Napatech A/S (NAPAO.OL) Earnings Call Transcript & Summary

[Audio Gap] [Operator Instructions]. I will now hand over to Lars Boilesen, CEO, to begin.

Good morning. I'm Lars Boilesen, CEO of Napatech. I'm pleased to welcome you all to Napatech's presentation for the second quarter of 2025. Joining me today is our Chief Financial Officer, Heine Thorsgaard. Our second quarter 2025 report was released earlier this morning on Oslo Stock Exchange, and is also available on Napatech's website. For your information, a recording of this webcast will be available later today. Slide 2, please. There will be a question-and-answer session following this presentation. during and after these prepared remarks, 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. Slide 3, please. 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. Slide 4, please. Today's agenda will cover four areas. First, we will provide a business status for the second quarter of 2024, with focus on the major news items that capture the notable progress by Napatech's towards achieving our goals to transform our business. Next, we'll provide a market update that shares information about the opportunity ahead of Napatech. We will then shine a spotlight on some of our most recently announced wins and how those wins will positively impact our business in the future. We will then provide a detailed summary of our second quarter financial results Finally, we will conclude with a question-and-answer session open to the attendees of today's call. Slide 5, please. We have made considerable progress in meeting important milepost our strategic plan to strengthen our position as an early leader in the new and evolving mass market for our network interface cards or NICs. This includes both notable improvements in our existing capture business, and we have also made strong progress towards our design win goals that underpins our growth aspiration to deliver 60,000 to 80,000 units a year when those design reach peak production. This has progressed according to plan, and if we compare our position to just 1 year ago, we find ourselves in a much stronger position. Slide 6, please. Q2 was a solid quarter for Napatech. We did revenue of $4.8 million, an increase of 43% year-over-year. First half 2025 revenue was 26% above first half 2024. Our Q2 gross margins remained healthy at 67%, up 2% compared to Q2 2024. First half 2025 gross margins ended at 68.4%. Q2 EBITDA was negative at DKK 19.6 million. This was an improvement of DKK 7.7 million compared to Q2 2024. Net working capital slightly reduced from Q1, DKK 97 million to DKK 95 million. Free cash flow in Q2 was negative at DKK 21.2 million. This was an improvement of DKK 23.4 million compared to Q2 '24. Q2 was a step in the right direction for Napatech. I'm also very pleased to report Q3 is looking relatively strong. And I can already report that our revenue for Q3 2025 will be better than both Q2 2025, and it will also be better than Q3 2024. In support of significant steps forward with our current customers and expanding design win pipeline, Napatech successfully completed a private placement capital raise of DKK 210 million. The placement attracted interest from both leading existing investors and new high-quality investors. The proceeds will be used to finance the growth opportunity arising from the announced partnership, pipeline and design wins. We were also fortunate to expand our Board of Directors with new members holding key executive position from respective companies with proven success in with customers in the markets that Napatech is navigating today. The partnership Intel-Altera continues to go well. Most of our pipeline in strategic design wins continues to come from our partner Intel-Altera. So we are pleased to see the existing captive business to improve, but even more important is the strong progress we are seeing with our strategic design wins. One year ago, we announced a design with Intel-Altera and a Tier 1 server OEM and to build a next-generation solution to their specification for high-volume use cases as well as the general market. I'm glad to report we consistently met the halfway milepost ahead of plan and exceeded their expectations. We are now involved in the next stage of their process, which includes development and integration of key software to meet their deployment requirements. We are excited that our efforts to date have resulted in expanding our cooperation to additional use cases and opportunities, all of which represent potentially high volume to Napatech. More information will be later in the presentation about this opportunity. We are equally excited to share more information about our latest high-volume design win with d-Matrix, a leader in artificial intelligence inferencing for hyperscale cloud, next-wave cloud and enterprise data centers. Our Intel-Altera Programmable NIC enables AI infrastructure that d-Matrix requires to deliver efficient ultra-low latency disrupted inferencing across many AI servers. Their customers get the benefit of deploying an industry-standard Ethernet-based scale-out solution to take advantage of d-Matrix, placing fast influencing speeds all at massive scale. This delivery is also going according to plan. We have also recently disclosed other winning solution across an array of applications and services by leading companies in their respective