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

I'm Lars Boilesen, CEO of Napatech. I'm pleased to welcome you all to the Napatech Q4 2023 Interim Management Statement Presentation. Our Q4 2023 interim management statement was released earlier this morning on Oslo Stock Exchange 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 questions via text on the webcast page or we can take your questions on the phone. If you would like to ask a question, please follow the instruction on this slide. 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 for the interim management statement includes the status and outlook for our business. I will also spend time outlining the progress in our strategic plan related to our internal investments in product development and our early success in partner and business development for our growth initiatives. Additionally, I will provide an update on the market for Napatech solutions. The presentation concludes with a summary of our financial results for the fourth quarter of 2023 and fiscal year 2023 and our expectations for 2024. On January 22, I was appointed CEO at Napatech, and I'm excited that both Napatech and I begin 2024 in new positions. I would like to thank Henrik Brill for leading Napatech as an interim CEO to a great 2023. Moving forward, Henrik will resume his previous role as COO. My entire leadership team and all our approximately 100 employees are, in my opinion, world-class, something I experienced particularly in my 7 years as serving as Chairman of the Board, and I'm excited to embrace this new role. The past year has been an incredible journey filled with challenges and successes. We have overcome many of those challenges and achieve remarkable milestones that strengthen our leading position in this new and evolving market for programmable NICs. I'm pleased to report that in both the fourth quarter of 2023 and for the entire fiscal year 2023, we have made notable progress in 2 areas, each of equal importance. First, our near-term business operations; and second, our medium- to long-term strategic plans. To briefly summarize here, we meet our overall financial guidance and objectives for fiscal year 2023 and some areas moved ahead of schedule in our strategic plan that underpins our long-term growth aspirations. I'd like to share a few details behind our financial results and progress in our strategic plan. In short, we had a solid Q4 that brought a successful end to our 2023 fiscal year. We met our lower part of the guidance on the revenue and project modest and exceeded on other key financial metrics. Later in the presentation, our CFO, Heine Thorsgaard, will provide additional details. While we are satisfied with the ending to our 2023 financial results, a great deal of our focus throughout the year was on executing our strategic plan, and it underpins our long-term growth aspirations. To achieve those goals, we have 3 areas of focus: first, we continue to service our valuable installed base of customers who are the early adopters of programmable NIC solutions. They are proving ground for the technology and the value that our solution brings to their networks and businesses. Second, we continue to accelerate our engineering in software and hardware technologies that extend our products into new areas that align with the highest projected growth segments for Napatech solutions. Third, we continue to develop an ecosystem through partnerships that expand our go-to-market reach with -- we are marketing business development and sales enable us to reach places we could not achieve on our own. I'm pleased to report progress during 2023 in each of these areas. I'd like to share a few highlights from the year. We met all product and fulfillment commitments to our valuable customers who provide a solid baseline for our business. We expanded our portfolio of programmable NICs by developing our first infrastructure processing unit the F2070X in partnership with Intel. We further expanded our portfolio by delivering 2 new Intel-based SmartNICs in the NT400 family to both current and new customers. We delivered new software for acceleration of high-growth applications, including network monitoring, 5G mobile infrastructure, cybersecurity, storage and networking. We secured more than $12 million in capital through investments and NRE from strategic partners strongly supporting the Napatech journey. This includes $7.5 million from our lead customer, Netscout and $5 million from our technology and business partner, Intel. These partnerships underline unwavering support to Napatech. We increased our research and development team by 13%, adding more resources and new expertise to align our skills with high-growth industry megatrends and ensure that Napatech has the velocity to keep pace with rapidly evolving requirements. We signed 10 new ecosystem partners, including server vendors, system integrators and independent software vendors to enable a more effective go-to-market strategy going forward. As we look ahead into the exciting opportunities of 2024, our confidence is significantly bolstered by our achievements in 2023. And we recognize the nature of our business has long sales cycles of design wins that can take 18 to 24 months before they mature to revenue. Nevertheless, these activities have unlocked a transformational pipeline of opportunities into new high-growth segments. And we project that during 2024 could achieve between 4 to 6 design wins, providing an accumulated number of programmable NICs between 2025 and '26 of 30,000 to 40,000 units annually. In other words, one account win with Intel will on average be equal to Napatech's annual historical production. Perhaps the most important part of our strategy is the work we have undertaken with Intel. In the first half of 2023, we disclosed part of our strategic plan to leverage Intel's market-making position behind SmartNICs based on FPGA technology and IPUs based on both FPGA and CPU technology. This slide highlights a few of the most notable milepost that Napatech met during 2023. During the first half of 2023, we delivered 2 SmartNICs based on Intel technology to our key customer, Netscout and new design win customer F5. In the second half of 2023, Napatech participated