Napatech A/S (NAPA) Earnings Call Transcript

Hello, and welcome to the Napatech Q4 2019 interim management statement. Speakers, please begin.

Good morning, everybody. I'm pleased to welcome you all to Napatech's Q4 and Full Year 2019 Management Statement Presentation Webcast. I'm Ray Smets, CEO of Napatech. With me today is Heine Thorsgaard, our Chief Financial Officer. Today's interim management statement for Q4 and full year 2019 was released earlier this morning on the OSE and is available on the Investor Relations page of our website at napatech.com. For your information, a recording of this webcast will also be available on the Napatech website shortly. Next slide. Please note that we'll be conducting a live Q&A session following our presentation, so please have your questions ready. If you would like to ask a question, please be prepared and follow the instructions on this slide. I will display this slide again when we're ready to take your questions. Next slide. 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. Next slide. During this presentation, I will present Q4 and full year 2019 business highlights, including a summary of our key financial results for the quarter, an update about our market and our business progress in the quarter. And Heine will provide a detailed review of our Q4 and full year 2019 financial results. Then I will close with our expectations about our 2020 outlook for our business. Next slide, business highlights. Next slide. 2019 was a very good year for Napatech, beating expectations in every quarter and fulfilling our promises to deliver a solid turnaround of our results over 2018, but the results in 2019 weren't just good. They were truly record breaking. In addition to delivering solid revenues in Q4, generating strong gross margins with continued improvements and positive EBITDAC, we have delivered positive free cash flow for 4 out of the last 5 quarters and for the full year of 2019. We are quite proud of this achievement, and I will speak about that a bit further in this presentation. 2019 was an important execution year for us. We have been diligently working to reestablish a solid and stable foundation, building sustaining and growing revenues. We managed our operating expenses and working capital to bring a well-executed balance to this business and as much benefit to our cash position as possible. Our team focused on delivering important enhancements to our products and preparing new features that will set up growth opportunities for us as we move forward, so we fully expect that the progress we made in 2019 will continue to deliver good results in 2020 and beyond. I am convinced that our expertise in FPGA software running on both the Xilinx and Intel FPGA chips will give customers new ways to solve the ever-expanding problem of getting better performance from CPU-hungry applications that run on servers in the data center and the cloud. Next slide, please, highlighting some of our key numbers. We delivered revenue in Q4 of DKK 54 million, our strongest performance of all quarters in 2019. We were up sequentially quarter-over-quarter, but more importantly, on an apples-to-apples basis adjusted for discontinued operations, we are significantly up 36% year-over-year over Q4 2018 where we delivered DKK 39.7 million. As you may remember, as part of our turnaround strategy, we divested off a nonstrategic product line in Q4 of last year. Thus, when comparing our results this year against revenue last year excluding this divested product and one-off adjustments for special circumstances, you get a clear view of how our underlying business performed for our current core products. On this basis, our revenues grew by 62% year-over-year on an apples-to-apples basis. Gross margins for 2019 finished stronger than guided at 74.5% due mostly to how we managed the costs of our products and some benefit from product mix, but these strong margins also demonstrate several other significant points for us. One is that we're doing a good job managing our product design and cost, but it is also a good sign that we are getting greater returns for the value product that we provide. Our good execution here has helped us improve our cash management too, which has been part of our diligent plan to preserve cash as much as possible all year long. All in all, our performance in 2019 shows that we delivered better than we promised. This wasn't by accident. We planned carefully. We guessed right. And we executed a number of initiatives all focused on aggressively innovating our current products, building new features and solutions, targeting and executing on a number of financial and business objectives to strengthen our foundation and keeping an eye on the bottom line. We've built a strong base of business with existing and new customers who are using our FPGA-based SmartNIC to solve a growing number of application performance, networking and cybersecurity problems. And we hope our investors will agree these results are a good reward for your investment. Next slide, please. When we announced our results 1 year ago, we also announced that we raised additional cash in Q1 2019 to support our business and allow us to invest in future growth. We have been good stewards of this additional cash. In fact, we did what has never been done before at Napatech. We benefited from