and it is quite an optimistic perspective. In 2021, the total NIC market grew to a sizable $2.8 billion, up from $2.3 billion the year before. And studying the programmable NIC market which are the pink bars on this chart, which is where Napatech's target market is, which changed from the last time you saw this as you can now see the segment is growing at an even faster rate than the overall NIC market. In this new report newly revealed forecasting for 2026 shows that the overall NIC market is growing to a whopping $6.4 billion. And the SmartNIC market, which is our focus segment, is growing from just under a $1 billion in 2021 to over $3.8 billion by 2026. That's a CAGR of over 31%. So we are focused where the action is. The SmartNIC segment is where the highest performing solutions reside, delivering ultra-high speed networking functionality with the ability to be reprogrammed and enhanced with new software to meet the ever changing customer requirements for high speed, mission critical apps. Napatech is keenly focused on addressing this programmable NIC market segment. There are a few additional points that I'd like to note. In the overall NIC market, we remain in the top 10 of the NIC makers. There are 40 other NIC companies that make up the other category. So being on the top 10 list is a significant part of this market. But more importantly, the SmartNIC market is the fastest growing part of the overall NIC market and we are listed as a top vendor in this part of the market. The growth of the SmartNIC market is being driven by the need for speed and the requirement for apps to perform better in highly virtualized environments, such as cloud, hyperscale and 5G Mobile. We're investing in new inline and virtual use cases to augment our already strong position in packet capture to get more growth in this market. So our solution is relevant and growing in this market and when we gain traction with new design wins in this area, Napatech will see significant growth coming from these opportunities. So why are NICs hot and what is driving the growth in SmartNICs? Well, an important underlying market trend that the NIC market rides on is the server market. So we track this trending market too, just to validate that our focus areas, and overall product strategy is focused on the most important opportunities for growth. The server market is also hot. This market is expected to grow from $80 billion in 2020 to $138 billion by 2026. Data centers are now the center of the universe for running applications and services that we consume on massively growing numbers of connected devices -- IP connected devices and these data centers are massively deployed sets of servers that are the CPU platform that run these apps and services. So each and every server that's deployed in a data center needs anywhere from 2 to 8 NICs to operate and perform, increasing the performance of their apps that run on the data center. Our FPGA-based SmartNIC is designed to fit within these servers to accelerate specialized CPU-intensive workloads, increasing the overall performance of the server, while improving the financial performance and ROI of the data center. So more SmartNICs means less servers, which has a significant financial benefit to data center operations, such as in telcos, Tier 2 cloud operators and hyperscale operators. We at Napatech are working hard to keep our technology relevant in these massively dynamic and growing parts of the market, and we see no limit to the potential here. So where do we fit amongst the key vendors in the NIC market? To keep this very simple, we use an FPGA as a foundation to our technology design, which gives us the highest performance with the greatest programmability. When both of these factors are combined, that's top performance and super programmability compared to the SoC based or ASIC-based NICs, FPGA-based NICs rise to the top of potential here in this market. FPGAs win on performance because we are a hardware accelerated performance, whereas SoCs are software accelerated. FPGAs win on programmability, too, because we are hardware and software programmable where SoCs are only software programmable. So we are the optimal mix of price, performance, functionality, cost and power. Napatech's solution is built to allow our customers to reap these benefits. So without a doubt, customers select Napatech because of our software, which is production grade, plug-and-play, feature-rich and, of course, high performance. This high performance is derived by our software squeezing every bit of performance we can get out of the FPGA and our hardware design. But we have to do this with the right cost consciousness mindset, selling this value at the right price with a mix of features and performance. Also worth noting here is that we exist in a dynamic marketplace of different players. We have seen consolidation and M&A within our space as companies align their strategies to go after the same market space. To top off a few years of M&A in Intel, Xilinx and NVIDIA, we have recently seen Xilinx fully acquired by AMD and then a sudden move by AMD to acquire Pensando, which continues to stir the pot. We remain confident that as the largest pure-play FPGA vendor in our space, we bring a unique value of a complete solution to the SmartNIC industry, a feature-rich high-performance plug-and-play solution, leveraging best-in-class underlying FPGA technology to solve some of the biggest problems evolving in networks today. I firmly believe that if we stay on track, Napatech will bubble to the top of this heat. By the way, please note that there's a blue link on this slide. If you click on it, it will take you to a great easy-to-read report that highlights these vendors in comparison to Napatech to give our investors a great idea of why you should be excited about Napatech. I invite you to download it and check it out. We will also make this link available on our IR website. So as we've mentioned before, our partners have been driving the next evolution of the SmartNIC to meet the unstoppable rise of business needs. The world has become even more dependent on data applications in the cloud. And to this, the architectural evolution of mobile networks to roll out 5G, the explosion of artificial intelligence and catalyst of IoT, the need for performance in the data center has become even more intense. In highly virtualized environments where our market is evolving fast, server computing resources are being stretched to their technical limits to process more complex applications along with hypervisor container engines, network and storage functions, security and greater amounts of network traffic. Server technology just can't keep up. So more infrastructure tasks need to be offloaded from the server to -- well, you guessed it, to the SmartNIC. So even the SmartNIC needs to have more compute horsepower. As in our design with the FPGA, which carries a generous load of compute, industry giants like Intel, Xilinx and NVIDIA have defined new classes of processors called deep user IPUs infrastructure processing units that include general purpose computing cores. The difference between the IPU and just a normal SmartNIC is that the SmartNIC can accelerate effectively any sort of infrastructure app, which is what we at Napatech do every day. But the IPU is designed to go further and offload and run the entire network stack, which will give service providers a brand-new option to deploy network and security functions. So how does Napatech participate in this evolution? Well, guess what, we already are. We will expand our SmartNIC hardware solution to include IPUs and it is our ambition to win new business in 2022 and beyond in this exploding space. To validate our seriousness about skating to where the puck is going, I would like to show you the newest evolution of our SmartNICs and IPUs that are rising and raising the bar of our performance, all with a focus on, and even more relevant opportunity in this growing CPU-hungry market that we serve. This series that you see in front of you of SmartNICs from Napatech demonstrates our focus on increasing our available port speeds and board densities focused on cloud, telco and enterprise requirements. A lot has happened since we first introduced the NT50, the board on the left, which was designed to get ahead of the curve with our virtualization solution where size and power was optimized to meet the market for a broad-scale deployment within the 5G environment. Since then, we've designed the other 3, which move up the technology curve of increasing speeds and densities and expand our potential to win higher performance, optimized designs that cloud and telcos need now. And there's a very important unseen development in the Link-400, the fastest, highest performance SmartNIC on this slide. This one is our first board ever that is designed with the Intel FPGA supporting 2/40, 100 and 200 gigabytes of throughput running the same software solution as our other SmartNICs based on the Xilinx AMD FPGAs. And guess what, we won't stop there. We are working on taking another step soon with a higher-performing 400-gigabyte solution so that bar none, Napatech will have the best overall performance of top-performing feature ability for the most demanding customer requirements in this space. So rest assured, we are continuously upgrading our product offering to put Napatech in the best possible spotlight for growing opportunities. So if you invest in Napatech, this is really important to know. It should be no surprise of what we are banking on at Napatech. We believe the growing need for accelerating workloads in the massively growing virtual networking areas such as in 5G, will create a significant growth opportunity for Napatech. And in order to win there, we need to drive our technology with this in mind. It is key and fundamental to our overall growth strategy. The backdrop of this is that 5G networks are changing everything. Networks are now data center applications running on servers with a growing number of CPU-hungry apps needing lots of CPU horsepower to run efficiently and effectively. 