Earnings Call Transcript - AMBA Q1 2022

Operator, Operator

Thank you for standing by. Welcome to Ambarella's First Quarter Fiscal Year 2022 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Louis Gerhardy, Corporate Development and Investor Relations. Please go ahead.

Louis Gerhardy, Corporate Development and Investor Relations

Thank you, good afternoon and thank you for joining our first quarter fiscal year 2022 financial results conference call for the three months ending April 30, 2021. With me on the call today is Dr. Fermi Wang, President and CEO; and Casey Eichler, CFO. The primary purpose of today's call is to provide you with information regarding the results for the first quarter of our fiscal year 2022. The discussion today and the responses to your questions will contain forward-looking statements regarding our projected financial results, financial prospects, market growth, and demand for our solutions, among other things. These statements are subject to risks, uncertainties, and assumptions. Should any of these risks or uncertainties materialize or should our assumptions prove to be incorrect, our actual results could differ materially from these forward-looking statements. We're under no obligation to update these statements. These risks, uncertainties, and assumptions, as well as other information on potential risk factors that could affect our financial results are more fully described in the documents we filed with the SEC, including the Annual Report on Form 10-K filed on March 31, 2021 for fiscal year 2021 ending January 31, 2021. Access to our first quarter fiscal 2022 results press release, historical results, SEC filings, and a transcript of our prepared remarks and a replay of today's call can be found on the Investor Relations portion of our website. Today, we'll begin with our business update from Fermi. I'll review the financial results. And then we'll open it up and you can direct questions to Fermi or Casey. With that, I will turn it over to Fermi.

