Earnings Call Transcript - AMBA Q1 2020

Conference Info, Conference Details

Company Representatives: Dr. Fermi Wang - President, Chief Executive Officer; Casey Eichler - Chief Financial Officer; Louis Gerhardy - Director of Corporate Development and Investor Relations.

Operator, Operator

Good day ladies and gentlemen, and welcome to Ambarella’s First Quarter Fiscal 2020 Earnings Call. At this time all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session and instructions will follow at that time. Operator provided instructions on how to ask questions. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr. Louis Gerhardy, Director of Corporate Development and Investor Relations. You may begin.

Louis Gerhardy, Director of Corporate Development and Investor Relations

Thank you, Skyler. Good afternoon and thank you for joining our first quarter fiscal 2020 financial results conference call. Our speakers today will be Dr. Fermi Wang, President and CEO; and Casey Eichler, CFO. The primary purpose of today's call was to provide you with information regarding the results for the first quarter of our fiscal 2020. 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 are 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 that we filed with the SEC, including an annual report on Form 10-K filed on March 29, 2019 for fiscal 2019. Access to our first quarter fiscal 2020 results, press release, historical results, SEC filings and a replay of today's call can be found on the Investor Relations portion of our website. I will now turn the call over to Dr. Fermi Wang.

Dr. Fermi Wang, President and CEO

Thank you, Louis, and good afternoon everyone. Before I address our financial results, I would like to comment on the geopolitical factors injecting higher levels of uncertainty and volatility into our business. Although there is currently no regulation in place, there is a lot of speculation that some security camera customers in China may become subject to U.S. government regulations limiting or restricting our shipments to them. In addition, some of our customers both in China and outside of China will be facing higher tariffs when their products are imported into the U.S. During these uncertain times, market share may shift between our customers and such transitions could be subject to disruptions. Furthermore, our non-security camera customers in China may also be subject to unfavorable geopolitical forces. Our largest competitor in the security camera semiconductors market, HiSilicon, a unit of Huawei, also faces headwinds of their own. As a result, one can see the environment is volatile with a wide range of potential outcomes. For example, in the last two weeks we have received orders pulled in from security camera customers in China. In terms of our financial performance in Q1 fiscal year 2020, the revenue of $47.2 million was slightly above the midpoint of our guidance and declined 8% from the $51.1 million in the prior quarter. During the quarter, we demonstrated solid progress towards a multi-billion dollar expansion of our addressable market. Our deep domain expertise in video processing, integrated with the computational horsepower of our proprietary CVflow AI processor yields a highly optimized computer-vision solution, enabling our customers' products to become more intelligent. An important milestone for us is that we started mass production of our second CV SoC, CV25, in Q1 with shipments scheduled in Q2. Also during Q1 we continued our early ramp of the CV22 shipments and maintained strong design activity in our core automotive and security camera markets. I will now talk about our progress in our target security and automotive markets, starting with security. During April’s ISC West Security Convention, Ambarella demonstrated its full range of security solutions including our CVflow family of computer vision SoCs, as well as announcing our new S6LM SoC. At the show many leading professional camera suppliers demonstrated new AI-enabled cameras based on our CVflow SoC, in advance of formal product announcements to be made over the coming months. This included a leading Korean supplier, Hanwha Techwin, who demonstrated a professional IP camera based on Ambarella solutions for the first time. Our CVflow SoCs are in design at nine of the 10 leading professional