rightsizing our business, driving our operational costs down by 12% year-over-year, and delivered well on our top line objectives. When you crunch the numbers, we had a first -- we had our first year of positive free cash flow ever as a public company. That is an achievement I hope you will agree is noteworthy and significant. And we intend to keep investing for growth, with an eye on the bottom line, and optimize our financials for our shareholders. Next slide, please. At the end of the day, our scorecard is simple and the numbers speak for themselves. We did -- did we estimate the business correctly, and did we deliver as promised? One of our promises was to stabilize our business, which we did. One of our promises was to try and beat each and every one of our objectives where possible, and we did that too. In fact, in every single metric we guided to the Street, we delivered. And we beat most all of them and delivered positive EBITDA and EBITDAC in 2019. I knew we had a lot of shareholder trust to regain in 2019. If you trusted us and you invested in our business, you should have been nicely rewarded. I'm thankful for your trust in me and my team, but this is a team sport, and the Napatech team deserves all of the credit. I'll invite Heine in a little bit to present more details of our financials. Next slide, please. Now I'd like to turn our attention to our business strategy. Napatech sits at the crossroads of 2 major market forces. On the horizontal level, our physical addressable market is rapidly -- is a rapidly expanding number of commercial off-the-shelf servers where network interface cards or NIC cards can reside. The industry data confirms the server market is growing at a significant rate, which is a positive impact on the growth of NIC cards. Keep in mind not all NIC cards are created equal. Some provide basic connectivity functions, but it's the SmartNIC, which is what we design and sell at Napatech, that delivers the higher performance and value to accelerate applications that need the extra horsepower. Consequently, there is a vertical market force shown here which is a growing set of critical applications across a spectrum of areas like cybersecurity, virtual switching at the cloud and at the edge. And they require more and more compute power to operate and perform faster and securely. The demand for higher-performance compute for these applications is a harbinger of SmartNIC growth, and the demand for faster-performing compute options has a long arc of growth ahead of it. So Napatech sits at a position where these 2 markets intersect. [ Our position ] is to play on the high end of this market, where the FPGA technology is needed to run those mission-critical, compute-intensive applications faster and more efficiently and more securely, with unmatched performance. That is where Napatech will focus its expertise to catch and grow future revenues. Next slide, please. So what are the big drivers behind this market growth? A number of megatrends are impacting the way networks are architected and built and how applications are deployed. Cloud, IoT, 5G, edge computing and other things are having a major and large and lasting positive impact in our market. And we sit right at the heart of where the action is. The server market expansion continues to grow as networks are built at massive scale to run more CPU-hungry applications, to serve these markets. And every server needs a NIC card to provide server connectivity, and they need SmartNICs to support the advanced applications when standard CPUs just can't keep up. By the way, the SmartNIC card in the green box on the right is making me very excited. It is one of our newest SmartNICs targeted at application acceleration in the cloud and the edge. Next slide, please. So let me explain why I'm so excited about it. This slide makes it just a bit clearer. That silver SmartNIC on the right side of this chart is one of Napatech's newest products we call the NT50, and we're bringing it to market this year. It is the smallest, most energy-efficient, most powerful SmartNIC with the newest FPGA chip we've ever delivered. And we've designed our best-in-class software to run on this new SmartNIC so that we can target existing and new customer applications from the data center, to the cloud and out to the edge. We are also very excited to get this product adopted by customers addressing the growing demand in the 5G market space, where virtualized network deployments are key. And with this design, you get one more highly desired bonus. This new SmartNIC is the most ESG-friendly, green and sustainable version from Napatech's product line yet. This is where things get interesting. We help our customers build smaller server footprints by giving them more horsepower on the NIC while giving them an even more efficient SmartNIC at the same time. We'll do our best to extract the value and the margins from the market by passing this ESG benefit on to our customers. We believe this will open up new opportunities we haven't been able to address in the past. It is early days as we prepare for the launch of the new NT50 to augment our current industry-leading SmartNICs, but we are excited about the use cases that this new product will bring us [ into ]. Next slide, please. We are glad that we can bring our technology expertise to solve problems in a