Napatech

to welcome you all to the Napatech Interim Management Statement presentation for the first quarter of 2024. Joining me today is our Chief Financial Officer Heine Torskov. Our Interim Management Statement 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. There will be a question and answer session following the 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. Please note that this presentation contains forward-looking statements that are subject to risk and uncertainties. Our actual results may differ from those discussed in forward-looking statements. Today's agenda will cover four main areas. First, we will provide a status on the first quarter of 2024 with focus on the major news items that's showing promising signs of progress by Napatech towards achieving our goals 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 first quarter financial results. We will finally conclude with a question and answer session open to the attendees of today's call. We have begun 2024 in two ways. On the financial metrics, we were up to a slow start of our existing capture business. However, on our new strategic data center cloud programmable NIC business, we were off to a very exciting start in reaching a commercial partnership with one of the biggest global server OEM manufacturers in the world in cooperation with our partner Intel Altera. Our focus throughout the year is executing our strategic plan as it underpins our long-term growth aspirations. To achieve those goals, we have three areas of focus. We must service our valuable installed base of customers who are the early adopters of programmable niche solutions. They are a proving ground for the technology and the value that our solution brings to their networks and businesses. These are mainly customers in the capture niche business. We are accelerating our engineering software and hardware technologies that extend our products into new areas that align with the highest projected growth segments for Napatech solutions, mainly in the data center cloud and 5G business. And we must continue to develop an ecosystem through partnerships that expand our go-to-market reach via marketing, business development and sales, enabling us to reach places we could not 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 start of 2024. To begin, on April 18, Napatech announced a collaboration with Altera, an Intel company, on the detailed specification of HotSpring Canyon's architecture for 400-gig IPUs. The collaboration develops new programmable NIC hardware and software solutions based on an architecture that promised to enable an innovative approach to powering modern public clouds, private cloud, edge, and enterprise data centers built for an 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 applications and services, artificial intelligence infrastructure, desegregated storage, big data analytics, cybersecurity, 5G mobile infrastructure, and microservices. next we disclosed that the product designs with intel altera were developed in partnership with the 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 optimizations 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 service fees from both companies to Napatech. The collaboration includes these significant contributions, reflecting the shared commitment required to expedite the underlying engineering to deliver products in the second half of 2024. As a result of these partnerships, the full potential is at the largest end of the spectrum for transformational growth that Napatech envisions. At peak annual volumes, this single opportunity alone has the potential to transform Napotec's long-term revenue and profits. Consequently, we are maintaining our target of 4-6 design wins, while increasing our guidance from 30,000 to 40,000 units to 50,000 to 60,000 units in peak annual production years. We also disclose important partnership with companies including Amentia, Hyperblox, A5G, Sabia and Supermicro, who are providing solutions for 5G infrastructure and artificial intelligence and machine learning. These valuable partnerships enhance our go-to-market strategy, taking Napatech products to customers beyond our reach. In support of these significant steps forward with our current customers and expanding design wind pipeline, Napatech announced and successfully completed a private placement capital raise on May 7, 2024. Napatech offered 9 million shares at a subscription price of NOC25, approximately 10% above the market price at the 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 a growth opportunity arising from the announced partnerships resulting in the increased guidings, including hiring more developers and working capital requirements in connection with increased productions. And finally, we have reaffirmed our financial outlook for 2024. Our financial results for the first quarter of 2024 were off to a disappointing start. However, the start of the year was expected to be slower than normal, primarily because one of our largest customer is continuing an inventory correction to deplete a COVID-driven safety stock that is expected to be completed through the first half of 2024. In addition, March order flow was unexpectedly slow, also driven by one last customer purchase that was deferred into Q2 2024. Our financial results include revenues of DKK 21.5 million or USD 3.1 million and gross margins of 72%. More details on our financial results will be provided in the final section of today's presentations. Given the progress in 2024 moving towards achieving our strategic goals, in the next few slides, I would like to share more information about Napatech, our products, and the opportunity opening to us. Napatech's products are key for server performance. The image to the right labeled F is a standard server. Servers are the primary system in modern data centers and are used to deliver the applications, services, and revenue to business in cloud, enterprise, telecom, and government networks. Historically, the most important part of the server were 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 in the figure. These expansion slots are most often used today for acceleration cards based on GPUs or FPGAs, for artificial intelligence, machine learning, training, large language models, and more. And finally, the slots labeled A and B show the network interface cards, or NICs. In this image, two of Napatech's NICs are shown. Together with Intel, Napatech is developing two types of programmable NICs, including smart NICs shown in B, and infrastructure processing units, or IPUs, shown in A. Napatech's programmable NICs play a crucial role in modern data center and server designs. The Napatech NIC cards are the sole link between the outside cloud and enterprise networks, providing access to critical CPU and GPU resources that deliver artificial intelligence, security, and many other services. The underlying problem Napatech programmable NIC help to solve is a server performance gap. The problem has originated from a spectrum of megatrends creating a huge demand for computing resources. These include cloud and edge computing and storage, artificial intelligence infrastructure, 5G mobile infrastructure, financial services and other fintech uses, cybersecurity, big data analytics, and others. This explosive growth is increasing network traffic as well as the demand for servers to more than 20 million servers a year by 2027. Unfortunately, these servers cannot keep up with the demands of the new applications and the services required by the megatrends. The CPUs within the servers end up spending