5G will boost speeds and mobile networks to 20 gigabytes per second while reducing mobile network license latency dramatically. These new abilities will generate a lot of new mobility use cases from smart vehicles to remote control devices, all requiring high performance and bandwidth. So where does this all get built? Well, it gets built on data center servers, right, where Napatech solutions can add immediate value. Napatech is building our solutions in the heart of the 5G network virtual architecture and deployments. And there is 1 emerging area that is getting even more interesting for us that's driving some excitement. Napatech has introduced its solution to help maximize 5G performance in the core of the 5G network, accelerating the 5G user plane function for the video that we showed at the beginning of our presentation. I realize that this is deeply technical, but it is in a very basic way, the 5G user plane function is a bottleneck for the packet core infrastructure, requiring a lot of CPU, CPE horsepower to run. The 5G UPF is an industry standard data plane function that is required as part of the 5G packet core, performing packet routing and forwarding, packet inspection and quality of service handling, all of the things that we at Napatech know how to handle really well. If performance is weak, mobile networks' performance is impacted and more costly to build and operate. You can correct performance by adding a lot more servers or by adding less servers, but boosting their performance with SmartNICs that accelerate the user plane function. We do this virtually, and we have a market-leading performing solution that does it really well. When we do the math on the potential market for this requirement, we see with reasonable market penetration that this will be a viable market for Napatech. So we are working with partners now in building software and hardware solutions now to make an impact in this market. So can Napatech make an industry-leading solution in this new 5G arena yes, we can. Absolutely. When we benchmark our solution against the other guy's solution, we outperformed them significantly with double the throughput massively greater concurrent traffic flows and a much higher learning rate and throughput. We are already engaged with the top 5 U.S. and EMEA telecom operators. We are deeply aligned with the top 2 global ISVs developing the applications for virtual user plane function. We are already solidifying our go-to-market in fulfillment with the top 2 global server OEM and integrators, and we have active proof of concepts that are in process with stunning performance in benchmarks being achieved. So out of the gate, we have a SmartNIC platform that has the most comprehensive feature set for virtual user plane function, and we're going to go for it. We know we can't do this all ourselves. One of our key strategies for growth is by engaging key relevant strategic partnerships that give us access to growing parts of the market that we are serving. On the left side of the slide, our key important partners we've been nurturing over the last couple of years, and this list includes 3 of the most important FPGA makers globally. To touch on our most important partnership that we announced in 2021 with Lenovo, we continue to see Lenovo engaging and testing our network virtualization acceleration solution with important APAC cloud and telecom customers who are deploying 5G. Lenovo is a Tier 1 server maker with long and deep relationships with the kind of customers we want to get access to. In this partnership, we bring our latest hardware and software solution focused on virtually virtual networking to their market, running our newest Link Virtualization SmartNIC software designed to accelerate apps and services, meeting the most demanding virtual requirements in 5G mobile telecom operators. This sales effort with Lenovo is taking longer than expected, but we remain active and engaged, and we have not lost any deals and the pipeline of activity with Lenovo is still very attractive and growing. These potential orders via Lenovo are quite interesting to us because they can multiply quite fast. And due to the scale of these server deployments, they could dramatically increase Napatech's annual production volume. Napatech's partnership with Achronix continues to evolve, too. We are collaborating with the Achronix on their Speedster FPGAs, evaluating and aligning our software roadmap to better target growing customer markets in cloud, telecom and enterprise data centers. As we mature this collaboration, we will release more information about the intentions of this evolving partnership. So this is a work in progress with an early innovator in this expanding space and domain. So watch this space more to come. We are proud that we continue to make solid progress with Intel as a strategic partner on a number of strategic fronts. We will deliver the first generation of Intel-based FPGA SmartNICs in the coming quarters as we showed earlier in our presentation. And Intel has selected Napatech -- very important topic here -- to develop a special software support package for VMware acceleration on Intel-based SmartNICs and IPUs to make their FPGA work more seamlessly in the VMware environment. We expect this will open the door to other interesting VMware-based use case opportunities with Intel. The deal from Intel is a 7-figure deal paid by Intel, which will be delivered in the 2022 timeframe. So Napatech is in a better position than ever to grow with these larger ecosystems. One of the ways we'll grow is by getting access to the market through them and through these important partnerships. So we consider them important steps to growth. And the value that Napatech brings to these partnerships is the rich software solution and expertise that we've created for the SmartNIC. So let's get into the financial details finally. I'll start with a brief highlight of Q1 and a review of the key customers who expanded their data center technologies with Napatech SmartNICs in Q1. Then I'll hand it off to Heine Thorsgaard for a more detailed overview of our results. Q1 is always a momentum-building quarter for Napatech, where we get a good and a better feel for what the full year and what our stride looks like towards these annual goals. Napatech started this year working hard to make our new partnerships work, and we kept expanding our customer base and shipping our solutions for customers' deployments even at a time when more supply chain uncertainty has been occurring. We feel Q1 started as expected. Revenue growth in DKK was up 12% year-over-year with favorable foreign exchange, and we grew 4% year-over-year in USD. This represents an unbroken record of year-over-year growth for revenue for the 14th quarter in a row going back to 2018. Gross margins were 51% in Q1, which is a bit unusual for Napatech, but for good reasons. As communicated earlier, we've been working on disaggregating our prices to support the sale of software-only and hardware-only products. We announced both software-only and hardware-only solutions over the last few years. In Q1, we shipped the larger hardware-only order as requested by our customer, who has decided to buy the software when the hardware was ready for their customer deployment. Of course, this customer will also buy the software needed to power the hardware in this initial order. Thus, this ordering arrangement had a significant impact on the margins in Q1. To add some color, if the solution they bought had just been purchased normally as a hardware software bundle, revenue totals in Q1 would have been around USD 9.5 million and over 60% gross margin. We promised our investors that we'll built a leverageable business model. In 2021, we proved that to be the case. In 2022, we will do the same. We agreed to spend more investment in engineering resources, which has gone very well. And despite this increase in hiring, we have done a great job keeping overall staff costs low with the use of lesser expensive third-party resources. So let's move on to key customer orders in Q1 2022. I'd like to show you some of the more interesting customers that have ordered from Napatech in Q1. We have well over 200 customers that have selected Napatech solutions over the last 4 quarters. This is a sampling of some of our Q1 customers from all over the world and from different market domains who put their trust into Napatech SmartNICs and software. What you will see as you scan through this list, I'm showing you here of active customers is a mix of both OEM and end user customers. OEM customers like IBM, Mobileum, Polystar, Pico, NEOX, TOYO and VIAVI and some that we cannot show you or name, have designed our product into their product lines, which often result in a strong order volume over a number of years. These customers represent about 75% of our revenue, and we consider them to be extremely strategically important to the long-term viability of Napatech to remain stable and to grow. End-user customers like Facebook, GoDaddy, Yoroi, Navantia, Ghost, Jump Trading or even Starbucks, purchased our products for specific deployments and use cases where we help them improve their application and data center operations. Let me just highlight a few. Ghost is one of the newest autonomous driving tech companies using our product to deliver next-generation transportation solutions, pretty cool application. Baraja is building deep technology that has reinvented LiDAR for self-driving vehicles, also very cool. Herrick Tech Labs uses our solution in their software-defined radio products for defense use cases, pretty useful right about now. GREYCORTEX is a network security monitoring and response solution using our SmartNIC security features. Yoroi, a web light wallet for Cardano, which is a public blockchain company to use in the growing crypto market is also leveraging our solution to grow their product line. We are very happy that Facebook is expanding on their Suricata opensource deployment that we helped accelerate and GoDaddy use our solution in their DNSPod build-outs. And other new logos like Spark, a telecom company in New Zealand, Guard Technology, an enterprise cybersecurity and event management company in Germany. Decent, an investment company in Shenzhen, China and QoSient and network situational awareness company in New York City, all use our SmartNICs for key applications in their data centers. These end users represent the other 25% of our annual business. So we're pleased with the overall customer wins in Q1, and we're building progress through 2022. I would now like to turn the call over to Heine Thorsgaard to review more details about our Q1 results. Heine?