in the global public launch of new Napatech IPU product based on both Intel FPGA and CPU technology. This event took place in September during the Intel Innovation 2023 event in Santa Clara, California. I'm also pleased to report today that our hardware and software development efforts to create Napatech's first Intel-based IPU products remained on track, allowing us to begin accepting orders for the first customer shipments in December of 2023. The partnership combines with premier technology from Intel with the Napatech competencies in product development, delivery, service and support, which our customers require. Throughout 2023, we began joint sales, marketing and business development efforts that have provided a solid pipeline of business opportunities, somewhat ahead of the schedule we envisioned at the start of 2023. The pipeline of business opportunities with Intel are on scale that could be transformational to Napatech's business. When compared with our historical business, shipping around 5,000 to 6,000 units per year in total. These new opportunities individually require between 1,000, 5,000, 10,000 or 25,000 units per year, with some opportunities even exceeding 50,000 units annually, meaning, in average, one win alone with Intel equals historical annual production for Napatech. As a part of the recent IPU launch, Intel noted Napatech's IPU can help deliver the scalable and high-performance products, solutions and services customers required to make their cloud and enterprise data centers more efficient and cost effective with high feature velocity. Of note, beyond IPUs, we also launched our first 2 Intel-based SmartNICs that have several customer design wins, including our previously disclosed win at F5 that has already resulted in initially unit sales, and we anticipate beginning production in 2024. In 2025, we expect F5 to be in full production, which will make F5 by today by far our biggest client. While we are still relatively speaking, early in a long process, we are seeing many positive signs of progress and success resulting from our partnership with Intel. The great advantage now for Napatech is that we now have a market maker like Intel to specify the product specification for us. And then our world-class engineers in Copenhagen will then deliver on these product specifications. Combining our new products and partnership allow us to address a major opportunity. We recognize that our industry has long design win cycles with a duration of 18 to 24 months to revenue, but our work so far has shown very positive results in business pipeline building. The Napatech investments have not only addressed new application and use cases for programmable NICs but have done so for a class of customer who have larger demand at a higher scale. With a solid foundation of core business below us and favorable tailwinds behind us from the market exposure, our new products and solutions have increased our addressable markets. We end 2023 with an addressable market increase in both the number of prospects we can serve, and more important, the total annual unit demand has substantially increased the total revenue potential for Napatech. As we look deeper into the market that Napatech serves, we see how the market is expanding. Programmable NICs were initially vitally adopted by 2 classes of customers. First, were hyperscale cloud operators who make up the majority of early market demand and growth. Second, we're a larger group of OEMs, telco and enterprise customer who represent the majority of Napatech's historical sales who deployed the technology critical for smaller scale designs. Now together with Intel, Napatech is commercializing the solution for the mass market. With extension to our existing hardware and software portfolio, we are making those proven products and technologies from the hyperscale cloud innovators and other early adopters available to IT organization of every size. It is these new high-growth segments that are fueling Napatech's increasing pipeline. Simply put, Napatech products are now becoming relevant for the largest portion of the unfolding markets. To begin 2023, when we started the journey with Intel, we showed the initial pipeline view on the right side to illustrate a transformational scale of our business given these new opportunities. After 1 year during which we developed the product to meet these new needs, we can validate this demand, and we have made progress towards converting opportunities to future design wins. As mentioned on the previous slide, we have moved closer to these new designs. We have a line of slide to individual opportunity that between 1,000, 10,000 or 25,000 units per year with some opportunities even exceeding 50,000 units annually. Another important aspect of our strategic plan is expanding our ecosystem. I'm pleased to report that we continue to expand our partner ecosystem for solutions that includes Napatech products. These types of partnership plays a valuable role in Napatech achieving our growth ambitions. While the first and critical part of our strategic plan is to develop the products that align 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 customer who need them by aligning with their purchase behavior. These partners provide many key functions like application software, servers and the system integration to form the final solution to the end customer. They also have important direct relationship with the end customer that Napatech may not have. The partnership activities include joint sales and marketing and optimizations that accelerate the proof-of-concept, trials and the overall design win cycle. In many cases, it also includes fulfillment in a way that's acceptable to the customer. In total, these partnerships play a crucial role in the pipeline development fueling our revenue growth ambitions. The partnership we announced in 2023 include activities with leading server manufacturers like Advantech, Kontron, Dell Technologies, Lanner and Jabil with several other in progress. These server manufacturers who the end customer traditionally do business with, consider Napatech's SmartNICs an imperative part of their solution. We also announced partnership with several of the biggest software companies who