Fermi Wang, President and CEO

Thank you, Louis. Good afternoon, and thank you for joining us today. The first quarter was another strong quarter with revenue growing nearly 13% sequentially, and 28% on a year-over-year basis. We continued to deliver positive operating leverage, with non-GAAP operating margins expanding to 12% from 8% in the prior quarter and 1% a year ago. Our results are clearly being driven by the beginning of our CV new product cycle, and to a much lesser degree by industry-wide cyclical forces. In fact, currently, cyclical forces are actually constraining our results, not exaggerating them. Supply chain challenges remain significant, but our execution is strong, and our guidance assumes the worst of the supply chain challenge from the Texas freeze will be felt in Q2 and gradually improve as we progress through the second half. Capacity is tight and lead times for certain substrates remain extended. With solid support from key supply chain partners, including foundry partner Samsung, we usually are not the bottleneck for our customers. With our higher revenue outlook we remain confident CV will be at least 25% of our total revenue this year. Professional security CV revenue, or CV Wave 1, became material last year and momentum continues to build, with new design wins and new customers entering production. We expect our home security CV business, or Wave 2, to become material this year, with several large programs entering mass production. Automotive, or CV Wave 3, has clearly commenced; in fact as of yesterday, May 31st, we have cumulatively shipped more than 450,000 CV SoCs into the automotive market. We expect our automotive business to roughly double this year, and we see tremendous remaining headroom for growth. Our share exiting the year is expected to be only a few percent of a serviceable market we estimate to be about $2.2B in calendar year '21 and approaching $5 billion in calendar year '25. I will now update you on our target market progress, beginning with automotive. The automotive market is being transformed by the introduction of electric vehicles that enable sustainable, high-performance transportation. The requirements for advanced active safety features in these vehicles represent a significant new opportunity for our AI Vision SoCs due to the need for increasing levels of performance in camera-based AI perception. During the quarter, we were excited to see the successful IPO of UK-based electric vehicle maker, Arrival. Founded in 2015, Arrival's mission is to provide affordable and sustainable urban transportation by producing electric vehicles at competitive prices and by pioneering a new method of manufacturing that challenges traditional economies of scale. I am pleased to announce that Arrival has selected Ambarella's CVflow AI vision processors for the environmental perception module used to enable L2+ autonomy in Arrival passenger buses and delivery vans. The inclusion of L2+ autonomous driving capability provides the driver an array of safety and convenience related driver assistance or ADAS capabilities. Ambarella's AI vision processors were chosen because of their neural network processing performance, stereovision support, excellent image quality, and extremely low power. We look forward to sharing more information regarding our partnership with Arrival in the near future. In addition to the efficiency our CV SoCs offer, we have also highlighted the advantages of our open platform approach, which allows OEMs and Tier-1s to create differentiated combo products. Today I'm pleased to discuss four examples of this form with recent Shanghai Auto Show, namely Great Wall Motors, Momenta, Autocruis, and HASCO. In April, we announced that the leading domestic Chinese SUV auto maker, Great Wall Motors, has launched a 3-in-1 combo system based on our CV25AQ for drive recording, driver monitoring or DMS, and occupancy monitoring or OMS. The system is integral to the new WEY Mocha flagship SUV, which was launched during Auto Shanghai 2021 as the first model from GWM's Coffee Intelligence driving platform. This CV25AQ-based system can support a variety of simultaneous, multi-camera channel combinations for recording and/or DMS and OMS, with the entire system meeting Euro NCAP 2025 standards and playing a key role in GWM's Intelligent Drive process. Another combo product leveraging our open CV platform is Momenta's AutoRing A4 fleet management solution combining front ADAS, DMS, and drive recording functions. Based on Ambarella's CV22, the product includes front ADAS features such as Forward Collision Warning, Pedestrian Collision Warning, Headway Monitor Warning, and Lane Departure Warning; while DMS features include Face-ID, Fatigue Detection, and Distracted Driver Detection with Full HD video recording. Another active safety combo system, this one from automotive Tier 1 Autocruis, is expected to enter mass production this year targeting commercial fleet deployments. This solution combines front ADAS and DMS functions on a single CV25 SoC. Lastly, HASCO, a spin-out of leading OEM SAIC, demonstrated its Adapted Driving Beam or ADB solution based on Ambarella's CV22AQ SoC. The solution utilizes both ADAS and the DMS algorithms for intelligent headlight control. As you can see, Ambarella's exhibition at the Shanghai Auto Show in April generated strong interest with more than 50 automotive OEMs and Tier 1s visiting our booth. Ambarella demonstrated a number of designs covering ADAS, electronic mirror, DMS, and OMS applications, while also demonstrating partnerships with many of China's leading third-party automotive software companies. One area of significant interest at the show was our Rebel front ADAS reference design, a turnkey platform based on our CV2FS SoC and Sensetime's software stack. This solution includes front ADAS features such as pedestrian detection, lane detection, drivable area detection, traffic light and traffic sign detection, while also supporting millimeter wave radar and visual perception, providing sensor fusion between the camera and radar. Our Rebel reference design provides Tier 1 suppliers and software development partners an open platform for differentiated high-performance automotive systems. I will now update you on our continuing progress in the IP security camera markets. During our Q2 FY21 earnings call on September 2, we stated that, in addition to our SoC share gains in professional security outside of China, for the first time we were also seeing additional opportunities in the professional security market within China. During the last quarter, UnisinSight launched the first of its cameras based on Ambarella solutions, including 2 megapixel and 4 megapixel models with full-color night vision and people counting capabilities. This is the first camera design in mass production using our new low-cost CV28M CVflow SoC, which was introduced at the end of last year. Also during the quarter, Kedacom introduced its first Ambarella-based designs; the IPC695 and IPC445 cameras based on our CV2 and CV22 SoCs. The IPC695 features include 9 megapixel resolution with HD snapshots and AI-based exposure optimization while the IPC445 features a 4 megapixel dome design with advanced area intrusion detection and motion detection. Our CVflow SoCs are raising the bar in multi-sensor camera designs based on their ability to process multiple high-resolution streams concurrently with AI processing. In April, iPro, formerly Panasonic's security camera business, introduced two new models based on our CV2 SoCs; the 8530 and 8570. These cameras are equipped with four sensors per camera capable of independent operation for 360-degree viewing with minimal blind spots and color imaging in just 0.05 lux, or extremely low-light conditions. In the body worn security camera category, UK-based Reveal became the first to introduce new cameras with Ambarella CVflow SoCs to provide a platform for advanced AI-based features. Based on our CV25 SoC, the new K-series cameras include HD recording, movable lens, and full color display. In April, home monitoring market leader, Ring, a unit of Amazon, introduced two new models based on Ambarella's CVflow SoCs. The new Video Doorbell Pro 2 model raises the bar for video doorbell designs, with 3D motion detection, head-to-toe HD+ video and integration of Alexa greetings. Additionally, Ring's new Floodlight Cam Wired Pro also includes 3D motion detection and adds bird's eye video for precise motion alerts. Lastly, among new customer product introductions, Insta360 introduced its tiny GO 2 action cam based on Ambarella's H22 SoC. The waterproof camera can record 4Kp30 video, includes a 6 time speed hyperlapse mode, image stabilization and is small enough to be worn on shirts or headbands. From these customer engagements, and others, you can see Ambarella's SoCs are enabling customers to add significant value to their products. While efficiency benchmarks like performance-per-Watt and performance-per-dollar are important elements of customer design win decisions, our open platform and its flexibility also uniquely enable our customers to create optimized and differentiated products and to price them accordingly. Open platform means customers can develop their own software to run on our SoCs, but flexibility means they can be creative and use the hardware and software resources on our SoCs to develop proprietary configurations and feature sets. Such flexibility is usually not available from our competitors. For example, in the automotive market, earlier I discussed projects with Great Wall, Momenta, Autocruis, and HASCO that take advantage of the flexibility of our SoCs to create unique combo systems. These powerful solutions integrate what used to be two to three discrete camera products with limited functionality into a unified feature-rich solution operating on one Ambarella CV SoC. And we are especially excited by our design win at Arrival where the performance, flexibility, and low power of our SoCs is being harnessed for the next-generation of electric vehicles. In conclusion, Ambarella's product portfolio is the strongest in our history. After a very good Q1, despite the supply chain challenges, we are guiding Q2 revenue to be up 48% to 54% year-over-year. Our long-term outlook is fueled by our high level of investment into proprietary technology that is setting the pace of innovation in the visual AI market. Not only is our CV portfolio continuing to expand our reach into new markets, but we believe our visual AI roadmap will enable us to capture more processing value per design win. With that, we are very thankful to have stakeholders, in particular, our dedicated employees, as well as our network of suppliers, customers, and investors, who understand the AI vision opportunity and support us as we continue to execute amidst all the challenges that the market has thrown at us in recent years. So, once again, thank you.