Thank you. Revenue in USD in Q1 was up 4% compared to last year. Due to the strengthened U.S. dollar revenue in DKK was up 12% compared to Q1 of '21. Gross margins in Q1 ended at 51%, down 19 basis points compared to last year. As Ray mentioned, margins are significantly impacted by the larger hardware-only orders shipped in Q1. Product margins are also impacted by the fact that our new price list does not fully take effect until Q2 this year. Many orders shipped in Q1 were placed on the old price list as the component cost for manufacturing these products were materially impacted by the higher prices caused by supply chain shortages. We expect product margins to be back to normal levels from Q2. Our staff costs and other external costs amounted to DKK 35.4 million in Q1 compared to DKK 30.9 million in Q1 of '21. The growth in staff costs reflects on new hirings and R&D staff that we communicated around last year. EBITDA in Q1 amounted to negative DKK 9.1 million compared to plus DKK 2.4 million in Q1 last year. Staff costs transferred to capitalized development costs in Q1 amounted to DKK 7.1 million compared to DKK 6.4 million in Q1 '21. EBITDA in Q1 amounted to negative DKK 2 million and EBIT amounted to negative DKK 7.7 million compared to EBITDA of DKK 8.8 million and EBIT of DKK 3.6 million in Q1 last year. The results of Q1 amounted to a negative DKK 6.6 million compared to DKK 5.2 million in Q1 of '21. Net cash flows from operating activities in Q1 amounted to negative DKK 0.3 million compared to a negative DKK 12 million in Q1 of '21. Net cash flows in investing activities in Q1 amounted to DKK 10.9 million compared to DKK 7 million in Q1 of '21. Free cash flow in Q1 amounted to negative DKK 11.7 million compared to negative DKK 19 million in Q1 last year. Cash and cash equivalents at the end of Q1 amounted to DKK 33.4 million compared to DKK 40.8 million at the end of Q1 last year. Back to you, Ray.