provide application that power the 5G core networks. The customers in this growth vertical has shown a great deal of interest in the Napatech programmable NIC acceleration of the 5G core software. Finally, we have announced partnership with several companies who have developed specialized software that requires SmartNICs to accelerate the application in the financial service market. During 2024, we expect to expand the list of these important partnerships as we continue to align our products with the highest growth application and services that demand a programmable NIC. Another notable milepost in our plan was enhancing the R&D investment to fulfill our product strategy. In 2023, we continue to accelerate the investment in our products that were necessary to expand our pipeline. We will continue to make these investments in 2024, aligned with our products tree that have 3 key directions: first, we are application driven. Our solutions are driven by the needs of software applications, which means that all capabilities and performance metrics in our programmable NIC software are designed with specific software applications in mind. We ensure that our solution target the largest and fastest-growing application in the emerging cloud telecom security, financial and artificial intelligence verticals. Second, we are software-focused, the value of Napatech solutions shines through in our software. We deliver production grade, high quality, high performance and feature reach programmable NIC software that brings life to our SmartNIC and IPUs. Basically, our software create stickiness and the more software we deliver, the higher price and margin. Third, we are hardware independent. Napatech designs and develop its own family of SmartNICs and IPUs based on FPGA and CPU technology from the top technology providers such as AMD and Intel. Napatech ensures that our hardware design conform to open industry standards so they can be deployed within the top server platforms globally. Combined, these product strategy enables our solution to align with the highest growth segments within the programmable NIC market. As you have heard many times today, Napatech builds network interface cards, also referred to as NICs is crucial to grab both the growth and evolution within our market to fully comprehend our position. The early stages of this market was served by basic NICs. These network interface cards were simple and provided nothing more than connectivity between the server and the network. As network began to get smarter and increase in speeds, a second type of device emerged known as offload NIC. These offload network interface cards took some steps towards increasing performance beyond that what the basic NIC could provide, but ultimately fail to keep pace with the rapidly changing requirement in modern networks. The later stage of the evolution in network interface card is known as programmable NICs. These network interface cards meet the most demanding requirement by utilizing advanced processing technology, such as field programmable gate arrays or FPGAs in combination with onboard CPUs to deliver the optimal mix of performance, functionality, programmability, power and price. Napatech's focus on SmartNICs and IPUs allow us to address these new and high-growth segments of the NIC market. The end user market Napatech can serve our forecast to consume more than 20 million servers and appliances per year by 2027, up from 14 million in 2023. This translates to an overall NIC market approaching USD 7 billion in that time frame with the programmable NIC segment dominating the growth while the basic NIC and offload NIC demands enters a rapid decline. Napatech benefits not only from the overall growth in the NIC market, but also the major change within the NIC market to Napatech types of programmable NICs. Napatech's position has been established by being in the top 10 among more than 50 vendors serving the overall NIC market and the #1 vendor of complete hardware and software solution for SmartNICs and IPUs. This explosion is where Napatech and our partners like Intel have set our sights. Programmable NICs are envisioned to power many servers in many networks because of the wide range of profitable application services they enable. Programmable NICs are used today in cybersecurity applications such as next-generation firewalls, data loss prevention, intrusive prevention and many others. Programmable NICs are used to improve 5G mobile application for infrastructure virtualization, signaling gateways, subscriber observations and service delivery. Programmable NICs are used in cloud and edge computing for network and server virtualization and tenant isolations. Programmable NICs are regularly found in financial services for high-frequency trading and trading algorithm simulation. Programmable NICs also have a long and proven history of success in numerous network monitoring, recording and testing applications. Programmable NICs unlock new large and expanding use cases, including acceleration of user plane function called UPF in telco and enterprise 5G network, storage, content delivery, machine learning and artificial intelligence. This concludes the first section of the presentation. And before we move on to the financial review, I would like to share with you what we are presenting this week from Barcelona, Spain at one of our industry's largest event, Mobile World Congress. This event brings together the top product, technology and solution from companies around the globe to meet with the thought leaders and buyers of mobile networks. This event is also a major business development opportunity for Napatech. In the days leading up to the show, we disclosed 9 news and other promotional efforts attracting attention of clients who attend the show. In addition to our own presence at the show, Napatech's product and solution can be found at 7 partner locations at the show. Our booth featured demos from several key partners and, of course, showcase our programmable NICs for the top solutions. If you happen to be at the Mobile World Congress this week, I invite you to stop by and visit us. We would enjoy showing you much more about Napatech. I will now hand over the presentation to our CFO, Heine Thorsgaard.

