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

Good morning. I'm Lars Boilesen, CEO of Napatech. I'm pleased to welcome you all to Napatech's presentation for the first half of 2024. Joining me today is our Chief Financial Officer, Heine Thorsgaard. Our half year report was released earlier this morning on the Oslo Stock Exchange and is also available on the Napatech website. For your information, a recording of this webcast will be available later today. 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. Today's agenda will cover 4 main areas: First, we will provide a status on the first half of 2024, with focus on the major news items that show promising signs of progress by Napatech towards achieving our goal to transform our business. Next, we will provide a business outlook that shares information about the opportunity ahead of Napatech. We will then provide information on the second quarter financial results. We will then conclude with a question-and-answer session open to the attendees of today's call. The first half of 2024 has progressed last year according to expectations particularly good progress in reaching important milepost of our strategic plan that has clearly strengthened our position as an early leader in the new and evolving market for programmable NICs. Our priority in the first half of 2024 has been on executing our strategic plan, as it underpins our long-term growth aspirations. To achieve those goals, we have 3 areas of focus: We must 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 the network and businesses. We are accelerating our engineering in software and hardware technologies that extend our products into new areas that align with the highest projected growth segment for Napatech solutions. And we continue to develop an ecosystem through partnerships that expand our go-to-market reach via marketing, business development and sales, enabling us to win new design that will be challenging to achieve on our own. I'm pleased to report progress in each of these areas and I'd like to share a few highlights from the second quarter of 2024. To begin, in early April, Napatech extended our agreements with Altera, an Intel company to include a next-generation 400-gig infrastructure processing unit or IPU. The collaboration develops new programmable NIC hardware and software solutions based on an architecture that promise to enable an innovative approach to power and modern public cloud, private cloud, edge and enterprise data centers built for the era of artificial intelligence. The new solution is purpose-built for the highest growth and largest volume applications, services and use cases for programmable NICs. These include modern cloud and edge computing application and services, artificial intelligence infrastructure, dessicated storage, big data analytics, cybersecurity, 5G mobile infrastructure and micro services. Next, on April 18, we disclosed that the 400-gig IPU product is signed with Intel/Altera was developed in a partnership with a Tier 1 global server OEM that continues to lead in enterprise and cloud data center deployments. The product is packed with the latest technology from Intel/Altera and is designed with optimization to meet the exact requirements of the server manufacturer. The collaboration is anchored by commercial agreements, associated statements of work that define the product specifications and professional services fees from both companies to Napatech. The collaboration includes the significant contribution, reflecting the shared commitment required to expedite the underlying engineering to deliver products in the second half of 2024. I'm happy to report that our engineering team has met every development milepost on and, in some cases, ahead of schedule so far. On May 2, based on these developments, we increased our guidance on the impact from design wins for these new products from 30,000 to 40,000 units to 50,000 to 60,000 units in peak annual production years. On May 7, in support of these significant steps forward with our current customers and expanding design win pipeline, Napatech successfully completed a private placement capital raise from 9 million shares at a subscription price of NOK 25 above the market price at that time. The private placement was significantly oversubscribed and attracted interest from high-quality accounts as well as receiving strong support from existing shareholders. The net proceeds will be used to finance growth opportunity arising from the announced partnership resulting in the increased guidance, including hiring of more developers and working capital requirements in connection with increased production. Later in today's presentation, we will share more information about the latest design win for our Intel-based IPUs, SigmaX.AI, which is an innovative provider of high-performance and cost-effective big data analytics solutions for an exploding list of data center and edge computing, artificial intelligence workloads. This new design win represents another new customer for Napatech, created by our business development partnership with Intel and from our new Intel-based IPU products. Finally, we also share more information about Amantya, a company focused on 5G infrastructure, specifically user plane function offload or UPF offload based on our new SmartNIC hardware and software products. Combined, these key areas of success allow us today to reaffirm our design win guidance for 2024. Our financial results for the second quarter included revenues of $3.4 million and gross margin of 65%. Sales in the first half of 2024 came in lower than expected. The first half of 2024 was expected to be slower than normal, but we were clearly hoping to see a bigger increase from Q1 to Q2 than we did. There are some explanation for the slow first half year. In general, we have seen less spend on equipment from our clients in the first 6 months. In addition, one of our largest clients are continuing an inventory correction to deplete carbon-driven safety stock built up during COVID uncertainties around component supply chain shortages. Despite the slow sales, we have retained 100% of our customers with no attrition. Taking a broader view of the information technology market, there are signs of macro top-down industry headwinds that can include less spending, longer buying cycles and increased design win development schedules. These issues, combined with our customers' inventory corrections, will continue to create short-term uncertainty in the revenue from our existing business for the remainder of 2024. There will be more details on the financial results provided in the final section of today's presentations. The majority of our efforts have remained on areas where we have much greater control and ability to influence, which is the pipeline building and design win focused for new businesses expansions. We remain excited and are pleased with those results. Since our last reporting, we have made progress on many fronts and have increasing confidence in achieving our goal of 4 to 6 design wins that drive between 40,000 to 60,000 units in annual demand in peak production volumes. I would like to share a few highlights on the progress made in the first half of 2024, representing a small sample of the much larger set of opportunities. First, we announced a Tier 1 global server manufacturer with proven success in cloud and enterprise designs and a strategic focus on artificial intelligence. Their product is packed with the latest technology from Intel/Altera and is designed with optimization to meet the exact requirements of the server manufacturer. The collaboration is anchored by commercial agreement, associated statements of work that define the product specification and professional service fees from both companies to Napatech. The collaboration includes the significant contribution and represents one of the largest opportunities in our pipeline. In addition, this product is a generic product for our new 400, 800 gigabyte Intel/Altera Napatech IPU product. The product will also later be sold as a standard product for Intel/Altera's existing customer base. Another example is a high-growth and innovative provider of high-performance and cost-effective data management solution for an exploding list of data center and edge computing AI workloads. This is our newest disclosed design win, SigmaX.AI, and we will spend a bit more time on them in our next slide. We have several quarters into engagement with a Global Fortune 100 banking and finance company, who is re-architecting their network to deploy micro cybersecurity services into every server based on Programmable NICs. We are also several quarters into another opportunity with the U.S.