vertical markets, including a cybersecurity solution with Broadcom Symantec, a network and server infrastructure solution with Eidection and an artificial intelligence solution with Myrtle.ai, and Xelera for ultralow latency transition in financial service markets. These are all examples of Napatech expanding its business to large or high-growth segments that require our Programmable NICs. We are also pleased that one of our UPF 5G packet core design wins has secured a design win from a North American 5G operator that is expected to lead our first production deployment in late 2025. Slide 7, please. In this section, I would like to share an update on our market and how it is positively being impacted by artificial intelligence. Artificial intelligence is not just the bus in the present, it is the future. And it is the majority of the future of all our segments we serve from network infrastructure, storage, cybersecurity and more. AI begins inside 1 processor in 1 server, but it only achieves its goal while working among an array of processor put together across a neural network, connected at very high speed over secure links with ultra-low latency that are highly dynamic and able to evolve quickly. These are networks that think. You will come to see in the next section, why it is, we believe, Napatech's networking cards co-created with market maker Intel-Altera are the optimal solution to power these new networks. Slide 8, please. Over a long 25-year evolution standard servers with basic networking cards provided best effort access to services like websites, e-mails and remote storage of files. These things were measured in speeds of 1 to 10 gigabytes, and the world was relatively static. And now what was the 25-year evolution has given way to a near daily revolution with the network required to deliver time-sensitive services. New artificial intelligence applications along with cloud services and 5G mobile access has caused these networks to change daily to support billions of users and devices in real time at blistering speeds without delay. Napatech sits in the eye of the storm of chains that is happening right now. Basic networking cards cannot fulfill the AI vision, and a new solution is needed to build modern data center, focusing on AI, cloud and local services. The solution is to replace basic server network cards with an advanced programmable network cards. This innovation has many names, ranging from SmartNIC, intelligent NIC, accelerator cards, offload card, data processing units, infrastructure processing units and more. But despite many names, they have one thing in common. They are designed to replace basic NIC and fix the processing networking and scalability issues. Advanced programmable NICs bring three important improvements to data centers and servers. First, they fix the server CPU processing problem by offloading and accelerating the networking security, storage and other burdensome task from the CPU to the advanced NIC. This significantly increases the performance of the server and those tasks while at the same time, returning the CPU resources to the core function of AI, cloud and mobile services. Second, the advanced NIC is fully programmable, enabling the data center to reconfigure itself on a daily basis to respond to changes in technologies, new applications, new services, unforeseen problems and new cybersecurity threats. Third, the increased networking performance improved CPU capacity, creates and increases improvement in server performance dramatically reducing power, space and cooling requirements and enabling the data center to expand as needed to meet the new demands. Slide 9, please. Advanced programmable network cards are widely used today by the largest data center operators, known as hyperscale cloud operators. They were the first to deploy AI, cloud and other advanced services and ran into these issues. Lacking merchant solution, they deployed massive software and hardware engineering resources to build their own advanced NICs and deployed more than 12 million units last year. It is important to note that Intel-Altera helped to make this market and is deployed in nearly all of the largest data centers globally. Today, as large enterprises, telco operators, neo clouds and Tier 2 regional cloud providers accelerate the adoption of AI workloads and cloud-native infrastructure, they are facing the same networking challenges as the top hyperscale cloud operators. Unfortunately, these next wave users must solve the same problems without having hyperscaler level hardware and software engineering resources. This creates an urgent demand for merchant-based programmable high-performance advanced network cards to bridge the gap. As you can see in the graph, all these new players are expected to grow significantly in the coming years. As the primary provider of an engineering solution to hyperscale operators via component sales, Intel-Altera has partnering with Napatech to deliver a merchant solution for the mass markets. Based on Intel-Altera's proven winning hardware and software design that is widely deployed in the largest early adopter hyperscaler networks, Napatech is uniquely positioned to deliver the turnkey, production grade and complete solution to the IT buyers in the mass market. Slide 10, please. As demand for more AI, cloud and mobile services continues to grow, an