Thank you, Lars. Napatech revenue in Q4 in DKK was up 71% compared to Q4 of 2022 and amounted to DKK 58.1 million. In USD, revenue was up 75%. For the full year of '23, revenue in DKK was up 15% compared to 2022 and amounted to DKK 182.7 million. In USD, full year revenue was up 17%. Gross margins in Q4 ended at 79%, up 20 basis points compared to Q4 in 2022. The overall gross margin in Q4 is impacted by revenue from our large NRE project. The gross margin of our product revenue in Q4 was 70%. Gross margins for the full year of '23 ended at 73%. Our staff costs and other external costs in Q4 amounted to DKK 38.5 million compared to DKK 28.5 million in Q4 of 2022. For the full year, staff costs and other external costs in 2023 amounted to DKK 143.3 million compared to DKK 133.1 million in 2022. Staff costs transferred to capitalized development costs in Q4 amounted to DKK 0.9 million compared to DKK 4.5 million in Q4 of '22. Transferred costs for the full year of 2023 amounted to DKK 9.3 million compared to DKK 23.3 million in 2022. EBITDA amounted to positive DKK 8 million in Q4, a negative DKK 0.4 million for the full year of 2023 compared to negative DKK 4.2 million in Q4 and negative DKK 20.1 million for the full year of 2022. Net cash flows from operating activities in Q4 amounted to positive DKK 1.9 million compared to negative DKK 11.2 million in Q4 of 2022. Net cash used in investing activities in Q4 amounted to DKK 2.5 million compared to DKK 5.5 million in Q4 of '22. And for the full year of 2023, net cash used in investing activities amounted to DKK 12.7 million compared to DKK 32.7 million in 2022. Free cash flow in Q4 amounted to negative DKK 0.6 million and free cash flow for the full year of 2023 amounted to negative DKK 19.5 million compared to negative DKK 16.6 million in Q4 '22 and negative DKK 56.7 million for the full year of 2022. Cash and cash equivalents end of Q4 amounted to DKK 42.4 million compared to DKK 12 million at the end of Q4 2022. In 2023, besides making significant progress on our strategic projects, we were able to meet our financial guidance for the year. Towards the end of 2023, we started to feel the impact of the slowdown in the U.S. SmartNIC market, especially within the telco operator segment. We expect this to continue into 2024, especially in the first half of the year. On the other hand, we do expect to start seeing some revenue from our new IPU products. As a result, for 2024, we expect revenue in the range of DKK 170 million to DKK 180 million and we expect gross margins for the year to be in the range of 69% to 71%. We expect staff costs and other external costs to be in the range of DKK 145 million to DKK 155 million, and staff costs transferred to capitalized development costs in the range of DKK 10 million to DKK 15 million. With performance in the middle of the guided ranges, revenue is expected to decline 4% and EBITDA will be negative DKK 15 million. Over to you, Lars.