Louis Gerhardy, Corporate Development and Investor Relations

Thank you, Fermi. I will now review the financial highlights for the first quarter of fiscal year '22 ending April 30, and provide a financial outlook for our second quarter of fiscal year '22 ending July 31. I will be discussing non-GAAP results and ask that you refer to today's press release for a detailed reconciliation of GAAP to non-GAAP results. For non-GAAP reporting, we have eliminated stock-based compensation expense adjusted for the impact of taxes. Robust demand was capped in the quarter by supply chain challenges, nevertheless revenue of $70.1 million was slightly above the high end of our original guidance. This represents a sequential increase of about 13% from Q4, and a 28% increase from the year-ago quarter. Automotive revenue increased about 40% sequentially, security grew more than 20% sequentially, and Other product revenue was down more than 25% sequentially. Non-GAAP gross margin for Q1 was 62.9% compared to 61.4% in the preceding quarter. We incurred some higher costs to manage the supply chain challenges, but a relatively stable pricing environment and a more favorable customer mix combined to offset this. Non-GAAP operating expense for the first quarter was $35.4 million, compared to $33.4 million for the previous quarter. Operating expenses increased primarily due to a seasonal increase in payroll taxes and increased headcount. Other income was $593,000, reflecting continuation of the low interest rate environment. Non-GAAP net income for Q1 was $8.9 million, or $0.23 per share compared with non-GAAP net income of $5.1 million, or $0.14 per share in the fourth quarter. In the first quarter, the non-GAAP earnings per share were based on 38.1 million diluted shares as compared to 37.6 million in the prior quarter. Total headcount at the end of the first quarter... The increase was primarily driven by supply constraints which caused the quarter to be more back-end loaded. Net inventory at the end of the first quarter was $33.1 million compared to $26.1 million at the end of the previous quarter. Days of inventory increased to 102 days in Q1 from 93 days in Q4 for anticipated demand. In Q1 our operating cash outflow was $4.5 million. Cash and marketable securities were $435.5 million, down from $440.7 million at the end of the fourth quarter. We had two 10% plus revenue customers in Q1. WT Microelectronics, a fulfillment partner in Taiwan who ships to multiple customers in Asia, was 63% of revenue and Chicony, a Taiwanese ODM, manufacturing for multiple customers, came in at 16%. Dahua and Hikvision, combined, declined sequentially and represented about 10% of our total revenue in Q1. I will now discuss the outlook for the second quarter of fiscal year 2022. During Q2 we expect to continue to experience a variety of supply chain challenges, in particular from the Texas freeze, which disrupted video processor manufacturing at Samsung's Austin, Texas, wafer fab. We expect wafer deliveries from Samsung's Austin fab to gradually recover in the second half of the year, while other industry-wide cyclical forces are likely to constrain supply through the end of the year. Based on these factors and our best judgement at the current time, we expect total revenue for the second quarter ending July 31, 2021 to be in the range of $74 million to $77 million. We anticipate both, Auto and Security, to increase about 10% sequentially, with Other revenue down about 20% sequentially. We estimate Q2 non-GAAP gross margins to be between 61% and 62% versus 62.9% in the first quarter. We expect to continue to incur higher costs to manage the supply chain challenges, but a stable pricing environment should continue to support gross margins at the mid to high-end of our long-term model of 59% to 62%. We expect non-GAAP operating expenses in the second quarter to be between $36 million and $37.5 million, due primarily to accelerate hiring and increased chip development costs. Other income should be modeled around $200,000 reflecting lower interest rates on our cash and marketable securities. Q2 non-GAAP tax rate should be modeled in the 3% to 6% range. We estimate our diluted share count for Q2 to be approximately 38.3 million shares. Ambarella will be participating in Cowen's TMT Conference and Craig-Hallum's Institutional Investor Conference, both of them tomorrow, June 2, Rosenblatt's Age of AI Scaling Conference on June 3, Bank of America's Global Technology Conference on June 8, and Stifel's Cross Sector Insights Conference on June 9. In addition, in advance of the International Security Conference, also known as ISC West, we will be hosting virtual demos on June 23; please contact us for more information on those events. With that, I will turn it over to the operator for polling on Q&A.

Operator, Operator

Thank you. Our first question comes from Joe Moore with Morgan Stanley. Your line is now open.

Joseph Moore, Analyst

Great, thank you. Congratulations on the numbers. I'm wondering if you could talk about the automotive split; since you're saying it's going to more than double this year. You know, what's the split going to be around kind of numbers between OEM and aftermarket? And how much of that do you think will be CV this year?

Fermi Wang, President and CEO

First of all, I believe that strong growth is coming from three areas. The first is a significant increase in OEM drive recorders, particularly in Japan, China, and Korea, where we are performing very well. We are also seeing solid growth in the aftermarket, especially in the fleet management segment of our recorder business; this represents our existing market. The second source of growth is from our new markets. We have designed products with TMS and ADAS, and both revenues have been increasing since last year and are showing growth this year, which will definitely contribute to more growth for us. Additionally, we believe that L2+ capabilities will help increase our revenue in the near future. The third factor is related to the CV ASP; we noted that CV ASPs are higher than video prices, and this is another contributor to the overall growth in automotive revenue. While we haven't disclosed the exact percentages between CV and non-CV, we can report that we have shipped over 450,000 CV chips to date, and we are continuing to ship well in the CV segment of our automotive market. I hope that answers your question.

