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

Good morning. I'm Henrik Jensen, CEO of Napatech. I'm pleased to welcome you all to the 2023 Napatech Half Year Report Presentation. Our half year report was released earlier this morning on the OSE and is also available on the Napatech website. For your information, a recording of this webcast will be available later today. As usual, we will answer questions at the end of the presentation, and you may submit your question via text on the web page or we can take your question on the phone. [Operator Instructions]. Please note that this presentation contains forward-looking statements that are subject to risks and uncertainties. Our actual results may differ from those discussed in forward-looking statements. Our agenda today will cover updates on progress in business and partnerships, an update on the data center market over the coming years and how it relates to Napatech's strategic plans. And I'm also going to brief you about the progress in our strategy in relation to our key partnerships. And finally, we'll do a review of our half year financials and expectations for the rest of 2023. Group-focused efforts and instrumental teamwork, we have made significant progress in key areas and are on track to meet our overall objectives for the year, which I'm going to brief about during the next couple of slides. I'd like to begin our business update for the first half of 2023 by sharing important results that position Napatech for new high-growth market segments by delivering our next-generation programmable NIC solutions. As I've talked about earlier, Napatech have made significant investments in developing new programmable NIC solutions that match customer-driven needs from mega trends. And now we start to see the result of this by early customer engagement, recognizing the acceleration performance, business and sustainability benefits of the Napatech Programmable NIC solutions. We also see the first results from key parts of our strategic plan, including our initiative with Intel that combines state-of-the-art technology from Intel with the Napatech competencies in product development that our customers require. We have begun joint sales, marketing and business development efforts and unlock new prospects for Napatech projected to drive increased demand on a potentially transformational scale over the coming years. Our new SmartNIC design win with a Tier-1 equipment manufacturer, F5 Networks, providing network security solutions will contribute to our 2023 results as well as for the coming years. Napatech have delivered the first SmartNIC to F5 for their validation and solution integration. Finally, I'd like to underline an important fact. All of the new SmartNIC and IPU products, Napatech are delivering during 2023 and over the coming years are leveraging Napatech's many years of FPGA-based product technology as a recognized brand name in the industry. All these results are strong signals of the potential for the new Napatech Programmable NIC products within new high-growth market segments that I'm going to talk more about over the coming slides. Here at the halfway point of our financial year, we must recognize that our business mirrored the underlying market trends. The end-user IT spendings within our traditional business remained guarded. And in addition to this, the server shipments had an unexpected slowdown in server shipments in the first half of 2023. That likely played some part in our performance year-to-date, which is reflected in our financial figures. However, we continue to see signals of improvement across many areas of the IT industry that allows us to affirm our 2023 guidance. As we look forward, Napatech continues to execute upon our strategic plan that consists of 3 key elements: the first is about servicing our valuable installed base of customers, the early adopters of programmable SmartNIC. These customers anchor our current business and their product requirements are the foundation from which our growth will begin. Secondly, we continue to accelerate our investment in engineering for the new hardware and software requirements that extend our product portfolio with new SmartNIC and IPU products, enabling Napatech to service and sell into the new projected high growth segments. Thirdly, we continue to develop our ecosystem to partnerships that expand our go-to-market reach through marketing, business development and sales activities that strongly supports our efforts to develop our pipeline and deliver our next-generation SmartNIC and IPUs to customers. I'd like to begin our market update by sharing our point of view on the mega trends within the IT communications industry that are having the most significant impact on driving new network architectures and hedge opportunities for Napatech. This include the rapid ascent of artificial intelligence applications and utilization scenarios and next wave of cloud service providers who are creating tailored solutions for targeted customers, telecom operators deploying new core in its networks for advanced 5G services and private 5G networks or a near infinite set of emerging IoT use cases. In all economies, cybersecurity demands are pervasive and new verticals continue to emerge within fintech and finance services as well as storage and content delivery. In total, we have not seen so many changes impacting the way organizations are designing their networks since perhaps the dawn of the cloud era more than a decade ago. These mega trends play a direct role in the significant growth forecast in the market Napatech are targeting to service by delivering our programmable NIC. These days, programmable NIC products are known by many names, including SmartNIC, infrastructure processing units or IPUs. But regardless of the name of the programmable NIC, they all