significant processing power handling non-core infrastructure tasks for networking and security, rather than running the applications and services. This leads to decreased revenue and lower overall performance of the systems. In small scale examples, this is resolved by adding more servers. But in most networks built by cloud, enterprise, telecom, and government operators to support these megatrends, servers can only scale to a point. They reached breaking point limitation in physical space, cooling cost, power consumption, and the raw compute capabilities. Napatech programmable NICs helped to bridge the server performance gap. As shown in the first image to the right, historically the way operators solve this problem was by adding servers. But stacking servers quickly runs into scalability problems as noted in terms of space, power, cooling, and not to mention cost. The second image to the right illustrates the problem and how Napatech helps. As the number of applications, services and tenants continues to increase, so too does the network throughput. In addition, the workloads that these applications are required to perform on the increasing packet data rate is potentially increasing. In an ideal scenario, the server would scale with the demand of applications, services, tenants and network. Unfortunately, they do not, as they run into limitations in space, power, cooling, computation, and cost. Given these constraints of adding new servers to the network, programmable NIC have proven to be a solution for bridging the server performance gap. Napatech, in conjunction with our partners, Intel and Altera, have created a unique and compelling solution to this problem. Programmable NICs, including smart NICs and IPUs, are used to improve server capacity and accelerate the performance of applications by handling infrastructure process that the server CPUs would normally handle. In a traditional server approach, the server is required to run application and services for their users and tenants, but also non-core tasks such as storage, security, network and management function. Top network operators such as Google and Facebook estimate that these non-core workloads can consume up to 80% of the most valuable and most expensive server resources, meaning the CPUs. This leads to the low server performance. In the new approach to server design, a programmable NIC such as a smart NIC or IPU replaces a standard NIC. The new programmable NIC offloads and accelerates the infrastructure process for network, security, storage and management. This returns the compute resources to the CPI for the applications and services that were intended, resulting in higher server performance, lower server cost and significantly reduced power, space and cooling demands. NABITEC is pleased to partner with Intel Altera in creating these solutions for the largest and highest growth segments for programmable NICs. Napatech is building a family of programmable NICs, including smart NICs and IPUs that are packed with the leading technology from Intel and Altera, including the latest generation of CPUs and FPGAs. Napatech designs, develops and delivers a complete solution for the end users. It includes the hardware as well as Napatech's main competitive differentiator, the software that powers the system. Our partnership with Intel continues to exceed our expectations. We continue to benefit from joint engineering and product management collaboration, ensuring that our products meet the most demanding requirement identified by market makers like Intel, Altera, and their global scale customers. We gain access to tip of spear technology, including CPUs, FPGA, and servers. We also benefit from joint pipeline building and business development, improving our go-to market by leveraging on Intel's global reach, including sales and marketing for demand generations. Each of these benefits results in Napatech entering large and high-growth markets that increase demand for Napatech products and transformational volumes and scale. Napatech finds itself uniquely positioned. The industry megatrends discussed earlier in our presentation are creating more applications 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 style of programmable NICs. Napatech's exclusive focused on programmable NIC market with our SmartNIC and IPUs. Intel and Altera's market making position cannot be understated. FPGA-based SmartNICs and IPUs have already been adopted by the largest hyperscale network operators globally. They have proven the technical and commercial benefits of this architecture and design, and the majority of these operators are dominated by Intel Altera. While server growth continues among the hyperscale operators, the same cost, power, space, compute, and cost benefits are demanded by a wide range of other network operators. Together with Intel Altera, Napatech is targeting this next wave of cloud enterprise and telecom users. Although still early in our journey, we are seeing indicators of success. As noted earlier, we disclosed an agreement with Intel Altera to develop the next generation 400 gigabit IPU. This happened because of the early success in both joint engineering and joint pipeline development for the 200 gig solution we launched in the fourth quarter of 2023. That success made us moving on to the next generation IPU from Intel Altera, It is equally important to note that this next generation was defined in collaboration with the tier one global server manufacturer with proven success in high volume cloud and enterprise networks. These and other early customer successes have substantially increased our customer engagement and their associated annual unit demand. This in turn has increased the value of our design wind pipeline by more than 40X while delivering a complete solution of hardware and software with attractive margins. The pipeline includes the top cloud, enterprise, telecom and government networks spanning all global area, including North America, EMEA and APAC, the top use cases of network security and storage offload for all of the top megatrends we mentioned before. While there is much work to do to secure new design wins that drive large volumes in their peak production years, we are making solid strides. In success, we aim to transform our business as a niche supplier to a high volume partner to customers in the largest and highest growth segments. Our historical annual volumes in our existing business has been ranging from five to 6,000 units per year. The four to six design wins we expect to close this year will result in annual unit demand of 50 to 60,000 units per year when they reach peak production. This increased volume guidance is due to a new OEM client that is in the plus 25,000 unit annual peak volume category. We maintain our guidance in terms of number of design wins, despite we only had one big win so far this year. We still expect to land another three to five design wins in the rest of the year. It will require hard work from the team and some tailwind in terms of timing, but we believe it can be done. In our capture niche segment, we have had good design win progress in the first five months of 2024. Several new customer wins for solutions in fintech, cybersecurity, monitoring and recording that give us reasonable hopes for still achieving our 2024 goals despite the slow start in Q1 in our existing capture niche, but very valuable business. The last few slides of our update provide more details on financial results for our first quarter of 2024. I would like to ask our CFO, Heine Torsgaard, to provide this update.