security camera suppliers. We are continuing to displace SoCs from HiSilicon and computer vision coprocessors including many third-party and FPGA-based solutions and new designs. We also believe that around five professional IP camera makers should be in mass production of cameras based on our CVflow SoC in the second half of this year. During the show we introduced our new S6LM camera SoC targeting both professional and home security cameras. It includes Ambarella's latest high dynamic range and low-light processing technology, highly efficient 4K H.264 and H.265 encoding, multi-streaming on-chip, 360-degree dewarping, cybersecurity features and a quad-core Arm CPU. Fabricated in 10nm process technology, the SoC has very low-power operation, making it well-suited for small form factor and battery-powered designs. Fully software compatible with our CVflow family of chips, the S6LM expands our IP camera product portfolio to address the most size-conscious applications with no compromise on image quality. In addition to our ongoing investments and progress in AI processing, we are continuing to advance our image processing technology, which remains a critical differentiator in both security and automotive applications. At ISC West we demonstrated the low-light capability of our new SoCs by generating full-frame-rate color video in less than 0.07 lux lighting conditions, or near total darkness. At these light levels, previously cameras had to turn on power-hungry IR LEDs for illumination, which provided only grayscale images. This new low-light color capability is available on all of our new CVflow and S6LM SoCs. We have now worked with over 50 customers and partners who successfully ported their deep neural networks to our CVflow SoC with our advanced tools typically enabling net porting in a few days. The number of leading third-party computer vision software developers who joined us at ISC West for demonstrations included Anyvision for face recognition, FX group for vehicle and license plate recognition, Pilot AI for person and vehicle detection, Trueface’s access control, IntelliVision's license plate recognition, and Xnor's person detection and recognition. In the consumer home monitoring market, Vivint, a leading smart-home company owned by Blackstone Group and serving over 1.4 million customers in the U.S. and Canada, introduced its first Ambarella-based product, the Outdoor Camera Pro. The camera is sold as a part of Vivint’s complete integrated home security system and 24/7 monitoring services. Based on Ambarella’s S4L SoC, it includes a 4K sensor, 10-bit HDR video, Night Vision, 2-way audio and the ability to both detect and to deter threats. I will now update you on our continuing progress in automotive markets. In April Ambarella exhibited at the Shanghai Auto Show for the first time. We hosted a significant number of leading Chinese automotive OEMs and Tier-1 suppliers. Dr. Alberto Broggi, General Manager of Ambarella’s VisLab team, delivered speeches highlighting autonomous driving technologies to almost 600 attendees. Our technology demonstration included our partner HELLA Aglaia front camera AI-based ADAS software running on our CV22 CVflow SoC. We also demonstrated driver monitoring solutions from partners EyeSight and RealSense. The RealSense camera will run on Ambarella’s new CV25 CVflow SoC. Yesterday we announced that we are working with leading Chinese Tier-1 supplier Longhorn to develop an automated parking system based on a combination of visual and ultrasonic technologies, with sensor fusion software. The platform uses Ambarella’s CV22 H2 SoC to run multiple AI algorithms simultaneously to enable free-space detection, parking detection, vehicle identification, obstacle type identification and emergency brake in a full 360-degree panoramic parking system. Yesterday we also announced a collaboration with Baolong, a leading Chinese Tier-1 supplier to the automotive sensor and ADAS market. Baolong’s DMS AI was run on our CV22 H2 SoC to create a high-performance, low-power and compact form-factor driver monitoring system. The driver monitoring system solution captures the drivers’ facial information, including characteristics of the eyes, head and mouth from an image sensor and the CV22 H2, and then provides both real-time video processing and the AI