growing market. Think about the total market as all NIC cards sold for basic connectivity, to offloading of servers and to accelerate applications. In the most recent IHS Markit report for the NIC market published in December, the overall market is growing fast from $1.7 billion [ today ] to $3.4 billion in 2023. In contrast, the programmable NIC market is where the -- where we operate, and that market was $306 million at the end of 2019 and expects to grow to $1.6 billion by 2023. The latest market report indicates that this programmable market will be an even larger part of the overall NIC market as previously reported. It is hard for NIC makers to address all parts of the NIC market. The technology has way too many applications and use cases to be a one size fits all, so Napatech focuses its product development efforts on the part of the market that will generate the best results based on our core competency. It also will guide us where we can invest further to grow our business either organically or inorganically. So the way we see it, Napatech and its FPGA software and [ SmartNIC ] solutions are in the right place at the right time with the right technology to capitalize on the growing needs for application acceleration. Next slide, please. This is a slide that should impress a lot of you. These logos represent some of the new and existing customers from all over the world that ordered Napatech FPGA-based SmartNICs in Q4 alone. Here you see large existing customers like Cisco, IBM, Corvil, Polystar, Facebook, Walmart, Citadel, TOYO Corporation. And then you see new customers or those with new applications like Corelight, British Telecom, MTS, Sedmi odjel, Deutsche Telekom; and also new customers we announced last quarter, like Bank of America and Morgan Stanley, who continue to buy quarter-over-quarter as they expand their deployments. These customers span use cases across key markets like cybersecurity, network monitoring, infrastructure, cloud and edge, mobile and financial. In all of these cases, they have open-source or specialized applications and services that need to be accelerated. We expect that these customers will continue to buy more products as they deploy more servers within their data centers for the key use cases we help them solve. Q4 revenue was not impacted by any activity related to Intel sales of our software-only solutions. However, we continue to be motivated by our growing pipeline of evaluations for our joint product with Intel. And we are happy with the Intel partnership as we continue to collaborate and work to grow software sales with Intel in 2020. The bottom line here is that we are getting to the right kind of customers who need our solution and we are gaining traction with companies that are growing and thriving. We are motivated to find more and grow more with them. Next slide, please. We have been articulating our 3-pronged plan of attack all throughout 2019, and it is the basis of our growth strategy. And it is focused on our unique core competency leveraging our expertise in FPGA-based software, building new higher-growth product lines in application acceleration for virtual networks, cybersecurity solutions and mobile deployments as well. We have been making good progress in all 3 of these attack vectors. First, we've been driving our FPGA-based SmartNIC leadership with our current packet capture solutions. We have delivered new features on our core product line throughout 2019 focusing on our customers' immediate needs. This product delivered all of our revenue and revenue growth in 2019, which is a sign that this is a -- part of our business is rich with opportunity and remains a stabilizing foundation for growth now and into the future. Secondly, we've been expanding our SmartNIC leadership beyond packet capture to address new higher-growth areas in the cybersecurity market by supercharging our FPGA solution for in-line firewall applications. We have made good progress in 2019 delivering on this vision from early concepts to actual features released late in 2019, and there is more to come. We expect these new features to be adopted over time in new use cases in 2020 and beyond. And finally, we have been working hard in driving our innovative development in virtual switching acceleration to attack emerging opportunities in the edge, cloud computing and 5G mobile areas. Our goal is to deliver a top-performing FPGA-based virtual switching acceleration solution in 2020 and beyond. We have been invited into customer labs, which is a necessary step as our customers test our deliverables. And we hope to see growth come from these efforts as we enrich our solution to a full-fledged product solving a massive performance challenge for our customers in virtual networks. So we continue to keep our noses to the grinding wheel and put more power in the hands of our customers with FPGA-based SmartNIC solutions. Our plan of attack has served us well in 2019, and we will double down on this plan in 2020 to fulfill the benefits of the strategy for our customers and for our shareholders. Next slide, please. So Napatech delivered a lot in 2019, and we are excited to share the details of our fully audited financial reports. I would now like to turn the call over to Heine Thorsgaard to review the -- more details about Q4 and our year-to-date 2019 results. Heine?