Thank you, Lars. Revenue in Q1 amounted to 21.5 million, a decline of 42% compared to Q1 2023. As we communicated in our Q4 presentation towards the end of 2023, we started to feel the impact of the slowdown in the US SmartNIC market, especially within the finance and telco operator segments. Q1, therefore, was expected to be a slower than normal start to the year, with March being particularly slow. We expect the slowdown in the US market to continue at least for the next couple of quarters. The gross margin in Q1 was 71.6%, an increase of 16 percentage points compared to Q1 last year. The gross margin of our product revenue in Q1 was 70%. We are now past the period of extraordinarily high component costs related to components purchased in 2022, and our margins have normalized to their historical levels. Our staff costs and other external costs in Q1 amounted to 40.6 million compared to 38.4 million in Q1 of 2023. The increase is a result of our strategic R&D investments and follows the plans we've communicated. EBITDA in Q1 amounted to a negative 25.2 million compared to a negative 17.9 million in Q1 last year. Staff costs transferred to capitalized development costs in Q1 amounted to 0.9 million compared to 5.1 million in Q1 of 2023 EBITDA in Q1 amounted to a negative 24.3 million and EBIT amounted to a negative 32.3 million Net cash flows from operating activities in Q1 amounted to negative 5.4 million A net cash used in investing activities in Q1 amounted to 1 million compared to 6.1 million in Q1 of 2023. Free cash flows in Q1 amounted to negative 6.4 million compared to 17.2 million in Q1 last year. At the end of Q1, our cash and cash equivalents amounted to 27.5 million compared to 12.3 million at the end of Q1 2023. With this, I'll turn the presentation back to you Lars.

We maintain our 2024 financial guidance on chains. So that means revenue of DKK 170 to 180 million, gross margin 69 to 71%, staff expenses and other external costs, 145 to 155 DKK, and capitalized development costs in the range of 10 to 15 million. The change here is the increased volume guidance from 30 to 40,000 to 50 to 60,000 in annual volume production. This is due to the announced new OEM client that we have categorized in the plus 25,000 annual peak volume category. We maintain our guidance in terms of numbers of design wins, despite we only have one big win so far this year. We still expect to land another three to five design volume wins in the rest of the year. Our current pipeline proves it's possible, but of course it will require hard work from the team and some luck in terms of timing, but we clearly believe it can be done. This concludes today's prepared materials. We will now open the call for any questions that may exist from the attendees. Operator, do we have any questions?