Thank you, Heine. Yes, let me comment the guiding both on our existing products line Capture, but also on our new business with Intel. So on Capture business, our existing products business line, that is a business that has been stable and very profitable for years. This is also the case for 2024. The decline we expect in 2024 is due to a safety stock with one of our largest clients. During COVID back in 2022, we experienced component shortage, which resulted in creation of a safety stock with the specific client. Now the stock needs to be burned in the first half year, which will reduce 2024 total orders from this client with around $2 million to $3 million. Without this safety stock, the 2024 guidance would have not resulted in a decline. In general, 2024 is all about winning new design wins on our Intel pipeline. We are targeting 4 to 6 IPU design wins with a total annual unit potential of 30,000 to 40,000 units at peak years. These design wins are the wins which will boost the value and the results for Napatech in the years to come. We are very optimistic on the future, and we will keep the market updated on potential design wins in the coming quarters. And now we are ready to answer your questions. [Operator Instructions] Operator, do we have any calls in the queue?

This is Lars live. We have a lot of questions. So I will start then from top. First question. You're guiding 3 to 6 design wins in 2024, we produced and shipped 30,000 to 40,000 cards annual, which is 6 to 8x annual production in '25 and '26. How do you view the average sales price and gross margin development going forward given this substantial increase in annual card production compared to 2023? How will the production cost per card evolve, giving higher volume production, Napatech? Yes. All right. So the answer. I think today, we have gross margin over 70%. This high margin is due to great hardware design, but really the unique part of our solution is our software and the software part is clearly the main reason for the above 70% margin we report quarter-on-quarter. So if you look at our business today, a big order for us is around a few hundred cards. In this new business, on this pipeline, we see with Intel, we see design wins from -- potential design wins from 1,000 units, 5,000 units, 10,000 units and even monster deals of 25,000 units. And in these deals, we expect margin to go down, but we expect it to remain healthy and attractive margins. Also, keep in mind that cost of goods sold will also go down on these big deals. It's -- I think it's too early to say where our gross margin will end up, but we definitely expect it to stay healthy and attractive. And the main reason for that will still be our software, which is really the unique part of our solutions. Next question. You guided sales volume for '25 and '26 -- is 6 to 8 produced volume of cards in '23. How realistic is this? And could you explain why Napatech should outgrow the FPGA and SmartNIC market compared to your slides? I think the simple reason is that we are going from a very attractive niche capture business where our SmartNIC solution is being an off-line passive capture solution. In the Intel business in this new high-growth solutions, our IPU solution will be an in-line device in a server solution in a big volume data center and cloud solution. So -- the use case is completely different compared to our Capture today's business. So we're simply going from an off-line very attractive niche business to an in-line mainstream business in data center cloud solutions. Next question, how sticky are the revenues giving design wins? And how recurring do you think these revenues to be? Well, Napatech, Intel IPU design win in a new data center architecture, our new cloud solution is simply sticky due to the fact that the life cycle of a new data center and a cloud architecture is many years. We're not talking 2, 3 years here, but more, more in the 5-plus range. What is your annual long-term goal for yearly delivery cards in 2008 -- 2030? So even though that our revenues on this Intel pipeline will be very recurring and very sticky, I think it's too early to estimate so many years out in the future. Okay. Next question. What's the reason behind the strong gross margin in Q4? Maybe Heine, you can answer that.