computational horsepower to determine the driver’s level of fatigue. In April we announced that we are working with China-based Momenta on a collaborative HD mapping platform for autonomous vehicles. The combined solution leverages our CV22 H2 SoC and Momenta’s deep learning algorithms to provide an HD map solution, including localization and map updates through crowdsourcing. The solution can create a close-to-real-time HD map and provide AI and HD map updates. We expanded our partnership with Momenta to include development of ADAS and map processing solutions in the future. Also in April we announced that we are working with Chinese Tier-1 automotive supplier Shanghai OFilm, a leading provider for smart driving solutions, on automated valet parking or AVP hardware platforms. The platform uses Ambarella’s CV22AQ SoC and OFilm’s intelligent driving algorithms to perform high-precision image recognition, free-space detection and obstacle detection, enable emergency braking and map construction. In the OEM automotive market, we are continuing to win new designs in car recorder applications, as this capability increasingly becomes a pre-installed option in new vehicles. In the last two years our drive recorder SoCs have been incorporated into 18 new car models with 10 different OEMs. These OEMs include Geely, Honda, Toyota, Nissan, SAIC, Dongfeng, Changan and BAIC. During Q1 a number of Chinese automotive customers introduced new car models with recorders based on Ambarella’s A12 SoC. This included Geely's Jiaji MPV with a car recorder supplied by Tier-1 Longhorn, Chery’s Tiggo Fly SUV with a car recorder supplied by Tier-1 Skyworth and BAIC's Soul Max MPV. In the automotive aftermarket, Garmin announced its new mini-family of compact dash cameras consisting of four new models ranging from $129 to $249, all based on Ambarella’s A12 SoCs. The new cameras include features such as 1440p resolution video, 180-degree field of view, parking security recording and the ability to link up to four cameras together to form a synchronized network that provides full coverage around a vehicle. In April Ambarella’s Italian team VisLab obtained authorization to test autonomous vehicles on public roads in Italy, the first authorization to be issued by the Ministry of Infrastructure and Transport under the new Smart Road decree. The authorization was obtained based on evaluation of VisLab’s technology, its proven experience in operating in real-world environments and the vehicle safety records. Commemorating the occasion, Ambarella’s EVAs autonomous vehicle was demonstrated to an Italian Deputy Prime Minister and Minister of Economic Development on an iconic Torino Lingotto test track built on the roof of the former Fiat factory. In the consumer camera market, drone market leader DJI introduced its Osmo Action camera, raising the bar for features and image quality in the action camera market. Priced at $349 and based on Ambarella’s H2 SoC, it offers 4Kp60 video recording, full-frame-rate 3-axis electronic image stabilization called RockSteady, video HDR processing and excellent low-light image quality. The waterproof camera also featured a front-facing color display to illuminate the dashboard when taking selfies. In summary, despite the geopolitical headwinds, I’m pleased with our execution and the foundation we are building for the secular growth opportunity in the AI and computer vision market. With multiple CV devices now in production, with more CV design wins and with new technology and products in development, we see three CV waves taking shape. CV revenue from the professional security camera market has started and we expect it to become material in calendar 2020. The second CV wave is expected from the consumer security camera market. We expect it to commence in the second half of calendar 2020 and become material in calendar 2021. The first CV wave with automotive is expected in calendar 2022–2023 with a portfolio to be the largest wave yet. I would like to recognize Ambarella’s team for keeping their heads up and executing our plans despite all the macro uncertainty. Thank you to all of our employees, customers, vendors and shareholders for your trust. Now, I will turn the call over to Casey for the first quarter financial details and the guidance for our second quarter of fiscal 2020.