-based suppliers of networking equipment to U.S. government defense, civilian and intelligence networks focused on cybersecurity and network monitoring solutions. We have recently begun an engagement with a new data center designed by a global Tier 1 media streaming service provider. The solution utilize Programmable NICs to improve the performance and secure content and customers of their services. We have also made progress along with one of our 5G UPF offload and acceleration software partners on a design by a 5G packet core provider for a South-African 5G mobile telecom network operator. We continue to work with Intel on a lead customer, also with a high annual volume demand for network attached storage offload and acceleration utilizing IPUs. As a final example, a leading provider of 5G mobile packet core solution has completed their engineering integration of our SmartNIC software and hardware with their UPF applications, allowing them to begin targeting their customers and prospects with acceleration solution based on Napatech. The status of our design win pipeline has clearly exceeded our expectations. All the above examples are coming from our partnership with Intel/Altera, which is the high-growth unit Intel carved out from Intel last year. Today, Intel/Altera owns 7 out of 8 hyperscalers worldwide when it comes to Programmable SmartNICs. Their plan is now to scale this business to the growth in other cloud, telecom and enterprise network server and cloud market outside the hyperscale market together with Napatech. So far, we have not lost any cases, which has been provided to us from Intel Altera. And we also see that Intel Altera keeps bringing new opportunities to Napatech. While there is much work to do to secure new design wins that drive large volumes in their peak production years, these active opportunity examples give us confidence that we are making solid strides. In success, we aim to transform our business from a niche supplier to a high-volume partner to customers in the largest and highest growth segments. Our historical volumes in our valuable stable, but niche segments range from 4,000 to 6,000 units per year. These 4 to 6 design wins we expect to close this year will result in annual unit demand of 50,000 to 60,000 units per year when they reach peak production. And what lies beyond that are large and expanding pipeline of future design wins that drive even higher volumes. In just the first 6 months of 2024, we have secured valuable new customers for solutions in fintech, cybersecurity, artificial intelligence, monitoring and recording big data analytics and more. Each customer and use cases for new designs can range in the 1,000 or 2,000 per year to 5,000, 10,000 or even in some big deals, 25,000-plus per year. Every new design from small to large give us confidence in achieving our 2024 goals and longer-term growth aspirations. While these examples are great sign of progress that give us confidence towards meeting our goals, we constantly remind ourselves that all design win takes time and not all will be won. They require engineering by our customers after selection, but their size warrants the efforts to develop them. And our customer will take time to launch and ramp their products to reach full peak production, but the value warrants our patience. I'm eager to share with you more information about an exciting and high-growth company, SigmaX.AI that we announced today. SigmaX is a provider of high-performance and cost-effective data management solutions for an exploding list of data center and edge computing workloads driven by artificial intelligence and machine learning. Data center operators are racing to deploy an array of applications for artificial intelligence. The use case generate massive amounts of data, significantly driving up cost for networks and storage. Additionally, cloud-based data analytics services that are used to store, process and secure this data can be drawn businesses in operational capital costs overshadowing the benefits that AI application promised to deliver. SigmaX rescues data center sinking in the size, costs and complexity of their AI data with an innovative software solution that transforms IPUs from Napatech into powerful data management tools. SigmaX software intelligently ingests, transform and standardize log data from various sources into an AI/ML ready format at the network's edge minimizing data redundancy and ensuring real-time availability. The IPU is deployed in servers throughout the data center and run SigmaX.AI software. The power combination of software and hardware solves the AI data problem in multiple dimension by internally reprocessing data at source. The product and solution is anchored by a compelling business case that help users in networks of all types to get to the data that they need faster while reducing their data analytics and storage cost, and improving the overall network performance. This type of winning solution has the potential to drive transformation volumes of IPU units to Napatech as the business expands. This design win is the cooperation between SigmaX and Napatech and was again fostered through Intel/Altera. The design win was in progress and mature as SigmaX utilized the Intel/Altera development platform for early proof-of-concept demonstrations and trials. The solution then is ported to the Napatech production product, our F2070X IPU. Napatech find itself uniquely positioned. Industry megatrends are creating more application and services, which in turn create more servers to be deployed. Consequently, every server requires one or more network interface cards to provide connectivity to critical CPU and GPU resources. The explosive demand for NICs is accelerated by an underlying trend away from legacy basic and offload NICs to Napatech's style of Programmable NICs. Napatech is exclusively focused on Programmable NIC market with our SmartNICs and IPUs. The use case of fueling the growth of Programmable NICs has included cloud and edge computing, 5G mobile infrastructure, cybersecurity and others. And yes, AI infrastructure is an emerging use case that has further increased the demand for SmartNIC and IPUs. Several of our design wins we are pursuing will fit into the category described in the recent industry analyst report from Dell'Oro that predicted generative AI will drive Ethernet and adapter and SmartNIC market to surpass $16 billion by 2028. Intel/Altera is a leading provider of SmartNIC and IPU solution to many of the top hyperscaler networks operators, to grow and expand beyond the small number of large hyperscaler operators to the mass market of next wave cloud, telecom and enterprise networks. Intel Altera has partnered with Napatech to provide a complete commercial production grade solution to the mass market beyond these early adopters. This is the bet Napatech has placed with Intel Altera for Programmable NICs, including SmartNICs and IPUs. We believe that Intel/Altera has the market share, brand recognition and sales marketing, go-to-market to help Napatech to achieve our goals. We have a number of new investors that follow us to Napatech. So I would like to conclude by resharing a slide that put Napatech's position within these emerging networks into perspective. Napatech's products are key for our performance. The images to the right labeled F is a standard server. Servers are the primary system in modern data centers, are used to deliver application services and revenue to business in cloud, enterprise, telecom and government networks. Historically, the most important part of the server was the central processing units or CPUs. The CPUs from companies like Intel act as the brains of the server and are labeled E in this image. The CPUs are surrounded by memory labeled D. Memory stores data, including network traffic for the CPUs to process. A new and well published area inside of servers are the expansion slots shown as C. These expansion slots are most often used today for acceleration card based on GPUs or FPGAs for artificial intelligence, machine learning, training, large language models and more. And finally, the slots labeled A and B shows the network interface card or NICs. In this image, 2 of Napatech's NICs are shown. Napatech builds a new type of NIC known as Programmable NIC. Together with Intel, Napatech is developing 2 types of Programmable NICs, including SmartNICs shown in B and infrastructure possessing units or IPUs shown in A. Napatech Programmable NICs plays a crucial role in modern data, decenter and server design. They are so linked between the outside cloud and enterprise networks, providing access to critical CPUs and GPU resources that deliver artificial intelligence, security and other services. While GPUs and FPGAs for AI and programmable SmartNICs and the IPUs for networking are well understood today, there were a relatively new concept just a short time ago. Intel/Altera has created a dominant position among a small number of hyperscaler cloud operators who consume massive volumes. To capture the next wave of growth in other cloud telecom enterprise networks, Intel/Altera has partnered with Napatech to provide complete commercial production grade solution to the mass market beyond these early adopters.