Thanks, Heine. Now let's turn our attention to our outlook for 2022. So as we look at 2022, we say full steam ahead. We see a large opportunity in front of us and fast-growing target use cases in cloud, telecom, enterprise edge data center deployments. And our SmartNICs solved an immediate problem to offload servers and accelerate apps, and the problem is only getting bigger. Our SmartNIC software, which is our competitive strategic weapon will continue to improve performance for critical apps and use cases and our software is our key strategic advantage. As we mentioned in the last few quarters, Napatech has increased investments in software development to accelerate feature velocity within our evolving market, and our hiring is on track as predicted, and we will accomplish most of our employee contract hiring goals as expected in the first half of this year. We are confident that this focus and these investments will get us access to new design wins and revenue expansion for years to come. We believe focusing our business and making these investments now is the best thing to do for our customers and for our investors. So with everything that we can see today within our customer markets and pipeline development, we are reiterating our annual guidance for 2022. We expect revenues in the range of DKK 235 million to DKK 260 million, corresponding to a growth rate of 20% on the low end and 33% on the high end. Despite our Q1 gross margin results, we expect gross margin for the year will be achieved in the range of 69% to 71%. And staff expenses and other external costs are well managed. And even with our increase in engineering expense, we expect to be in the range of DKK 155 million to DKK 165 million in 2022, along with staff costs transferred to development costs in the range of DKK 28 billion to DKK 33 million. We expect depreciation and amortization to be in the range of DKK 23 billion to DKK 28 million too. So with performance in the middle of the guided ranges, EBITDAC would be positive at DKK 13.3 million and EBIT would be positive DKK 18.3 million. So in conclusion, well, we keep executing our business, and we're chasing a very lucrative opportunity for growth within a very, very important market that's expanding rapidly in the data center domain. Our core business has been solid in the most volatile environments around over the last 3 to 4 years. And we are building on this as we execute our way into bigger and very compelling market opportunities of accelerating apps, offloading functions and virtual networks and catching the wave with IPUs through partnerships and new ways to get to the market. Overall, we remain optimistic about the potential for growth, and we are striving every day to unlock the growth potential with innovative technology, SmartNIC solutions and features that deliver market-leading performance for our customers. We are in the most compelling era for Napatech right now. There is so much potential. We know what we can do. We have a plan to get access to the growing opportunities in this marketplace, and we have our eye on the prize. So we're full steam ahead in 2022. Now we just need to go get the job done. And now I'd like to invite Heine Thorsgaard to join me to take your questions. [Operator Instructions] Operator, do you have any calls in the queue?