increasing number of servers are in demand with more than 20 million a year being deployed by 2029. These servers require connectivity from network interface cards, and it's clear that advanced network cards are the future for data centers of all sizes. The hyperscale cloud networks have all moved on from basic NICs and consequently, they consume more than 12 million advanced NICs last year. They will continue to do so and their demand will grow to be nearly $11 billion in the next 5 years. Equally important, as the next wave of data center races to deploy similar AI, cloud, security, mobile and other services, this mass market opens up for merchant provider like Napatech and Intel-Altera. A simple reason is that you cannot call up a hyperscaler and buy their programmable network card, which they have developed in-house for only internal use. This greenfield growth is anticipated to approach $6 billion by 2029, and follow the same growth that fueled the hyperscaler market. The transition window is opening now for advanced NIC's from merchant suppliers to the next wave data centers that make up the mass market. They are expected to be the fastest-growing segment of network interface cards over the next 5 years. Slide 11, please. There is no shortage of application services within the mass market data centers, driving their demand for advanced NICs. They include high-volume designs for cloud and artificial intelligence. It also includes business-critical applications like cybersecurity and financial services, and it includes advanced network infrastructure like 5G mobile infrastructure. Slide 12, please. These mega trends create the opportunity for Napatech. As shown in this inside the box view of the server, Napatech's advanced NICs play a crucial role in modern data center server designs. Our products provide the access from the outside world to the CPU and the GPU FPGA resources that delivered the AI cloud mobile security, financial and other critical services. Our advanced NICs ensure these servers can deliver those services at the optimal mix of price, performance, space and power for the data center operator. Slide 13, please. A unique aspect behind Napatech's business model is an innovative go-to-market model that lowers our operating expenses and increases the scalability of our business. Napatech's and Intel-Altera have partnered to deliver advanced NICs to the mass market. This partnership brings four valuable points to Napatech. The first is increased volumes. While Napatech has been building NIC for nearly 20 years, our solution have historical target critical but smaller niche application with lower growth. This resulted in a stable capture business that drove 5,000 cards approximately per year. The Intel-Altera hardware and software designed for hyperscalers is now also addressing the mass market. The application and services addressable by the enhanced design now enabled Napatech to target a new set of customers and use cases that are a transformational scale, oftentimes requiring 1,000 units, 5,000 units, 10,000 units, 25,000 units or even in some cases, up to 50,000 plus cards per data center per year. Next, we can scale our reach beyond what we could have done on our own, limited by size, geographic and cost. As a part of our partnership, Intel-Altera does a significant portion of the sales, marketing, market creation and business development, bringing Napatech into big opportunities who have already embraced the solution and are looking to Napatech to fulfill that demand. Further, as a consequence of Intel-Altera desire to strategically develop the mass market based on their hyperscale success, they have granted Napatech access to the latest CPU and FPGA technologies, creating an incredible first-mover advantage ahead of other companies looking to enter this rapidly emerging market. Finally, the partnership requires frequent engineering collaboration throughout the joint product developments. We gain high confidence technical guidance from Intel-Altera's proven hardware and software solution that significantly derisk our product road map in the engineering designs. Slide 14, please. While this unique partnership with Intel-Altera has been 2 years in the making, the products and solutions have largely only been in development over the past years. In this next section, I would like to share with you both updates and news related to just a few examples of the success and potential we see from our new solution. Slide 15, please. As we look at the totality of our business, two bright spots emerge. We continue to expand the total pipeline in both the number of opportunities and the total value of those opportunities. Both are far beyond any Napatech's historical metrics. They continue to explain each month and the primary in our new products and solutions created in the partnership with Altera. Also, as we mentioned earlier, we have seen an improvement and acceleration in our capture core business. This is driven by large customer burning that build up inventories and returning to historical consumption, particularly fintech and cybersecurity, in those segments, we have seen a growth in the last 3 months, which is record high. The improving base business plus constantly expanding pipeline of opportunities and early success in new design wins provide great optimism towards realizing our growth