Yes. As also mentioned in the presentation, the margin on our product revenue in Q4 was just above 70% and revenue from our large NRE project has a very high margin. So the overall margin in total for Q4 ended up where it did. So basically, it's the fact that our product margins are back on historical levels after some quarters last year and in Q1 this year with lower margins due to high cost of sales. And then -- but now we are back at the historical levels and expect revenue for our product margins to stay like this in the coming quarters. So I think that's in total, the answer that good product margins and the impact of our large NRE project. Lars?

You talk about potential to land 4 to 6 major new design wins this year. Can you give some flavor on your visibility regarding this number? So when we look at the pipeline, the joint pipeline we have with Intel, we are looking at plus 30 projects. So when we say 4 to 6, this is simply the 4 to 6 which are early in the process, which we believe could be design win this year, and this is the reason for this number. Next question. Regarding the 4, 6 new major design wins you talk about, have you already begun to ship units to these potential customers so they can begin testing? On some of these projects, we are talking about, then we have -- we have sent evaluation units which they are testing, correct. Revenue guidance of DKK 170 million to DKK 180 million. Don't you expect any of these 4,000 units Intel bulk orders this year, how would this affect guidance? Will you inform the market if you receive such an order and adjust guidance accordingly? We -- of these 4 to 6 design wins, we did not expect much revenue this year. This will be revenue in '25 and '26. As you recall, we did announce an Intel-based design win last year, F5, we do expect revenue from F5 at the end of this year. With flat guidance -- next question, with flat guidance for 2024, when do you expect an uplift in sales, if ever? And why do you not see the growth in the SmartNIC market in Napatech's revenue? Well, as I said, the business we have on Capture is a very stable, profitable business. But at the same time, a relatively flat business. So all the new growth will come from the Intel-based business, that's where we will go into a high-growth market. We expect our Capture business to remain very high margin, very profitable, but very flattish. And despite the guiding is down, it's only down due to the fact that we have this safety stock with one of our clients that needs to bring down off. If you reduce for that, you will have actually a growth in the guidance on Capture. Next question -- just a moment.

Okay. It seems like we are experiencing some technical problems here. I do see an additional...

So I think the problem was on my side, sorry. We are sitting in a hotel room here in Barcelona. So I will think we have still 3, 4 questions. How much revenue from UPF and IPU segments are included in the guidance, respectively? On IPU, very little is in '24. That's all projected for '25 and '26. On UPF, we do have a budget in the second half of this year, which is also modest, but it is a 7-digit number. You were guiding 3 to 6 design wins in '24 that will result in 30,000 to 40,000 counts per year in '25 and '26. For how many years would that accumulate? So what I said was this is a sticky business, and we are delivering into new data design, data center designs, new cloud solutions. And this is not a 2-, 3-year cycle. It's many more years than that. Do you have -- and I think this is the last question -- do you have any additional funding need in 2024? We do not have any funding needs in 2024. The only reason why we will have funding needs will be if we would land one of these 25,000 units plus deals, then we might need to hire more engineers. But that's the only reason for funding needs if we really will land some monster deals in '24. So right now, we have no funding needs. Heine, I don't see more questions here on my side.

I think we're all good.

[Operator Instructions] There are currently no questions registered by the telephone lines. I'll hand back over to Lars Boilesen for either more webcast questions or the closing remarks.

Yes, I don't see any more questions on my end. So we thank you for participating, and wish you a very good day.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.