Joseph Moore, Analyst

Great, that's helpful. Thank you. And then just for a follow-up; in terms of the supply constraints that you guys are seeing in the July quarter; like, obviously, we've heard some of that from your customers. How much unfulfilled demand do you think there will be? And are you negatively impacting your customer shipments in the month of May or when does that start to get cleared up? Thank you.

Fermi Wang, President and CEO

The Texas freeze caused issues for the Samsung foundry, which affected us significantly. The impact on our Q2 revenue is greater than in other quarters, but we expect the situation to gradually improve in the second half of the year. Our revenue generation has been impacted, and we were unable to consult with suppliers. Additionally, we've had to enter allocation mode for the video processors produced at the Samsung Texas foundry. While we haven't quantified the impact, we have communicated with all affected customers. We anticipate that the impact will also be felt in Q3 and Q4, but to a much lesser extent than in Q2.

Operator, Operator

There are no further questions. I will now turn the call back to Dr. Fermi Wang for closing remarks.

Louis Gerhardy, Corporate Development and Investor Relations

Thank you. Our next question comes from Vivek Arya with Bank of America. Your line is now open.

Vivek Arya, Analyst

Thanks for taking my question. Our first one just on gross margin. So good, good upside in the April quarter but I think the outlook suggests some reversal of that. So, I was just hoping for some color around what drove the upside in April and what will drive a different trend in July?

Fermi Wang, President and CEO

Sure. So, a large portion of that, again, is our two major customers in China. So it's a mix overall, but certainly, when their mix goes down that helps our margin and we did see some of that in the quarter. That would probably be along with other margin mix, as that would be the thing that would probably have the highest impact.

Vivek Arya, Analyst

Alright. And for my follow-up, for me, I think you mentioned this very nice number over 450,000, I believe, CV shipments into automotive. I think the last quarter you mentioned 300,000; so it went up, right, almost 150,000 units sequentially. Could you give us a sense of how much revenue does that represent? And was this exceeding 450,000; was it in line or different than the expectations that you had?

Fermi Wang, President and CEO

First, I'd like to clarify the numbers. Last quarter, we reported a total of 300,000, and now we are discussing a total of 450,000. As of today, we have shipped 150,000 in the wrap, which indicates significant growth. To be clear, we are not stating that we shipped 450,000 this quarter; we are referring to 450,000 cumulatively, so that is just for clarification. Regarding revenue, I want to highlight that the average selling price (ASP) is higher because many products are transitioning to automotive grade, and the ASP for Advanced Driver-Assistance Systems (ADAS) is considerably above that of recorders. Additionally, the ASP for OEM recorders is higher than that of aftermarket products. Overall, our ASP in automotive is quite strong, and we anticipate continuing this trend. This assumes we are at the onset of a commercial vehicle (CV) ramp-up. We have previously mentioned that our CV revenue wave, designated Wave 3, will take shape in 2023. We just want to indicate that we are seeing progress with this wave and will keep you updated on how quickly we can increase this revenue.

Vivek Arya, Analyst

Thank you.

Operator, Operator

Thank you. Our next question comes from Gary Mobley with Wells Fargo Securities, Your line is now open.

Gary Mobley, Analyst

Hey guys, let me start off by congratulating you to a strong start to the fiscal year. I appreciate the fact that you're able to deliver gross margin upside due to mix and other factors, but I was hoping that maybe you can quantify the supply chain impact, you know, higher substrate cost, higher back-end tests and assembly. And could you speak to perhaps the ability of your group to pass along these price increases or renegotiate some of these price increases for your customers?

Fermi Wang, President and CEO

We have noticed an increase in substrate prices and, to some extent, in testing and packaging costs. However, we have not adjusted our average selling price yet, and we currently do not plan to change it. We may reconsider this stance if there are changes to our wafer prices, but for now, we are comfortable with our decision. The only price adjustment we've made in the past few months is related to some customers who are willing to pay more for larger allocations of high-priority lots. We assist them in obtaining these lots by incurring additional costs, and in return, we ask our customers to share the increase on these lots. This is the only way we have adjusted our prices for customers.

Gary Mobley, Analyst

I appreciate that. I have a follow-up question regarding your product roadmap direction. If I'm correct, I believe you are considering incorporating some sensor fusion domain controller technology. Could you provide an update on the status of this initiative?

Fermi Wang, President and CEO

As you can see, we have addressed nearly all aspects of the automotive CV market, except for the domain controller. We aim to develop a domain controller solution that not only offers full sensor premium capabilities but also delivers higher performance with significantly lower power consumption compared to our competitors in the near future. We are currently working on this and hope to provide updates soon.

Operator, Operator

Thank you. Our next question comes from Kevin Cassidy with Rosenblatt. Your line is now open.