ambitions. Slide 16, please. Our work with the Tier 1 server manufacture continues according to plan. We have met on-time delivery for all hardware deliverables according to their and the Altera specification. The design is anchored in an innovative hardware platform that includes 400 gigabit Smart NIC. It includes the ability to add an optional CPU, turning it into a data processing unit. We offer the DPU in two configurations optimized for servers of different sizes. These hardware programs, we develop at an incredible pace and we met each critical milepost ahead of schedule, exceeding expectation of all parties. As the hardware projects matured earlier this year, the team began the parallel work on the many key software requirements around network storage and security offload and acceleration. This will allow development of the customer solution for the use cases to begin on the hardware throughout 2025 and beyond. We're happy to report exceptional progress so far, resulting in stunning benchmark for each of those demonstrated today. During these successful stages, we were pleased to expand the opportunities from the initial project to include several opportunistic spanning use cases, including AI and cloud storage, data content reduction, cloud tenant services, 5G mobile infrastructure and more. Slide 17, please. We remain excited about the potential from our design win with d-Matrix, the creator of Cousera, the world's most efficient artificial intelligence computing platform used for inferencing in data centers. Inferencing is the cornerstone of artificial intelligence. It transformed the knowledge from trained models to create prediction, decisions and insights that are practical and beneficial in real-world applications. There are several things that underpin our excitement about this design. It is in a very hot space of artificial intelligence. It is a strong validation of everything we are doing in our partnership with Intel-Altera. It is a NIC solution for AI infrastructure in the AI data center back-end network. And as such, it is an extremely high volume deployment. It is also the same product shown on the previous slides, built in conjunction with Intel-Altera and the Tier 1 server manufacturer. And this particular design included a master supply agreement with 5 years of product availability, volume commitments and NEP work related to the software to power the solution. We're expecting production deployment in 2026. Our current biggest design wins are all related to AI. We are actively pursuing the increasing list of companies looking for AI infrastructure solutions, and this is a great example of our investment strategy for building a winning solution and leveraging that investment across additional customers with similar requirements. Slide 18, please. I would like to highlight a few of our recent design wins and the progress those companies are making in their markets. First, Broadcom, Symantec and Napatech created a joint solution in Q1 to deliver their data loss prevents in cybersecurity application to enterprise customers with exceptional performance. We are pleased to report that in a short amount of time, we have captured our first end user win at a large global banking and finance institution valued at north of $250,000. This first customer represents potentially just 1 of many among the global Fortune 5000 enterprises that could benefit from the same solution. Second, one of our software design wins with the company A5G, who provides 5G packet core solution is using our hardware and software to accelerate their application. They have just been awarded their first design win. We anticipate the solution to go live on towers at the end of this year or early next year. The customer is a North American 5G provider. Next, a leading hardware manufacturer Kontron has created a solution for an server power by Napatech's hardware and software solution to enable 5G UPF offload and acceleration. They are targeting telco operators who is looking to strengthen their 5G backbone networks. Most operators are these days running their IP core on a 4G architecture. Soon, many operators will have to upgrade to a new 5G IP core since the number of 5G subs will increase beyond the number of subscribers that can be sorted by their existing 4G packet core. Finally, we have earlier disclosed the design win with Myrtle.ai and their inferencing product Wolle. In Q2, they announced and disclosed their product launch to the general market, highlighting microsecond machine learning and inferencing with ultra high performance and low latency powered by Napatech. These solutions power by Napatech, among others, are great examples of work we have done in the past, laying a foundation for future growth beginning to show signs of success. Slide 19, please. As I wrap up the business section of today's reporting, I would like to invite you to come to see Napatech at one of these great events through the remainder of 2025. If you happen to be in one of these great cities during one of these events, we would love you to stop by in person and talk to one of our experts on hand. Slide 20, please. The last few slides of our update today provide more details on the financial results outlook for our fourth quarter and full financial year of 2024. I would like to ask our CFO, Heine Thorsgaard, to provide these updates. Please, Heine.