Currently no, but if you would like to ask a question, please dial star followed by one on your telephone keypad now. If you change your mind and would like to exit the queue, please dial star 2, and when preparing to ask your question, please ensure your phone is unmuted locally. Alternatively, you can submit any written questions using the webcast on the Q&A feature on your screen. And as a reminder, that's star 1 for any questions on the phones now.

I see that this is Lars Boilesen, CEO. I see the question come in. Would you read the questions or should I do that?

I'm sorry, Lars. Yes, if you'd like to go ahead, that'd be great.

Thank you.

Okay. So first question I see, could you please give us the number of actual product sales for Intel Altera product design so far? So as we said, Most of our projects here, or more or less all of them, are big, big projects for cloud, data center, 5G. So the sale so far has basically been like test units for the R&D teams who are basically preparing and planning new designs for the data center and clouds. So this is in the range that some of these pipelines, we have a pipeline of 20, 30 clients coming from Intel and they are buying anything from from one unit to 50 units so so so far it's just test units next question uh thanks for the update you mentioned super micro as client i think can you elaborate a bit further or about how you help super micro so in this specific case with super micro they are delivering a a solution hardware software for 5G and they are using our cards with the, and I think they actually are getting the software stack from a third party vendor. So they're integrating all this and they're offering this for the 5G market basically as a UPF acceleration solution.

Next question.

What is the number of design wins you have won so far? So we are mentioning some design wins we have in the presentation. They are all for our profitable niche business, but very stable business. So we kind of divide between our existing old niche business. And when we talk about design wins, when we guide for four to six design wins, we're talking about the IPU, more cloud data center business where we are not sitting offline, where we're sitting in the data stream. And we have so far announced one win. This was with the big new server OEM manufacturer. So it just happens that one of the first design win we got was one of the biggest we could get. But so far one design win. Next question. What is the technical difference between your current smart NICs and the ones you are developing in cooperation with Intel? so that's a that's a good question because i think what what what has been what is really the advantage for us is we have been doing network cars for 20 years and we have we basically uh doing everything ourselves hardware software the whole thing and we have like 20 years experience in that but up till now we have basically just done this for one use case which is packet capture basically where we sit offline um in the data center. And we're not sitting in the data stream like we are with the IPUs we're developing together with Intel. So basically, what we've been doing for 20 years is very much the same as we're doing for Intel on the IPU. It's just that the use case is completely different. In the capture business, we're sitting offline. You don't need so many units. But for the smart NICs we are building for Intel, this is there we are sitting basically in the data stream. And obviously, we're sitting in each server. So that is the main difference that we will be the volume are much higher. Then the other difference is that you on the IPUs, you have not only an FPGA, but you also have a CPU. and that makes the device more powerful for many use cases. In our existing product lines, we just have an FPGA where it's very good for programmable. But when you add a CPU like you do in an IPU, then you have this advantage that CPU is really good, particularly for determined tasks. And then you have the FPGA as well, where you can reprogram the entire device and server according to what kind of traffic you get in, which you want to offload or you want to accelerate, etc. So that's the main difference. Next question. Why will or can you not name drop the OEM partner for your first major IPU design when recently announced? The reason is simply that this is a big server OEM who is planning a complete upgrade of their cloud and data center. going forward. And they want to control the communication around that big expansion they're doing. And they don't want us to be the ones announcing this because we are delivering a very important component to this new server and data center. So we expect that will be announced later this year. Next question. How do you expect the volume to ramp? When do you expect to reach the 50,000-60,000 units? Which year? So what we're doing here is that for each design win we have, we guide on what is the expected volume in peak production years. So for this first one, which is a very big OEM, and this is the next data center cloud solution, which will last for many years. So here we probably expect the high volume, and this particular one we put in the category of more than 25,000 in peak production year. So that is expected in most likely 26,000. um the other the remaining three to five design wins we have guide as well there we have basically said that they can be anything from in the category of one thousand two thousand five thousand ten thousand and then we have these big whales which is more than twenty five thousand which is happens to be the first one we announced so we expect these um And these design wins, we will hopefully sign and announce this year to have peak production volumes basically in 2025 and 2026. For the really big ones, which requires a bit more planning, like the ones we have designed, we have announced so far, there it's 26. Some of the ones we will announce later this year will be peak production volume in 25 already. next question is the is the 50 000 units expected from one design when you have announced so in that one we're basically saying we categorize our our wins in one thousand two thousand five thousand 10,000 or 25,000. Basically, there are some few monster deals that's more than 25,000. The ones we have announced is in that category, more than 25,000. Have you signed a contract with the first customer for a specific volume? If not, when do you expect the customer to sign a contract for a firm volume? way it works is that now we are delivering the hardware which we have to deliver this year as soon as we also now in the process of agreeing on who who is delivering the software we will deliver many of the components there we will have the responsibility to basically make the final product meaning we need to productize the entire hardware software stack So that will be done on the software side. That will be done this year as well, but also next year. Then they will start building pilot in 25. And so I expect that next year on this specific one, there will most likely be in the four digit numbers units. And then you will move into basically they will roll out globally their data centers in 26 and 27. And there you will see the more than 25,000 units. So pig production will be in 26 and 27 for this monster big whale deal.