Kevin Cassidy, Analyst

Thank you, and congratulations on a strong quarter. You mentioned that Wave 2 will take place this year with some large programs, specifically in home security cameras. Can you confirm if any of those programs have been launched? Also, what percentage of the rollout would you say is complete? Do you anticipate a stronger performance in the October quarter compared to July?

Fermi Wang, President and CEO

I just saw my script. I mentioned that Ring unveiled two products featuring CVflow SoCs, which are essentially replacing our current Ring products with video-only solutions. We continue to see strong momentum in CVflow design wins and anticipate that other consumer IP security camera customers will introduce CVflow-based solutions soon, with production starting this year.

Kevin Cassidy, Analyst

Okay. Are there still any human vision designs or are all the new design CV designs?

Fermi Wang, President and CEO

We still see several human vision design wins but I will say that it's more towards lower end or the middle and higher solutions targeting CV space. We still see a mix of CV and non-CV support product space of our customers while we wish to continue to focus more on the CV side because that's where our strength is, and where we have differentiation.

Operator, Operator

Thank you. Our next question comes from Tore Svanberg with Stifel. Your line is now open.

Tore Svanberg, Analyst

Yes, thank you and congratulations on the results. First question is back to oil and some of the sub segments. If I can maybe just split between recorder and non-recorder, is it safe to say that this year recorder would be about 90% with a lot of the new applications being the other 10, roughly?

Fermi Wang, President and CEO

I think the 90% is too high for recorders. I don't have a number with me but operating tells me that our other business will be more than 10%.

Tore Svanberg, Analyst

Great, thank you. And as my follow-up, I know in the past you've talked about the amount of cameras going into car is about 1.5 in last year. Do you have any estimate this year based on conversations you're having with your customers; how that number could potentially trend up?

Louis Gerhardy, Corporate Development and Investor Relations

Yes, Tore. The 1.3 figure represents an estimate from a third-party market research firm regarding the total number of new vehicles produced in a year. This number is expected to rise as the use of cameras in cars increases, particularly the sensing cameras that utilize CVflow chips for applications like driver monitoring, front ADAS, surround view, and more. Third-party firms anticipate that this number will keep growing over the next several years.

Tore Svanberg, Analyst

Great, thank you. And congrats, again.

Operator, Operator

Thank you. Our next question comes from Andrew Buscaglia with Berenberg. Your line is now open.

Andrew Buscaglia, Analyst

Hi everyone. Could you provide the exact percentage that computer vision contributes to sales in the quarter? Also, considering the strength in automotive, do you still expect computer vision to account for 25% of your sales this year, or has that expectation changed?

Louis Gerhardy, Corporate Development and Investor Relations

Yes. First of all, we still expect that our CV revenue will be more than 25% of our total revenue this year. And yes, we think that we have a very good chance to believe on that. And with automotive continue to increase, definitely that will help us to drive mostly for CV growth. But as you can see that majority of our CV revenues still come from security, particularly professional security camera. And I think that will be continue driver for CV until next year, when the consumer IP can jump up and also more and more automotive CV revenue will come in. So I would say next year we can see continued growth on our CV revenue.

Andrew Buscaglia, Analyst

Okay. This is your fourth consecutive quarter at the upper end of the gross margin range, and your guidance suggests staying at the upper band at the midpoint. However, your long-term guidance indicates a significant decline in the latter half if you want to maintain the 59% to 62% range. What factors would give you confidence to potentially raise the lower end of that range? It seems like you continue to exceed your own expectations. Are there any mix issues you'd like to address?

Louis Gerhardy, Corporate Development and Investor Relations

Certainly, part of it is mixed and a part of it is the uncertainty that Fermi talked about for the second half of the year, depending on how that plays out and there are pricing issues and other issues that could create that to move. Again, we've been at the high end of the range as you commented, and we'll take that. But we felt that with everything that's going on right now, we needed to be balanced in the way we're looking at over the second half of the year or at least, certainly, the quarter to make sure that we keep our range to where it is today. And if we see something different longer term, then we'll start to think about that.

Andrew Buscaglia, Analyst

Alright. Thank you, guys.

Operator, Operator

Thank you. Our next question comes from Matt Ramsay with Cowen. Your line is now open.

Matthew Ramsay, Analyst

Thank you very much. Good afternoon. Fermi, I was particularly interested in the announcement you made about the CV2FS win with Arrival. Could you provide some additional details about that and share who you were competing against and the specific features that contributed to your significant design win? Thank you.

Fermi Wang, President and CEO

I believe we may have caused some confusion, but I firmly think that our collaboration with Arrival, along with others offering similar solutions, played a significant role. The primary advantage of CV2FS is our performance per watt, combined with its open platform that allows for extensive customization. These two factors contributed greatly to our success in securing design wins.

Matthew Ramsay, Analyst

Thank you, I appreciate that. My follow-up question is for Casey. Obviously, the primary drivers of Ambarella moving forward will be in auto and security, but I noticed that the other category was down around 20%, as you mentioned. It seems to be down another 20% again. I'm interested to know if there are changes in some of those smaller markets from a supply-demand perspective, or if this is due to supply tightness at Samsung, leading you to allocate wafers to your more strategic business, or if it's a combination of both. Thank you.