aim to solve the biggest problem facing these new network architectures that require acceleration of the most burdensome workloads running on the servers. The networking, storage, security and virtualization functions are critical components of the next-generation network design, but at the same time consuming a large amount of the most valuable resources in the server, the compute resources delivered by the CPU. Napatech's SmartNIC and IPU products deliver a complete solution of hardware and software support in a turnkey production grade solution that returns those valuable compute resources to the applications and services that generate the real business for the network operators. When Napatech provided our programmable NIC, we uniquely enable IT organizations of every size to achieve performance, business and sustainability benefits that were previously only available to a small numbers of the large hyperscalers network operators. Now I'd like to provide an update on the data center market as it provides insight into both our short-term expectations and long-term aspirations. The first bar chart on the left shows the historical server demand. Many of you know the servers are primary bellwether for network interface card demand. Server shipments showed an unexpected slowdown in the first half of 2023. This is due to several reasons within what have been cautious and reserved IT spending environment. It is with some optimism that industry analysts anticipate a return to normal growth in server shipments through the end of this year. The second graph in the middle fuels our optimism about the future. This first shows that NIC market continues to grow at record levels providing connectivity for servers and appliances that make up the next generation of data center networks. Within the raw growth of the NIC market, the programmable NIC dominate. In fact, the most recent data shows a continued decline of ASIC-based NICs and for the first time, a decline of offload NICs. The demand for programmable NICs that historically had come from a small number of hyperscale network operators who build their own solutions now begins to open to vendors, not only supplying the hyperscalers who created the market but a long list of newcomers, including next-wave cloud operators, telco operators, enterprises and government networks. The third chart provides some interesting information about the top solutions within the programmable NIC market. While we are still in the initial phase of the programmable NIC market growth, nearly 50 companies had set out to lay claim to this valuable segment within data centers. Although it's still early days, Napatech's history of building FPGA-based SmartNIC has allowed us to separate ourselves from the longer list of new entrants. This chart shows Napatech as one of the top 10 suppliers among all NIC types as well as programmable NICs. It is important to note that the companies like Microsoft and Amazon build their own solutions, sometimes referred to as self-build. And they do not supply the solutions to the general market, which make Napatech #7 globally among vendors for programmable NICs. An important nearing within the chart that is worth calling out is the fact that Microsoft solutions are based on an FPGA architecture powered by Intel. And in addition, Intel themselves has a broad set of solutions for the market. Combined, this is a 41% market share showing the dominance of Intel and the power as a market maker. And this is a key point behind our strategic plan and the initiatives we are undertaking with Intel, delivered this market-leading position, combined with our history to deliver equivalent solutions to the broader market, as previously mentioned, mega trends unfold. On this slide, I'd like to expand upon our Intel journey a bit further. In the first half of this year, we disclosed part of our strategic plan to take advantage of Intel's market-making position behind programmable FPGA-based SmartNICs and IPUs. I'm pleased to report today that all our hardband software development efforts to create Napatech's first into the based IPU product, on track for first customer shipment by December of this year. The partnership combines the premier technology from Intel with the Napatech competencies in product development, delivery, services and support that end customers require, where during the first half of this year, began joint sales, marketing and business development efforts are somewhat ahead of schedule. These business initiatives unlock new prospects for Napatech projected to drive demand into the coming years on a scale that could be transformational. When compared with our historical business shipping around 8,000 units per year, these new products and prospects could individually consume upwards of 5,000 units per year. In addition to those activities into recently published solution brief outlining the many benefits of FPGA and SmartNIC, IPU solutions, this paper features on the Intel website and promoted globally through Intel and Napatech marketing, highlighting breakthrough performance of cloud operators that can only be achieved with the combined Napatech and Intel solution. If you would like to read the IPU solution brief, a link is available on our website. The first half of 2023, we disclosed a new design win with F5 Networks, a Tier-1 original equipment manufacturer who built network and security appliances. Their security solution will include 1 or more programmable SmartNICs from Napatech. And this design, when includes, a Napatech SmartNIC based on the latest technology from both Intel and Napatech that allows our customer to achieve stunning product performance. This is a special valuable design for Napatech due to the combination of the revenue potential and the fact that this is tied to an established leading supplier with a