Thank you, Lars. Revenue in Q2 amounted to DKK 23.2 million and in USD 3.4 million, down 39% in both USD and DKK compared to Q2 last year. For the half year, revenue in DKK was down 40% compared to last year and amounted to DKK 44.7 million. In USD, revenue in the first half of the year amounted to $6.5 million compared to $10.9 million in the first half of 2023. Gross margins in Q2 ended at 65%, down 11 basis points compared to Q2 last year. The gross margin in Q2 is at the low end of our normal range due to a shipment to an Indian end user. The gross margins in the first half of 2024 was 68.2% compared to 65.6% in the first half of '23. Our staff costs and other external costs in Q2 amounted to DKK 43.3 million compared to DKK 34.3 million in Q2 last year. For the first half of 2024, staff costs and Other external costs amounted to DKK 83.9 million compared to DKK 72.7 million last year. Since our capital raise in May this year, we've accelerated our development activities significantly to bring new products to the market quickly. With the current plans, we are adding 35 new R&D resources during 2024. In Q2, amounted to a negative DKK 28.2 million compared to a negative DKK 5.6 million in Q2 last year. EBITDA for the first half of 2024, amounted to a negative DKK 51.7 million compared to a negative DKK 16.4 million in the first half of 2023. Staff costs transferred to capitalized development costs in Q2 amounted to DKK 0.9 million compared to DKK 2.1 million in Q2 last year and to DKK 1.7 million for the first half of '24 compared to DKK 7.1 million in the first half of 2023. The result for the period and the first half of 2024 was negative DKK 67.2 million compared to a negative DKK 34.7 million in the first half of 2023. Net cash flows from operating activities in Q2 amounted to a negative DKK 41.9 million compared to negative DKK 23.1 million last year. For the first half of 2024, net cash flows from operating activities amounted to negative DKK 47.4 million compared to positive DKK 0.2 million last year. Net cash used in investing activities in Q2 amounted to DKK 2.7 million compared to DKK 2.6 million in Q2 of 2023. And for the half year, net cash used in investing activities amounted to DKK 3.7 million compared to DKK 8.7 million last year. Free cash flows in the first half of 2024 amounted to negative DKK 51.1 million compared to negative DKK 8.5 million in the first half of 2023. Cash and cash equivalents at the end of Q2 2024 amounted to DKK 103.2 million compared to DKK 56 million at the end of Q2 2023. Back to you, Lars.