Next question. That is the same as we just answered.

When will you begin to deliver on your first customer from Intel partnership? So basically, we will deliver hardware this year. We will deploy the software also this year and next year, and we will start delivering the first units. Full completed will be in 25 for this announced big OEM. Next question, does Napatech produce inventory products based on actual orders, or do you need to hold stock for ad hoc orders? So we have manufactured or produced enough units so we can basically give this big pipeline we have so they can buy enough testing units for building their cloud and the data center, et cetera. So that is in the range of 100 to 500 we are manufacturing already. Aguas Martins Lova from Intel Altera Partnership Sales. Obviously, for this big OEM we have signed, which is expected to be in production and sales in the thousands in 2025 and then in more than 25,000 per year from 2026 and 2027. There, it's very hard to say exactly what's gross margin. It will most likely be lower than what we have on capture, but we still have an ambition to have very attractive gross margins on these high volume deals as well. But it's too early to say exactly where we will end up.

But the ambition is, of course, to be more than 50% on gross margin. What do you expect in volumes from the first customer in 2025?

I would say like this, if this will be a 48,000 number, if it's closer to a 5,000, sorry, if it's closer to a five digit numbers in 25, then we know that we will be in peak production in 26. So somewhere from 1,000 to 10,000 in 2025. The closer we are to 10,000, the more secure we are, much more than 25,000 units in 2026. It all depends on the rollout of this OEM client, which is a bit different. Some remaining design wins we expect to get this year because it is one of the biggest OEMs out there. You said the first design win with this top OEM was among the biggest you were working with. Can you ballpark predicate how much of the 50,000, 60,000 cars will come from one client? The way we're guiding this, because it's very difficult, is that we basically say that these design wins we will announce of the four to six we have guided, they will be in the categories 1,000, 2,000, 5,000, 10,000, and 25,000. So basically we are predicting that they are more or less around 5,000 units in average per design win. So that's why we came up with the 30 to 40,000 units that is approximate like 5,000 in average. Then we got one of the biggest oem we could get and that is in the plus 25 000 unit category so basically we just added 20 25 000 units to our guiding um so that's basically how we that's that's the structure we're working with so that's why it was added another 25 000 to it approximately in these last design wins would was margin be lower or do you expect them to stay in the same range? We expect them, if this is getting into a volume above more than 25,000 units, we don't expect to maintain 70% in gross margin, but we still expect it to be very attractive gross margins above 50%, but we'll have to come back to that when we start really manufacturing in four-digit numbers. What type of hardware are you delivering to the first customer already this year? So we are delivering full hardware this year so they can run full software on. So it's basically the real product, full prototype. And we call it prototype because obviously there might be testing where we need to improve it, but it's hardware. full in line with the full specification from the client here. I think that was all the questions. Do we have anyone from the operator as well? I'm just reading the dashboard here.

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Again, I confirm we have no further questions on the lines at this time. Thank you.

With no further questions, this will conclude the NAPA Tech Q1 2024 IMS conference call and webcast. Thank you all for joining. You may now disconnect your lines.