Thank you, Lars. Slide 21, please. Revenue in Q2 amounted to USD 4.8 million, up 43% compared to Q2 last year and up 41% compared to Q1 this year. In DKK, revenue amounted to 31.6 million, up 36% compared to Q2 last year. For the first half of the year, revenue in DKK was up 24% compared to last, year and amounted to DKK 55.4 million. In USD revenue in the first half of the year amounted to $8.2 million compared to $6.4 million in the first half of '24. Gross margins in Q2 ended at 67% compared to 65% in Q2 last year. The gross margins for the first half of 2025 was 68.4% compared to 68.2% in the first half of '24. Our staff costs and other external costs in Q2 amounted to 42.6 million compared to 43.3 million in Q2 last year. Compared to the previous quarter, our staff costs and other external costs declined by 12.9% in Q2. For the first half of 2025, staff costs and other external costs amounted to 91.5 million compared to 83.9 million last year. Staff costs transferred to capitalized development costs in Q2 amounted to 1.8 million compared to 0.9 million in Q2 last year and to 4.9 million for the first half of '25 compared to 1.7 million in the first half of 2024. EBITDA in Q2 amounted to negative 19.6 million compared to negative 27.4 million in Q2 last year. And EBITDA for the first half of 2025 amounted to negative 48.7 million compared to a negative 51.7 million in the first half of 2024. Slide 22, please. Net cash flows from operating activities in Q2 amounted to negative 18.6 million compared to negative 41.9 million last year. For the first half of 2025, net cash flows from operating activities amounted to negative 44.3 million compared to negative 47.4 million last year. Net cash used in investing activities in Q2 amounted to 2.5 million compared to 2.7 million in Q2 of 2024. And for the half year, net cash used in investing activities amounted to 6.3 million compared to 3.7 million last year. Free cash flows in the first half of 2025 amounted to negative 50.6 million compared to negative 51.0 million in the first half of 2024. Cash and cash equivalents at the end of Q2 2025 amounted to 133.4 million compared to 103.2 million at the end of Q2 2024. Slide 23, please. During 2025, we have planned and implemented several improvement initiatives aimed at reducing our net working capital in the second half of 2025 and through 2026. Napatech's main initiatives to improve net working capital are focused on reducing inventory levels and optimizing the planning of future production, on negotiating better payment terms with key suppliers and current customers and on optimizing payment terms and sourcing models for new high-volume agreements. In the coming years, we anticipate that most of our new business will stem from large volume orders rather than from production for stock. This shift will lead to an even more optimized logistics setup with a significantly lower need for working capital. Back to you, Lars.

Given the accelerated growth in our capture base business, we are on track to reach our guiding for 2025. We expect to be within the range and are positive that unit ships will be on target or more than 5,700 cards in 2025. In addition, we expect that OpEx will be lower in the coming quarters due to cost reduction measures implemented in Q2 2025. We expect the company is fully funded and cash flow will continue to be improved in the coming quarters. Next slide, please. Based on our design win pipeline and initial wins, we gain additional confidence in our financial outlook. Increasing unit sales are driven by increasing demand across mass market customers. High gross margins are enabled by the strong software component in Napatech products, which also promotes customer stickiness. Our OpEx is reduced through rightsizing the organization in Q2 2025, while still enabling growth. Additionally, net working capital is expected to be significantly improved due to new model taking orders before incurring expenses. Based on the work done in Q2 this year and the good start of Q3, we feel more confident that the unit numbers shipped going forward are within reach. And now we're ready to go to the Q&A session. Operator, please initiate.

[Operator Instructions] So we currently have no questions on the conference call. So I'll just hand over for any webcast questions.

This is Lars Boilesen, and I see three questions. Should I just go ahead and answer them?

Please go ahead.