current run rate business unlike other of our design wins, where our customer may have to go through a lengthy process of establishing themselves in the market before their product success translate to a product demand for Napatech. Additionally, this design win is a clear signal of the value of our Intel partnership. I'm also happy to report that our engineering development program is on schedule and meeting the end customer requirements. We have received and shipped initial orders for the product that are being used by the customer to continue their testing and qualification. And we have received preliminary volume forecast production ramp from 2024 and total production in 2026, meeting our business expectations. Another strategic milepost results that we have accomplished is the continued expansion of our ecosystem and customer reach through partnerships. These types of partnerships play an invaluable role in Napatech achieving our growth ambitions, while the first accretive part of our strategic plan is to develop the product aligned with the high-growth market segments. The second and equally important part of our strategy is to be able to deliver these products to the customers who need them by aligning with their purchasing behavior. These partners provide many key functions like application software, servers and the system integration to form the final solution to the end customer. And very important, a direct relationship with the end customer that Napatech may not have. The partnership activities includes joint sales marketing and optimization of time line around proof-of-concept trials and the overall design win cycle. In many cases, it also includes fulfillment in a way that is acceptable to the customer. So in total, these partnerships play a crucial role in the pipeline development, fueling our revenue growth ambitions for the future. The partnership we have announced in the first half of the year include those activities with the leading server manufacturers like Advantech, Kontron and Jabil with several others in the pipe. These server manufacturers who the end customers traditionally do business with, consider Napatech's part of the solution imperative. We also announced partnerships with 2 of the most recognizable software companies, A5G and Druid, who provide the software application that power the 5G core networks. The customers in the growth vertical have shown a great deal of interest in the Napatech Programmable NIC acceleration of the 5G core software. In addition to A5G and Druid, we have 17 5G core software companies in the pipe. Finally, we have announced partnerships with Databento and Orthogone, 2 companies who have developed specialized software that require programmable SmartNIC to accelerate the application software, targeting the financial service markets. And you can expect to see a steady stream of partner announcements over the coming quarters as we continue to align our products with the highest growth applications and services that demand a programmable SmartNIC. On this slide, I'd like to tie the results of our strategy together by elaborating upon one of our solution, enabled by our product investment and brought to life through the partnership we have developed. As briefed about earlier in the year, Napatech achieved a lot of interest for our new software for 5G user plane function exploration during the Mobile World Congress in Barcelona. On the hardware front, we've developed a new programmable SmartNIC capable of achieving very high throughput performance, and we have combined this hardware with our new in-line UPS software that secures massive acceleration of the 5G core software in both public and private 5G networks. This specific use case around accelerating the user plane function, or UPF, has generated astounding results in terms of the number of users that operators can service with a single-server footprint. These technology metrics immediately translate to valuable savings in both capital operating expenses. These results are what are driving both customer interest and partnership creation for our UPF solution. Through these partnerships, that provides a complete solution to the end customer, including the server, UPF software application and the Napatech Programmable SmartNIC, several early prospects, including a private enterprise customer have been able to validate these results. One last item about our product solutions that I would like to share with you is an important contribution that our solution is making to help our customers fulfill their ESG aspirations when building modern data center networks with sustainability in mind. The challenge that network operators are facing as they build their networks are well documented and they include increasing and fluctuating energy cost, limited availability of power, and for some of you, its data centers, regulatory constraints around power and emission. The sheer amount of power, space, cooling it takes to operate these networks are increasing concern and focus area. And until recently, many of these factors was outside of the network operators control. So we are pleased to share that Napatech solution helped to maximize the server utilization while at the same time, minimizing the overall data center power consumption. When Napatech solutions are benchmarked against legacy solutions of software-only scenarios and even competing solutions, our programmable SmartNIC offerings deliver very valuable and measurable energy-saving results. Telco operator is currently conducting evaluation and measuring these same positive business benefits. And more details of the Napatech solution will be featured in a Q4 global webinar from a top industry analyst, a system vendor and a European-based Tier-1 5G telecom OEM. I'll now hand over the presentation to our CFO, Heine Thorsgaard.