[Operator Instructions] I will now hand over to Ray for the webcast question first.

We do have a few questions that have been texted in. So I'll just take the first one. And Heine, I'll read it out loud. I think this is one that we can both answer. As component shortages continue to be a problem for most companies with hardware and its supply chain. Can you give us a comment about how this issue is developed for Napatech so far during the year and how you expect it to develop for the rest of 2022? So it's an interesting question, of course. We're not able to avoid this. Most companies are dealing with the supply chain challenge. We've done a really good job from an operational and manufacturing point of view to forecast what we believe our business will look like over the next 24 months, and we've been very good at securing pipeline of components within that time frame. So we feel very confident at this point in time that we have access to the components necessary to build out the solutions that we have from a hardware perspective over the next 18 months to 24 months, and we do not see any risk at the moment with our ability to achieve revenue. Of course, this is a highly dynamic situation. We're watching it very, very carefully. We give it a lot of management and executive attention and we will be evaluating our situation in that area. But right now, we view this as a very low-risk area for Napatech. Heine, do you want to add anything to that question?

And maybe just a slight comment on the feedback we are getting from the other companies in the supply chain is basically that this is expected to continue for the rest of the year and also basically into 2023. So it's -- I mean it's not getting worse for us, but it seems like the supply chain issues will continue for like at least a year or so. And it, of course, is creating some uncertainty with the end users as well, having difficulties in getting all of the components that they need in order to complete their products. So we have some issues, and we expect that this will continue. But as Ray mentioned, we are navigating and feel that we are basically controlling the situation as good as possible.

