Napatech

Good morning. I'm pleased to welcome you all to Napa Tech's third quarter 2021 interim management report web presentation webcast. I'm Ray Smets, CEO of Napa Tech. I'm located in Copenhagen today and joined by Heine Thorsgaard, our chief financial officer. Today's Q3 2021 IMS was released earlier this morning on the OSC and is available for the investors on our investor relations page of our website at napatech.com. For your information, a recording of this webcast will also be available on the Napa Tech website as soon as possible later today. As always, we will answer your questions at the end of the presentation via text, which you can submit on the webcast page using the button below the presentation. We can take your questions on the phone if you prefer. If you'd like to ask a question, follow the instructions on this slide, and we'll come back to it soon. Please note that this presentation contains forward-looking statements that are subject to a number of risks and uncertainties. Our actual results may differ from those discussed in forward-looking statements. As always, Hein and I will cover our Q3 results and review our guidance for 2021. But it's a great time to talk about our future. I will share some exciting developments about the progress in key markets, key evolutionary steps the SmartNIC market is going through, and where we are navigating Napa Tech to seize a key role in the evolving market and catch the growing and compelling opportunities that are ahead of us. So the future is bright for Napa Tech. So let's get into it. Napa Tech has built a solid business making SmartNICs, which has emerged as key components to the rapidly evolving networks, clouds, and data center markets. These SmartNICs are made to easily plug into any standard server which are the fundamental building blocks for all new networks designed and deployed. They are built with super powerful reconfigurable microprocessors called FPGAs, which combined with our software accelerate applications across multiple application segments such as cybersecurity, monitoring, infrastructure, cloud and edge, and mobile. These application areas require more and more compute power to operate and perform faster and securely. The demand for higher-performing compute from these applications creates demands for SmartNIC. But the key strategic advantage to our success is Napitech's software that runs on these SmartNICs that delivers the real value for our customers. The software provides the features that make our customers' software solutions work better, smarter, and more securely. But when it's married to our hardware, we add the benefit of hardware FPGA performance to accelerate these applications even further. But it doesn't end there. SmartNICs are evolving even more to meet the unstoppable rise of digital business. Even with the backdrop of the global pandemic over the past few years, the world has become even more dependent on data applications in the cloud. Add to this the architectural evolution of mobile networks to roll out 5G, the explosion of artificial intelligence, and the catalyst of the Internet of Things, the need for performance in the data center has become even more intense. In highly virtualized environments where our market is evolving fast, server computing resources are being stretched to their technical limits to process more complex applications along with hypervisors, container engines, network and storage functions, security, and greater amounts of network traffic. Server technology just can't keep up, so more infrastructure tasks need to be offloaded from the server to, you guessed it, to the SmartNIC. So the SmartNIC needs more and more compute horsepower. In our design, the FPGA carries a generous load of compute. But the industry giants like Intel, Xilinx, NVIDIA, and others have designed a new class of processors called DPUs, or IPUs, infrastructure processing units, that include general purpose computing cores. The difference between the IPU and a SmartNIC is that the SmartNIC can effectively accelerate infrastructure applications, which is what we at Napa Tech do every day. But the IPU is designed to go further and offload and run the entire network stack, which will give service providers a new option to deploy network and security functions. So how does Napa Tech participate in this evolution? Well, we already are. We will expand our software on the SmartNIC solutions to include IPUs. And we have already created partnerships, including the one with Silicon and Intel. It is our ambition to win new business in 2022 and beyond in this expanding space. So we at Napa Tech believe we have never been in a more compelling position to take advantage of this growing opportunity. According to the industry analysts that track our space, the total NIC market is expected to approach $2.8 billion this year, growing to about $5.6 billion by 2025. The SmartNIC segment alone in this market where NAPA tech is focused is expected to grow to $3.6 billion and accounts for the fastest growing segment of the overall NIC market. This growth is being driven by deployments by hyperscalers, tier two cloud operators, telecom service providers, and