Casey Eichler, CFO

Yes, it truly is a combination of both. A couple of years ago, we anticipated a decline in other categories over a period of three to five years. While we did experience some positive developments last year, we are moving everything towards the CV product line in many markets. The CV does not have the same advantage in these areas as it does in others we have discussed, so we expect that to continue to decline over time. In recent quarters, this has mostly been driven by a few customers, as Vijay and I have mentioned before. Looking ahead, if we spot opportunities or markets where CV is well suited, we may find some potential there. However, we have viewed this as a declining market overall. We will continue to take any upside that comes our way, but our perspective on it remains unchanged.

Matthew Ramsay, Analyst

Got it. Thanks, guys. Appreciate it.

Operator, Operator

Thank you. Our next question comes from Ross Seymore with Deutsche Bank. Your line is now open.

Ross Seymore, Analyst

Hi, everyone, congratulations on the strong results. I have a couple of questions, starting with the inventory and supply side. I'm curious about how your inventory increased so significantly. While it's not surprising compared to historical levels, I was a bit taken aback by the constraints you mentioned related to revenue in the second quarter being the lowest, yet your inventory still rose by about 25% to 30% sequentially. Are there specific areas where you're not supply constrained outside of the Austin fab, or certain markets that might be more affected by the Austin freeze? Any insights on this would be appreciated.

Fermi Wang, President and CEO

We have strong visibility for our customers and robust demand. The inventory numbers reflect this strong demand and the need for a longer lead time, which has increased significantly. As a result, we've decided to raise our inventory levels to safeguard ourselves and our customers. This combination drives our inventory strategy. However, we are confident that this inventory won't become obsolete since we understand our customers' run rates and have a variety of customers across different power lines. We believe we are building an inventory that we can sell. In the current environment, it's crucial for us to ensure we have ample products available for our customers, especially if lead times continue to pose challenges.

Ross Seymore, Analyst

Thank you, Fermi. My follow-up question has two parts and relates to a previous question about your other business. I'm trying to understand what seasonality might look like in the latter half of the year, given the easing supply conditions and your design wins, but also considering the potential downside of the consumer segment being smaller compared to the rest of your business. So, how do you view second-half seasonality? And can you provide an estimate of what percentage of sales the consumer business represents in the first half of the year? It seems like it might be around 10%. Any clarification would be helpful for our models.

Casey Eichler, CFO

Yes. I think when we look at the second half of the year, as we've talked about, there is a lot of uncertainty in the second half of the year. And so, when we look out, I think we feel the opportunity to continue to supply to our customers barring any change in some of the dynamics that we're seeing today. I think we don't guide beyond one quarter, but I think that we've seen the worst of it, as Fermi talked about earlier in a lot of the areas, and we should be able to meet demand as it comes through in the second half of the year. We're also looking into some of the newer markets that we talked about. As we said, we've got three phases networked; by the end of this year, into next year we're going to have all phases kind of starting to really kick, and that's what's really exciting to us.

Ross Seymore, Analyst

Great. Any sort of right-sizing on how big that consumer is? Was it percentage of sales? Was it kind of around 10%-ish in the first quarter and then you implied in your guidance for the second?

Casey Eichler, CFO

Yes, I believe you will see the numbers decrease in that market as well. At the same time, the other two will increase, while the consumer business will decline as we mentioned.

Ross Seymore, Analyst

Okay. And one final housekeeping one. Fermi, you talked about being low to mid-teens. Two quarters ago, you said it dropped to about 10% in the most recent quarter. Can you just talk a little bit about did the dollars drop as well as the percentages? And more importantly, what's the update on DAVA rolling out the CV design wins that you have had? Is that a customer that you expect to be a tailwind going forward? Or is there some change in the narrative there?

Fermi Wang, President and CEO

For Hikvision and DAVA, both companies are utilizing our video products, and we previously discussed the inventory build-up a few quarters back. They have been digesting the inventory and have started to reorder some components, although at significantly lower levels. As a result, I anticipate that our video product sales to these two companies will continue to decline over time. Regarding DAVA, we plan to increase our CV revenue with them, but this is somewhat constrained by supply issues and the subsidiary situation. Once we move past these challenges, we expect DAVA's CV revenue to contribute to our growth. Overall, I believe that the combined performance with DAVA is likely comparable to the last quarter.

Operator, Operator

Thank you. Our next question comes from Suji Desilva with ROTH. Your line is now open.

Suji Desilva, Analyst

Hi, Fermi, Casey, and Louis, congratulations on the progress here. Perhaps first for Casey, on the operating leverage here; you got the nice operating margin bump up to 12% here. You talked about the expectations well backs and what you think we'll be able to do as you continue to grow the revenue, will you need to invest more here or can you keep that relatively stable?

Casey Eichler, CFO

I think we'll continue to invest not only in people, but also in opportunity; and so I think we'll see that. Having said that, you know, we're kind of focused on getting to 20% right now, as you know, the business can in the past has done 20% to 25%, and we think that's still obtainable as well. But right now from where we are, we're focused on getting to those type of margins.