We start with our design wins, guiding on our new Intel/Altera IPU products. As communicated in our release on May 2, we target 4 to 6 design wins in 2024 with 50,000 to 60,000 units in peak annual production years. With our latest announcement, our design win with SigmaX, we feel comfortable maintaining the target for 4 to 6 design wins in 2024 and the increased peak volume related to these design wins. The revenues in Q1 and Q2 have clearly been weaker than expected and creates uncertainty with respect to our annual revenue guidance. We are according to the Danish Finance Commission obliged to give financial guidance despite that we were reluctant to do so. We would like to be as transparent as possible. And since the 2 first quarters were weaker than we foresaw it, it will be challenging to achieve the annual range. Right now it does not look like we will make the revenue guidance. However, we have a couple of new positive factors. First, we see that the pace of our legacy business is picking up in Q3. Second, we also see an opportunity to get revenue in 2024 from the latest IPU new design wins in 2024. As you recall, we did not guide any revenue in 2024 for our new Intel IPU products. If we look at all the upside we see across our products in the second half of 2024, we cannot rule out that we cannot end up in the guided range despite it's not very likely. We will continue to give our investors a transparent update on revenues in the coming quarterly updates. As already announced in our capital raise in May this year, due to the announced Tier 1 server OEM agreement, we have accelerated our development activities significantly to bring new products to the market quickly and to deliver agreed products to the new Tier 1 server OEM agreement. As a result, we now expect staff expenses and other external costs in 2024 to be in the range of DKK 170 million to DKK 180 million, up from previously DKK 145 million to DKK 155 million. Approximately DKK 8 million of this is noncash and related to accounting of stock options. Concerning gross margin, we maintain our expectation of gross margin in the range of 69% to 70%. This ends our presentation. We will now open up for a Q&A session.