Thank you, Ray. Revenue in Q4 '19 amounted to DKK 54 million, equal to revenue reported in Q4 '18, where Q4 '18 saw a large Pandion order of DKK 14.3 million. And when we adjust for the discontinued Pandion business line, revenue on continued operations grew 36% year-over-year in Q4 '19. Revenue for the full year of 2019 amounted to DKK 170.6 million compared to reported revenue of DKK 106.2 million in '18. Adjusted for the discontinued Pandion business line and special items in Q3 '18, revenue on continued operations grew 62% in 2019 compared to 2018. Gross margins continued to be strong in Q4 and ended up at 74.4%. And gross margins for the full year ended up at 74.5%, bringing gross profit for the full year to DKK 127.2 million compared to DKK 49.1 million in 2018. Staff costs and other external costs amounted to DKK 34.4 million in Q4 compared to DKK 38.7 million in Q4 '18. For the full year of 2019, staff costs and other external costs amounted to DKK 125.8 million compared to DKK 158.5 million in 2018. Adjusted for IFRS 16, costs dropped 17%. This drop in operating costs is a result of focused cost management initiatives, and we're satisfied with the results we have achieved. EBITDAC in Q4 amounted to plus DKK 5.8 million compared to minus DKK 16 million in Q4 2018. For the full year of 2019, EBITDAC amounted to plus DKK 1.4 million compared to minus DKK 108.8 million in '18. This improvement in EBITDAC of DKK 110 million is a testament to the turnaround achieved in 2019. Costs transferred to capitalized development costs amounted to DKK 4.4 million in Q4 compared to DKK 6 million in Q4 '18. Total cost transferred in '19 was DKK 13.9 million compared to DKK 33.9 million 2018. EBITDA in Q4 amounted to DKK 10.2 million, and operating result amounted to DKK 3.6 million, compared to an EBITDA of minus DKK 10 million and an operating result of minus DKK 62 million in Q4 '18. The operating result for the full year of 2019 amounted to minus DKK 10.1 million. Let's turn our attention to the cash flow, presented on Slide 18. Net cash flows from operating activities amounted to DKK 15.1 million in Q4 '19 and DKK 26.4 million for the full year of 2019 compared to DKK 15.7 million in Q4 '18 and minus DKK 47.9 million for the full year of 2018. End of the year 2018 -- sorry. End-of-year 2019 net working capital was DKK 17.4 million compared to DKK 28.2 million end of 2018. Net cash used in investing activities in Q4 amounted to DKK 3.4 million compared to DKK 4.2 million in Q4 '18. On the full year of 2019, net cash used in investing activities amounted to DKK 13.9 million compared to DKK 33.6 million in 2018. Free cash flow in Q4 amounted to plus DKK 11.7 million compared to DKK 11.5 million in Q4 '18. For full year of '19, free cash flow amounted to DKK 12.6 million compared to minus DKK 81.5 million for the full year of 2018. As Ray mentioned, we are pleased with the fact that 2019 was the first year with positive free cash flow since Napatech went public in 2013. The positive free cash flow of more than DKK 12 million for the full year of '19 and the improvement in free cash flow of more than DKK 94 million compared to 2019 also clearly demonstrates [ the effect ] of our turnaround in '19. Now back to you, Ray.