Thank you, Henrik. Revenue in DKK in Q2 was up 7% compared to Q2 last year. In USD, revenue was up 10% compared to 2022. For the half year, revenue in DKK was down 15% compared to last year and amounted to DKK 74.9 million. Q1 in 2022 was the last quarter before the market uncertainty following the Ukraine crisis impacted our revenue. In USD, revenue in first half amounted to USD 10.9 million compared to USD 12.9 million in 2022. Gross margins in Q2 ended at 75.7%, up 5.4 basis points compared to Q2 last year. The overall gross margin in Q2 is impacted by revenue from our large [ NRE ] project. The gross margins from our product revenue in Q2 was 68%. As we've communicated in the last couple of presentations, our product margin has been negatively impacted by higher component costs for some quarters. During Q2, we've burned through the last bit of inventory purchased at extraordinarily high prices resulting from the supply chain constraints we faced in 2022. We believe this is behind us and that our product margins have now returned to our expected levels. The gross margins in the first half of 2023 were 66% compared to 59% in the first half of '22. Our staff costs and other external costs in Q2 amounted to DKK 34.3 million compared to DKK 37.9 million in Q2 last year. For the first half of '23, staff costs and other external costs amounted to DKK 72.7 million compared to DKK 73.6 million last year. As we communicated at the beginning of '23, we have redirected resources towards our new strategic development products and are adding new R&D resources to accelerate our investments in new products even more. As part of this, we mended some cost-cutting initiatives earlier this year and are now in the process of adding engineering-focused resources. As a result, we are expecting our staff costs and other operating costs to grow in the coming quarters. EBITDAC in Q2 amounted to a negative DKK 5.6 million compared to a negative DKK 12.9 million in Q2 last year. EBITDAC for the first half of 2023 amounted to a negative DKK 23.5 million compared to a negative DKK 22 million in the first half of 2022. Staff costs transferred to capitalized development costs in Q2 amounted to DKK 2.1 million compared to DKK 6 million in Q2 last year, and to DKK 7.1 million for the first half compared to DKK 13 million in the first half of 2022. The result for the period in the first half of 2023 amounted to a negative DKK 34.7 million compared to a negative DKK 18 million in the first half of 2022. Net cash flows from operating activities in Q2 amounted to a negative DKK 23.1 million compared to a positive DKK 2.5 million last year. For the first half of 2023, net cash flows from operating activities amounted to a positive DKK 0.2 million compared to a positive DKK 2.2 million last year. Net cash used in investing activities in Q2 amounted to DKK 2.6 million compared to DKK 8.7 million in Q2 of 2022. And for the half year, net cash used in investing activities amounted to DKK 8.6 million compared to DKK 19.5 million last year. Free cash flows in the first half of 2023 amounted to a negative DKK 8.5 million compared to a negative DKK 17.3 million in the first half of 2020. Cash and cash equivalents at the end of Q2 2023 amounted to DKK 56 million compared to DKK 37.5 million at the end of Q2 2022. Our annual guidance for 2023 remains unchanged. We expect revenues in the range of DKK 180 million to DKK 200 million, corresponding to a growth of 20% in the middle of the guided range. We expect gross margins for the year to be in the range of 68% to 71%. And as a result of our increase in R&D investments, staff expenses and other external costs are expected to be in the range of DKK 160 million to DKK 170 million. Staff costs transferred to capitalized development costs are expected to be in the range of DKK 20 million to DKK 25 million. And with performance in the middle of the guided ranges, EBITDA will be negative DKK 10.5 million. With this, I'll return the presentation to you, Henrik.

Thank you, Heine. We are now ready to answer your questions. [Operator Instructions]. Operator, do we have any calls in the queue?

[Operator Instructions] At this time, I would like to pass the call over to Henrik Jensen for any webcast questions. Please go ahead.

Thank you. We currently don't have any questions on the webcast call queue here. So do you have any call on the audio queue, please?

There are currently no questions lined up in the audio queue. [Operator Instructions] There are still no audio questions. So I'll pass it back to Henrik for an update on any webcast questions.

Thank you. So we got 1 question here in the queue around the cash position and, "Whether it will be sufficient to our existing forecast." And so I think that we can confidently say that it will. So we are very confident that current position and basically the business has just laid out for the rest of the year and also into this year, we are doing pretty well. Seems to be the last question here. So we'll conclude today's earnings call. And thank you very much for attending today, and have a great day. Thank you.

This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.