Suji Desilva, Analyst

Okay, great. Well, my question is for Fermi. Perhaps, you know, a lot of press on autonomous attempts here and a notion of camera plus radar, perhaps shifting to camera plus LIDAR; and just you know, kind of what camera can and can't do. Maybe you can talk about the implications for Ambarella's product designs and automotive footprint, and you know, whether that is impactful to you? Whether you're kind of orthogonal to all that?

Fermi Wang, President and CEO

We firmly believe that the camera is the most critical sensor in the autonomous driving sector, and the demand for camera technology is set to increase. Every vehicle will incorporate more cameras, each requiring high resolution and enhanced processing capabilities. This includes stereo processing, improved computer vision for diverse detections, and sensor fusion. Consequently, we anticipate a positive trajectory for our camera product roadmap in autonomous driving. Additionally, I believe redundancy is crucial in this market, and radar serves as a valuable complement to camera solutions. The reason for this emphasis is that while LIDAR is costly, radar is more affordable and, importantly, it is not an optical sensor, making it a strong technological partner for our camera technologies.

Operator, Operator

Thank you. Our next question comes from Quinn Bolton with Needham & Company. Your line is now open.

Quinn Bolton, Analyst

Hey guys. I'll offer my congratulations. Well, I just wanted to come back to the to the Samsung Austin impact on the business. Did you say, Fermi, that that was just for the video processor side of the business? Or are there any CV products manufactured out of that facility?

Fermi Wang, President and CEO

Right. It's only video processor, all our CV processor appears in Korea foundries.

Quinn Bolton, Analyst

Thanks for the clarification. So, if you are most constrained on the video processor side, wouldn't that positively impact margins over the next few quarters?

Fermi Wang, President and CEO

No. Our margins basically are the same between CV and the vision-based products. While obviously, we talked about the fact that it doubles, you know, the top line doesn't really change the margin at all.

Quinn Bolton, Analyst

Got it, okay. And then, lastly, just with these video processor being constrained, do you think any of that demand that you might not meet this quarter or next is perishable? Or would you expect that demand just sort of roll into future quarters, and you'll meet it when you can get the wafers or substrates?

Fermi Wang, President and CEO

It's perishable. Some of the video products are used in professional security cameras, some in consumer security cameras, and others in different consumer markets like TGI. The reality is that demand for consumer security cameras and consumer cameras is perishable. Although professional security cameras may have ongoing demand, the timing can vary for them. Typically, at the end of the year, people attempt to finalize their budgets and tend to make significant purchases in the fourth quarter. Therefore, if we miss those opportunities, that demand could also become perishable.

Quinn Bolton, Analyst

Understood. Thanks for that clarification.

Operator, Operator

Thank you. Our next question comes from Justin Gera with Baird. Your line is now open.

Unidentified Analyst, Analyst

Hi, good afternoon. Just a quick follow-up on the risk margin outlook. And you've mentioned that some of the candidates that might have an impact on gross margin direction or you put the second half of the year. As your supply improves; is it fair to assume that your surveillance camera customers in China are going to improve as a percentage up to those make them; that's going to be gross margin component to consider for the second half. And also, if you could give us an update on the impact of your development cost on gross margin for the next few quarters?

Fermi Wang, President and CEO

Yes. As I mentioned, we are maintaining our existing guidance related to margins on a quarter-by-quarter basis. We have provided that indication. Looking ahead, we expect to see some changes in the mix, particularly in Japan, which can affect us from one quarter to the next. As we look into the upcoming quarters, we will need to monitor how this develops for us.

Unidentified Analyst, Analyst

Okay. And then, just as a quick follow-up. Any changes that you see in terms of the competitive environment in China, in surveillance, notably at the low end? I'm assuming that would not impact you, but do you expect any changes in the pricing competitive environment medium-term?

Fermi Wang, President and CEO

In terms of the competitive landscape in China, we need to keep an eye on HiSilicon, as they have a substantial amount of inventory either with customers or within their own facilities, ensuring that product shipments remain smooth. Aside from HiSilicon, there are other competitors in the high-end product line. Additionally, numerous low-end competitors from China and Taiwan are actively vying for market share in the lower-end video segment, and some are even competing in the low-end computer vision space. Consequently, we experience constant price pressure at the lower end, but we remain confident in our current average selling price guidance for the mid-range and high-end sectors.

Unidentified Analyst, Analyst

Okay. And then just one last quick follow-up which is, when do you think HiSilicon inventories might normalize? And would that translate into an acceleration in demand for your product?

Fermi Wang, President and CEO

Well, we don't know. But however, our customers gave an indication they can easily survive without for another 12 months, without any new product. So, I think they are sitting on tons of inventory right now.

Operator, Operator

Great, thank you very much.

Richard Shannon, Analyst

Thank you for taking my question. Fermi, I have a broader industry question. Looking at the professional security sector in relation to CV, how do you perceive the adoption rates compared to past transitions from analog to digital? Is this transition occurring more quickly or more slowly? What insights do you have regarding market pricing that reflect those changes?