enterprises driving the need for SmartNICs. Combine this with the evolution of the SmartNIC to the IPU to offload the entire network stack, and the SmartNIC market is more lucrative and compelling for us than ever before. We see this evolution taking place, and we are navigating Napitech to be a key player in this evolution, leveraging what we do best, accelerating applications and virtual network functions on FPGA-based SmartNICs. And we are going deeper with key partnerships to get access to the new and growing IPU market opportunity by bringing our best-in-class high-performance software to the IPU. We have already revealed partnerships as part of this effort and what we have communicated about Lenovo as becoming their OVS accelerator solution, importing our software to Silicon's Intel-based IPU, while building on longstanding partnerships with Xilinx, Intel, In our newest partnership in the space, Acronix, Napa Tech is in a better position than ever before to seize these opportunities. Napa Tech will announce new products in this space, and we will sign new important deals soon to keep up this momentum. And if we are successful, the revenues from these opportunities will be transformational to Napa Tech. But in order to achieve this, we need to invest for success. And the time is now. We have been successful building a solid base of revenue and profits in our core product line, but we are also keenly focused on executing to build new product capabilities and solutions with our inline and link virtualization product offers to unlock faster areas for growth. This multi-pronged approach in our product strategy assures that we are building core revenues on a solid foundation while enthusiastically building new revenues in areas where we believe we can win. Our SmartNIC link virtualization software will improve performance on SmartNICs and IPUs by offloading virtual workloads, improving server performance and overall network economics. As such, management has taken a decision to increase investments in software development to accelerate feature development within this evolving market. We have already begun expanding our engineering capacity by hiring full-time engineers and subcontractors to help us leverage the business and get revenue faster with a more competitive solution. We expect by the end of Q2 2022 that we'll have added more than 30 additional engineering headcount subcontractors compared to Q2 2021, which is about a 70% increase in engineering capacity year over year. This is substantial. This investment will impact our cash flow over the coming quarters as we accelerate this investment, but we fully expect these investments will enable new 2022 design wins which will drive revenue expansion for years to come. We believe using this resource now is the best thing for our customers and our investors. The timing of this investment is strategic, and now is the time to accelerate this effort. So with all of this enthusiasm as a backdrop, let's provide an update on our Q3 performance. As we address a growing market and navigate a complex global business environment, we are pleased to report our continued streak of solid business performance. We delivered our 12th quarter in a row of year-over-year revenue growth, and we delivered a combination of year-over-year revenue growth and profit for the sixth quarter in a row. We delivered third quarter revenue of 7.5 million for a year-over-year growth of 7%. As Hein and I highlight in other areas of our Q3 results, you will see that across the board, our performance was solid. but we know we can do much better on revenue growth as we execute on our strategy, as I just reviewed. Even without significant revenues from our linked virtualization efforts so far in 2021, results were solid, and more importantly, our strategy for long-term growth potential will be much more interesting. We generated solid gross margins of 73% plus in Q3 and within our annual guidance range. The strength of our gross margin is a continued validation of our value proposition and our software value proposition in the marketplace. On the earnings front, overall earnings were significantly up and growing year over year, demonstrating the overall strength from our business from the top line to the bottom line. We have been navigating a very difficult global supply chain challenge in semiconductors and other vital technology components. We have done well to stay ahead of this worldwide challenge by stocking up on component supplies all year, despite the shifts we have encountered with supply chain stability. We continue deploying more working capital than normal as we secure component supply well into 2022 to ensure that we have them in place to support our demand and our planned revenue goals in 2022. Although this wasn't expected even at the beginning of 2021, we have shown resilience with how we have managed to do this to the best of our abilities. Despite this challenge, we handled the situation well. We delivered positive free cash flow in Q3. Free cash flow year-to-date is positive, 12.1 million DKK when adjusted for early deployment of working capital due to supply chain impacts. So, so far so good. This