And I'll just make one additional comment and then read the next question, which is somewhat related. We've also taken action in Q4 of last year to raise our prices accordingly to deal with the rise in prices of components. So we have that in effect. It will be in full effect starting in Q2 this current quarter. So I think we're in good shape in terms of nipping that in the bud as well. I do have a second question online. I'll just keep going here. We'll go back to the phones here in just a second and check with the operator. Can you comment on the gross margins for Q1? Can you explain it further? And do you have any expectation when you might see software revenue for this order that you commented on? So yes, I think, first of all, it's related to the first question to some degree. In this particular case, we disaggregated our pricing our price book. We sell typically a bundled solution, a hardware and software solution bundled together. Most of our customers consume our products that way. But as you guys know, we've been also embarking on a mission to increase our software-only revenue. And we've disaggregated our price book to do just that. In this particular case, we have a customer who chose to purchase our product but defer the purchasing of the software until the actual product is deployable. So we see this as probably an effect related to component supply challenges by certain customers in the end user space. But we have this well in hand. We feel pretty confident that this customer will place the remaining portion of the order for the software before the end of the year. So it has had an impact in the Q1 margins, but what we feel confident that the annual gross margin plan that we currently have in place is achievable for the year. Heine, do you want to make any additional comments on that one?

I think you covered that fine.

Operator, do we have any calls in the queue?

And we currently do not have any at the moment.

All right. Then I'll just keep going with the texting questions. There's one that just came in, so I'll read that one. There's also a follow-on question, I think, is related to that. Any update or can you add any additional color on the opportunity with Lenovo? And a related question is, can you talk about the progress you have with virtualization opportunity during Q1 and going into Q2? As we mentioned in the webcast, just a few moments ago, we continue to work with various partners to get access to markets that we can't easily get access to. Lenovo is a very important partner that we put in place early last year with a branded Lenovo solution, it's our NT50B that is branded as Lenovo that Lenovo takes to their market, especially in the APAC telco space and cloud domain, and they're actively engaged with end user testing right at the moment to position their product with our product packaged within it in those particular customer use cases. We continue to see activity in this space. We don't feel like we're missing any opportunities here. This does take time. It's sometimes hard to predict when the order will actually drop. But we feel very confident that the software and the hardware is performing very well against a set of tested tests within those use cases that are being tested by these cloud and service providers. And we're hopeful and optimistic that we'll see this develop sometime during the course of 2022. It's hard to predict exactly when we'll receive these orders, but I can assure you we are fully engaged with Lenovo and feel very, very positive about the relationship that we have with them so far. And the related comment here, or the question about progress with virtualization in Q1 and Q2. Overall, our product line continues to shift from the past where we did primarily packet capture solution to a number of features that we've developed across the entire product software platform that address many, many new different use cases. And obviously, one major use case within the telco and cloud arena is virtualization. So virtualizing applications and services on data center -- in the data center on servers, and that can be those workloads can very well be offloaded onto the SmartNIC. So it is having an impact in our business. You probably detected in some of the customer use cases that we talked about that they're deploying our applications in certain virtualized environments, and we're going to continue to swing for the fences. So we feel very confident that the opportunity exists for us and virtualizations and so it has had an impact in Q1. It's certainly taking our time and effort to develop the solutions for our channels to the marketplace, and we expect to see more progress in Q2 through the entire 2022 and beyond. And we feel confident that a major growth driver for Napatech over the next 2 to 3 to 4 years is going to come directly from the virtualized infrastructure that we're accelerating right now in the data centers. So thank you for that question. Operator, any questions out there online?

No. We don't have any questions. [Operator Instructions].

All right. We do have another question that has been texted in. This one is related to our hiring progress of engineers to increase our software development capabilities within Napatech. I'd like to say that we're doing very well in terms of acquiring the headcount that we've outlined. We indicated last quarter, and again, obviously, this quarter, that progress is going well. We anticipated adding 30 new engineers within our engineering team over the last couple of quarters with an expectation that we'll achieve that will result by the end of Q2. And I think we're doing pretty well getting there, and it's all factored into our guidance and our cost infrastructure. So thank you for that last question. I don't see any additional texted in questions at the moment. So operator, I think we're done on this side. If there are no more dial-in questions. I think we'll bring this to close. Are there any other calls holding?

We currently do not have any questions.

All right. Then I'll bring this webcast to a conclusion. So first of all, I'd like to thank our investors for listening in today. We continue to be very optimistic about Napatech in the direction that we're casting for Napatech over the next year to 2 to 3 years, we will strive for greater growth as we execute faster by getting those partnerships in place and getting access to customer revenue. So I'd like to thank our investors, I'd like to thank our viewers and obviously, thank our employees for a job well done, and thank you for listening today for our webcast.