Fermi Wang, President and CEO

Right. So first of all, while we navigate this transition from traditional to digital IP security that began 10 years ago, I recall that the first two years were slow, and then suddenly there was a shift. I would say we are not experiencing a rapid growth phase yet, as the majority of our professional security camera shipments are still comprised of video-only solutions. Therefore, I believe we are still in the early stages of moving from video to CV. I think the main catalyst for this transition needs to materialize. Customers need to test the pricing of CV camera products, which should ideally be just a slight premium over the existing video products, as that will trigger the transition, and I don’t think we have reached that point yet.

Richard Shannon, Analyst

That's helpful perspective for me. Thanks for that. My last question here is in the automotive side; again, related to CV applications like DMS and ADAS, etcetera. Not looking so much at the higher end ones like L4 and L5, but more than immediate term ones. Anyway, you have a sense of and can you characterize for us what kind of shared design wins do you think you have in that space right now or have visibility into?

Fermi Wang, President and CEO

We don't have a specific number to share at this moment. However, if you look at our design win activity over the past few quarters, you can see that we consistently publish those design wins. There's a steady, if not increasing, number of design wins in the DMS, OMS, and ADAS sectors. This indicates that our market share is growing in newer markets, but I don’t have concrete figures as most of these wins are still quite new. I would note that in the ADAS market, we have yet to gain significant traction, though we are beginning to secure some design wins there. I hope this momentum will continue. While ADAS is still a relatively small segment, the OMS/DMS market is new, and I believe we have an opportunity to capture a larger share there.

Richard Shannon, Analyst

Okay. Fermi, anyway you'd want to characterize what your goals might be in OMS and DMS? I mean, obviously, it's difficult to compete against directly gets Mobileye, but could you get to 20%, 25% of that market overtime?

Fermi Wang, President and CEO

In fact, what we really want to emphasize is not just capturing market share in DMS and OMS; we are trying to promote the idea that our Tier 1 OEM customers, who have ADAS and recorders, need a unified platform to manage all of that. When you consider ADAS, it essentially involves a front-facing camera used for mobile ADAS as well as recording, and there is no reason why these two products can't be combined. At the same time, the DMS operates at the same location as the ADAS camera, facing inside to observe the driver. Additionally, we believe the driver and the ADAS need to be synchronized in the video so that when an incident occurs, we can clearly see what the driver was doing; synchronization is crucial. I strongly believe that this combined product approach makes sense, and if this scenario becomes a market requirement, it will certainly help us gain market share because I don't see any other competitor's solution that can offer such combined products at this time.

Operator, Operator

Thank you. Our next question comes from Tore Svanberg with Stifel. Your line is now open.

Tore Svanberg, Analyst

Yes. Just a quick follow-up and maybe related to the last topic there. Are you still attracted to sampling CV5 this quarter? And is everything sort of on-track with Samsung's 5 nanometer process there?

Fermi Wang, President and CEO

Yes, we are on track with both projects and are currently working on CV52 in our lab. We believe we will be ready to sample it soon. Additionally, we are collaborating with Samsung on the CV5, which is our first 5 nanometer chip. We are focused on improving the CV5 process and executing our production plan. I remain confident that we will begin generating revenue from CV5 sometime next year.

Tore Svanberg, Analyst

That's great. Thank you.

Operator, Operator

Thank you. Our next question comes from Martin Yang with Oppenheimer. Your line is now open.

Martin Yang, Analyst

Hi, thanks for taking the question. Just one for me. I'm curious if current supply constraints may affect or change how HiSilicon think about adoption for CV? Is there anything that may change their view, maybe getting CV sooner; do you have a view there?

Fermi Wang, President and CEO

Well, you are talking about Hikvision. So, I believe we have consistently communicated with Hikvision that they are working to minimize their use of U.S. components as much as possible. This company seems to adhere closely to that policy, which is why they have accumulated significant HiSilicon inventory. I think they are exploring options with other suppliers, potentially Chinese ones. That's the current state of affairs. As I mentioned earlier, we cannot compel others to consider U.S. components; our role is to offer solutions that are difficult to replace with anything available in China, which helps us maintain our market share.

Operator, Operator

Thank you. Our next question comes from Derek Soderberg with Colliers Securities. Your line is now open.

Derek Soderberg, Analyst

Hi, guys. Just one question for me as well. Fermi, I'm wondering in your view, which design wins you announced are the most meaningful for the company? If you could maybe just call out the top two or three wins and provide any additional detail on those wins; I think that'd be helpful. Thanks.

Fermi Wang, President and CEO

I think Arrival is the most significant one for me. Not only is it an automotive design win, but it’s important for other reasons as well. This is a level 2+ application using our CV4 engine. More importantly, this is the first CV2FS chip design win we announced, which shows that our CV2FS functional safety chip is in excellent shape, and the customer is already adopting and testing it. I’m excited about that perspective. Additionally, Arrival is a notable European company that has attracted significant attention, which is definitely important for us. Equally exciting is the recent announcement with Great Wall, a well-known Chinese OEM that has adopted our solution. Their tumble solution is essentially a driver recorder that includes CMS and OMS all in one. They are the first to really promote this concept, and I hope our strong capabilities and performance with Great Wall will encourage others to follow suit, leading to more design wins in the future. Thus, these two projects are the ones I’m most excited about. Thank you very much for joining us today. And looking forward to seeing you next time. Thank you. Bye.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.