slide shows our solid positive results on a year-to-date basis year-over-year. Even though we are not generating any of the new virtualization revenues, Thus, we didn't get the higher growth that we had hoped for. We still continue to build on a solid and profitable core business as we keep working on our strategy to unlock growth. Q3 21 year-to-date revenue was 22.6 million USD, which is up 6% year-over-year from 2020 and up over the prior year-to-date periods. From an overall results perspective, the chart on the right shows that with well-managed expenses and careful product cost structure, we delivered record earnings over this period. This is by far the strongest earnings report in the history of Napa Tech. This demonstrates our business leverage and the potential for long-term profitability. So I'm pleased with the earnings results in 2021, despite the tougher than normal global environment, but rest assured, we have much higher aspirations for revenue growth than what we have experienced so far in 2021. And we are optimistic about it. Here's a sampling of logos of customers from all over the world who put their trust in the Napa Tech SmartNICs and software in Q3. The logos are categorized into key market segments, networking and security, telecom and cloud, government and defense, and financial technology or other. We had important sales across all these segments with solid revenue business customers in the networking and security sector, including key growing markets and customers like IBM, LiveAction, Emergent, VIAVI, Arteza Networks, and PolyStar, just to name a few. We have also had revenue from Intel in support of a very important effort to showcase our joint product solutions within their centers. Networking and security is where performance against evolving threats takes center stage. On the telecom and cloud side, we again saw ongoing business with Orange, Nokia, and Mobilium, for example, all focused on telecom. We saw renewed business with Triveni, neometrics, and others where higher speeds and the need for better performance is driven by 5G, increasing security threats, and the need for greater visibility and faster packet processing. Q3 is an important quarter for government and defense segments in any industry, which has been a growing focus for us too. With returning OEM customers like Rheinmetall, Accelio, and Dell, but also agencies such as NASA Ames Research Center, the Japanese Ministry of Defense, NIST, also known as the National Institute of Standards and Technology, and NATO's Cooperative Cyber Defense Center of Excellence. In all of these use cases, mission-critical apps need higher performance with zero packet loss, but with greater network visibility and control. In the fintech sector and the other category, we continue to earn business with OEM customers like Pico Corville, Velocimetrics, and Refinitiv. and a very important end-user customer business win over the last couple quarters with Bank of America and Eurex International Exchange. We had business with a handful of top universities too, such as Carnegie Mellon and Emory University. It was good to extend business with several key pharmaceuticals too, like Gilead and Novo Nordisk, all fighting the battle of the pandemic. We are pleased overall with our customer wins in Q3 as we build our progress year over year. As I have mentioned earlier in this presentation, we have been operating our business in a changing and complex global supply chain situation. The cost of components that we buy to build our products have been escalating all year long. Coupled with the lack of historical available supply, Nathatech has been aggressive at securing component supply to protect our customers' needs and to assure our long-term supply support our planned revenues going into 2022. It is unusual for us to now have to compete for components on technology marketplaces where we have seen the availability and their prices change literally on a day-to-day basis. So far, we have done well to maintain our margins and prices. However, we did receive word a few weeks ago about a significant price increase for a key component of our product line, namely the FPGA. We needed to react by issuing a price increase which is now effective for January of 2022 for all Napa Tech impacted products. Given the environment, this is the right decision to make. We have thus communicated this to our customers. We are not out of the woods, so to speak, as we continue to see the global situation evolve. Other areas that we are closely monitoring are industry server availability, where we have reports of tighter supply for servers for data centers, which can impact smart availability. Another area where we have heard reports are around shortages of customer personnel to deploy projects, which has caused some project delays and increasing time when customers need our products. So we are being cautious, but on the positive side, we are seeing strong backlog development as customers also respond to their own concerns about SmartNIC supply. So let's get into the financial details. I'd like to now turn the call over to Heine Thorsgaard to review more details about our Q3 2021 results. Heine.