Thanks, Heine. Next slide, please. Now let's turn our attention to the outlook for 2020. Next slide. We remain transparent and pragmatic about our 2020 goals, a strategy that has served us well in 2019, but we are optimistic about our efforts to grow on a -- on top of a stable foundation of business while we execute across many different dimensions to get after more growth and profit in the future. So we are communicating what we believe is the right positive outlook for 2020 based on what we can see now. We expect revenue to be in the range of DKK 185 million to DKK 205 million or about USD 27.7 million to USD 30.7 million, which is -- which will represent 20% growth on the high end of the range. It takes some time for new products to be adopted by our customer base, and we hope we can beat this as the year matures and we gain traction with our new products. Gross margins will remain healthy in 2020 between 68% and 72% for the full year 2020. The gross margin will benefit from good cost execution in our products and our ability to maintain our products' value in the market. We will focus on managing our operating expenses in 2020 just like we did in 2019, and we will deliver operating expenses in a range of DKK 125 million to DKK 135 million. We have strived to set a new standard inside of Napatech to prudently maintain the right level of capitalized development costs. We are guiding a range of DKK 15 million to DKK 20 million for transferred capitalized development costs and keeping this metric efficient and well managed. With performance in the middle of the guided ranges, EBITDAC would be DKK 6.5 million. EBIT would be DKK 1.5 million, as we expect this to be a better-than-breakeven year. Regarding the coronavirus, it is worth noting that we are watching the impact being felt across many of the markets today due to supply chain deliveries from China as a result of the coronavirus outbreaks. We have carefully planned our supply chain to avoid any near-term impacts due to component supplies, but we can't control the impacts felt by our customers who are ongoing problems that may occur later in 2020 if this virus continues to impact deliveries from China. At this time, we believe this is a low risk for Napatech in the near term, and we will be very vigilant to avoid any challenges that might arise from impacts to supply from coronavirus in 2020. In -- next slide, please. In conclusion, we are proud of the work we did in 2019 to build trust and deliver a banner year. We have momentum from good performance in late 2019; and we intend to deliver on our new guidance in 2020 for you, our investors. I believe our results in 2019 so far have shown our potential to be a predictable and viable business going forward building a more stable, more transparent, more predictable Napatech. And we will not stop working hard to improve upon all aspects of our business. There are a few points I'd like to reiterate to our new and existing customers, and here they are. First, we're a stable and growing business with underlying positive growth and solid financials, with revenue delivered on the higher end of our guidance range; cash growth and positive free cash flow; and a highly leverageable business model. Also, we are executing on our 3-pronged plan-of-attack strategy, building innovation in a world that needs us more every day; landing top brand customers and making them happy and successful; and delivering a more powerful and ESG-friendly, cost-effective product to get after our evolving customers' needs. You can be assured that we are a team of technology professionals who really do strive to improve our spot in the business world, solving real-world problems that just won't go away but are solved with the technology and expertise that we bring to the market. And in doing so, we build a good prospect for investment for our investors. Me and my team at Napatech will continue to work hard and work smart growing a business built upon a solid foundation of FPGA technology excellence. We are living up to the expectations we have made to our shareholders, and we will continue to strive to improve all aspects of our business to capitalize on the opportunities we see ahead of us. And we will always strive to give you a realistic view of what we can achieve, and we are committed to find a way to beat it. So now we need to get that job done. Next slide, please. And now I'd like to invite Heine Thorsgaard to join me now to take your questions. [Operator Instructions] Operator?

So at the moment, there are no questions. [Operator Instructions] So there are still no questions, so I will just hand back to the speakers to -- for the conclusion.

All right, well, thank you, operator. And thank you to everybody who's listening to the webcast. We appreciate your involvement, and we certainly do invite your questions. If you have any, please feel free to send them either to Heine Thorsgaard; or to me, Ray Smets, at Napatech -- at the napatech.com site. And our e-mail addresses and contact information are on the press release that we send out. So in conclusion, I'd like to thank you, our new and existing investors for your support and advice. We get quite a bit of it and we appreciate it, but I'd like to thank all of you, the employees of Napatech, for a job well done in 2019. Now we go onward to 2020 to do it all over again. Have a good day.