[Operator Instructions] We do have a question on the telephone line here from Øystein Elton Lodgaard at ABG.

Just starting off with the legacy business. There's one big customer contributing much to this quarter. Can you say is there any reason to believe that this customer shouldn't come back to its previous volume contribution in the future?

That's correct. As you can see from our historical data, then we had many quarters in the last 2 years where there's -- where one of our biggest clients were around 50% of our revenue. So obviously, this has a very big impact on our first half year. This is mainly due to -- it's due to 2 things: One is that they have a safety stock they're drawing from, and this results basically again very few orders to Napatech. Second thing is they also have experienced what the market has experienced over the last half year, very significant less spend in '24 compared to previous years. So these 2 things are the reasons. We certainly know that this safety stock will go empty and that will help orders from this client. In addition, we also believe that the market will come back. So this -- so yes, we expect this client to come back to normal order situation again.

Great. And congrats on the new design win. Could you just give some flavor on how we should think of the ramp-up of that design win in '25 and beyond? And you indicated 5,000 to 10,000 units, is that the likely scenario for '26, '27? Or how should we think about potential...

Yes. So this client, their offering is mainly a software offering for aggregated data security. So -- and they're using our 200-gig IPU product standard. So basically, what they've done is they've ported their software to our 200-gig product standard. So obviously, they -- it all depends on how many project they win. We have some insight to that. But it's kind of outside our control. So if they -- so if we say that they will do 5,000 units next year, it, of course, there's a lot of uncertainty that it can be more, it can be less. It all depends on how many projects they win, but they have good traction in the market. So we are hopeful that they will be in that range.

And just an update on the previous design win that you announced. Is there anything to share regarding that, regarding time line, anything else?

The project is going really well. We have delivered the first hardware on time. Some of the features we have delivered has actually been ahead of time. So the project is going really well. And it's a development project done in connection with Intel/Altera on 400 gig, our next product. So if you look at the dashboard for the schedule, it's all green.

Great. And you shared some of your further pipeline, but how should we think about potential for further design wins beyond the 4 to 6 in 2024? Do you like to share anything of that on -- I guess you have more in the pipeline, like you indicated.

Yes. So we try in this presentation to give you a little bit more insight on what kind of different projects we are working on. All our entire pipeline is coming from Intel/Altera. Altera is the growth unit in -- at Intel, which was carved out last year. They're doing really well. They came in above expectation in the last quarter, and we benefit from that. So we clearly -- our entire pipeline on IPUs is coming from Altera and it's clearly -- the number of leads has clearly exceeded our expectations. So we have really high activity level with Altera on their projects where we are the sole supplier of IPUs. And we basically just try to give you a flavor of what kind of different projects we're working on. This is just a snap chat of that. Some of them will come in, some might not come in, but we are hopeful that we definitely will be in the range of 4 to 6 design wins. So all in all, it's looking good.

I'll now hand over to Lars for any webcast questions.

There is a question here from [indiscernible]. Can you elaborate on your cash position? And do you expect any additional capital raise going forward? So we certainly have no plans of new funding rounds. Even with very conservative revenue projection for 2025, we have full funding in the next 18 months. And obviously, we hope that we will have good revenue streams already next year from the new products. So we consider ourselves fully funded. I think this ends the questions unless there are more questions from the audience. Okay. That concludes today's call for the first half of 2024. On behalf of Napatech, we thank you for your interest in our business, and I hope you share our excitement about our future. Please note that there are several ways to stay informed about what's happening with Napatech in between our quarterly financial reporting, including our social media venues, monthly newsletter and other forums. Thank you for attending today's call.