Thank you. Revenue in Q3 was up 7% compared to Q3 last year. Revenue year to date in USD was up 6% compared to last year and amounted to 22.6 million. In DKK, revenue year to date amounted to 140.5 million. Gross margins in Q3 ended at 73.1%, up 3 basis points compared to Q3 last year. Gross margins in the first three quarters of 2021 was 71.7%, up 0.3 basis points compared to last year. Our staff costs and other external costs in Q3 amounted to 28.3 million compared to 25.3 million in Q3 last year. Year-to-date staff costs and other external costs amounted to $88.6 million compared to $86.3 million last year EBITDAQ in Q3 amounted to $6.2 million compared to $5.4 million in Q3 last year EBITDAQ for the first three quarters of 2021 amounted to $12.1 million compared to $14.9 million in 2020 Staff costs transferred to capitalized development costs in Q3 amounted to 6.1 million compared to 2.5 million in Q3 last year. Transferred costs year-to-date amounted to 17.8 million compared to 8.7 million last year. EBITDA in Q3 amounted to 12.4 million and 29.8 million for the first three quarters compared to 8 million in Q3 and 23.6 million year-to-date last year. Results for the period in Q3 amounted to 7.6 million, up 6.7 million compared to 2020. And for the first three quarters, the result for the period amounted to 18.6 million compared to 3.4 million last year. Net cash flows from operating activities in Q3 amounted to 12.7 million compared to 14.8 billion last year. End of Q3, net working capital was 36.4 million, compared to 6.6 million at the end of Q3 2020. Compared to end of Q3 last year, our inventory is up 14 million and receivables are up 15 million. As we mentioned earlier, we've proactively been sourcing components for some time due to the uncertainty around the supply chain. And this conscious choice is reflected in the network and capital level. Net cash used in investing activities in Q3 amounted to 8.4 million compared to 3.4 million in Q3 of 2020. In year to date, net cash used in investing activities amounted to 18.8 million compared to 9.2 million last year. This is reflecting our acceleration of investments in our new product development and as Ray mentioned earlier. Free cash flow in Q3 amounted to 4.3 million and reported free cash flow year to date is negative 19.1 million. When adjusted for the increases in working capital, free cash flow year to date is positive 12.2 million and we've now managed to produce a positive adjusted free cash flow for the last nine quarters in a row cash and cash equivalents end of q3 amounted to 40.6 million compared to 70.7 million at the end of q3 2020. now back to you ray thanks heiner let's take a look at our outlook for 2021. we have a robust pipeline of opportunities in 2021

Given our pipeline of opportunities within Q4, we remain committed to our current guidance for 2021. We are confident in partner and customer opportunities within our pipeline for Q4, and we are working very hard and we are going forward to deliver on our annual revenue goals. We feel good about our gross margin development against the backdrop of the global supply chain challenge, and our increase in engineering investment is fully accounted for in our annual plan. So we hope to demonstrate good results in Q4 along with interesting key developments with our strategic partnerships. So watch the space. We will remain diligent on the risks for us in Q4 as well. As I've already said, related to the global supply chain challenge situation, areas we are closely monitoring are industry server availability, reports of shortages of customer personnel to deploy projects, and other things which can cause some project delays. So in conclusion, We are a stable and growing business chasing a very lucrative opportunity for growth within a very important market for data center expansion. Our core business is sound, which is an important foundation that we're building on as we navigate our way to a bigger and very compelling market opportunity of accelerating applications, offloading functions and virtual networks, and catching the wave with IPUs through partnerships and new ways to get to the market. Overall, we remain very optimistic about the potential for growth and are striving every day to unlock that growth potential with innovative technology, SmartNIC solutions and features that deliver market leading performance for our customers. As they say, timing is everything. We have the smarts, we have the team, we have the technology, we have the ability and the potential for success. The time is now to invest more to get the success we and our investors deserve. So we remain committed to our growth strategy, and now we need to go get the job done. So now I'd like to invite Heine Thorsgaard to join me and begin to take your questions. If you'd like to ask a question, you could submit it now on the live webcast page using the button below, or you may dial into one of our phone numbers on the screen where an operator will answer your call and place you in a queue. Please keep your questions to one or two per caller, and we'll do our best to respond to as many text questions as we receive. Operator? I'll let you take it from here. Do we have any calls in the queue?