Casey Eichler, Chief Financial Officer

Thank you, Fermi, and good afternoon everyone. Today I’ll review the financial highlights for the first quarter of fiscal 2020 ended April 30 and provide a financial outlook for our second quarter of fiscal 2020 ending July 31. During the call, I'll discuss 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 excluded stock-based compensation expense, adjusted for the impact of taxes. Consistent with our previous guidance, our Q1 revenue totaled $47.2 million, which represents a decrease of 8% from Q4 and a decrease of 17% when compared to the same quarter of the prior year. In Q1 revenue by market was in line with expectation: automotive and other product revenue was up sequentially and security was down sequentially with consumer security increasing and professional security declining. Non-GAAP gross margin for Q1 was 59.6% compared to 60.6% in the preceding quarter and slightly above the midpoint of our guidance. Non-GAAP operating expenses for the first quarter were $29.9 million compared to $29.5 million for the previous quarter. OpEx increased primarily due to an increase in payroll taxes and other payroll-related expenses. Other income of $2.2 million was higher than anticipated as we received a $346,000 one-time government subsidy. Non-GAAP net income for Q1 was $266,000 or $0.01 per share compared to non-GAAP net income of $4.5 million or $0.14 per share in the fourth quarter. The non-GAAP effective tax rate in Q1 was approximately 36%. In the first quarter the non-GAAP earnings per share were based on 33.5 million shares as compared to 32.8 million shares in the prior quarter. Total headcount at the end of the quarter was 750 with about 81% of our employees dedicated to engineering. Approximately 70% of our total headcount is in Asia. In Q1 we generated positive operating cash flow of $5.3 million. Cash and marketable securities were $366 million, up from $359 million at the end of the fourth quarter. We did not repurchase stock during the quarter under the $100 million repurchase program authorized through June 4, 2019. On May 29, the company's Board of Directors authorized the repurchase of up to 50 million of the company's ordinary shares through June 30, 2020. Total accounts receivable at the end of Q1 were $26.5 million or 50 days sales outstanding. This compares to accounts receivable of $26.2 million or 47 days sales outstanding at the end of the prior quarter. Net inventory at the end of the first quarter was $17.6 million compared to $18.3 million at the end of the previous quarter. Days of inventory declined to 85 days in Q1 from 93 days in Q4. We had two 10%-plus revenue customers in Q1: WIT Micron (our fulfillment partner in Taiwan) which came in at 59% of revenue and Chicony, a Taiwanese ODM who manufactures for multiple customers, which came in at 18%. I will now discuss the outlook for the second quarter of fiscal 2020. Before the recent geopolitical news, we were comfortable with the market expectation for second quarter fiscal year 2020 revenue outlook. However due to recent order pull-ins, we are now raising our revenue guidance above the market's expectation. We expect total revenue for the second quarter ending July 31, 2019 to be in the $51 million to $53 million range. We anticipate automotive and security revenue to increase sequentially; all other revenue is expected to decline. We continue to expect other revenue, comprised primarily of custom electronics products, to remain volatile and decline as a percentage of revenue in the next two to three years. Although forecasting is difficult in the current environment, we continue to expect our revenue will increase in the second half of the year when compared to the first half. The global economic and political environment is generating a significant amount of uncertainty with our customers’ outlook and our customers' supply chains. Overall, conditions remain extremely volatile. A number of factors impact our gross margin outlook. In anticipation of export restrictions that might be implemented, our professional security camera customers in China have pulled in orders which are lower-margin products. In addition, rises in tariffs may have a greater impact on our customers’ ability to sell their products incorporating our higher-margin devices. There is also some supply chain congestion in the packaging and test area that may make it difficult and/or more expensive for us to pull in orders. As a result, we estimate Q2 non-GAAP gross margin to be in the 57% to 59% range as compared to 59.6% in the first quarter. We expect non-GAAP OpEx in the second quarter to be between $29.5 million and $31.5 million due to increased engineering headcount, payroll tax accruals and other engineering expenses. For Q2, tax rate should be mid-30s at 32%. The tax rate is a result of our inability to use tax losses in certain jurisdictions and tax rate should return to the high single digits as we become more profitable. We estimate our diluted share count for Q2 to be approximately 34.1 million shares. Ambarella will be presenting at the Bank of America Merrill Lynch 2019 Global Technology Conference on June 5, the Stifel 2019 Cross Sector Inside Conference on June 10, and participating in CES Asia, June 11 to June 13. Please contact Louis for more details on these events. Thank you for joining our call today. With that, I'll turn the call over to the operator for questions.

Operator, Operator

Operator provided instructions. Our first question comes from Kevin Cassidy with Stifel. Your line is now open.

Kevin Cassidy, Analyst (Stifel)

Thanks for taking my questions and congratulations. Just to be clear, the pull-ins—these were because of high concern about potential bans and concerns of not being able to ship, not a concern that the U.S. may ban surveillance products or your products being shipped into surveillance products. Do I have that right?

Casey Eichler, Chief Financial Officer

Well, it’s hard for us to have perfect visibility into that, but I would say primarily the pull-ins are related to customers' concern about a ban or potential ban, and so I think we're seeing some order patterns move around a little bit, and we think that we're already seeing some pull-ins into this quarter and that's what we were referencing. From a HiSilicon standpoint, we may see some increased orders due to concerns around HiSilicon, but it's hard for us to have visibility into their backlog.

Kevin Cassidy, Analyst (Stifel)

Okay, thanks. So should we be thinking of the second half? I know you're saying it’s still higher than the first half, but maybe not as high as your first thinking, because the first half is going to be higher than expected?

Casey Eichler, Chief Financial Officer

I think what we are going to see is movement kind of quarter-on-quarter over the next two to three quarters. We are seeing the type of traction we were expecting, especially across the CV products and some of the other products, but as all of this gets digested and we try to get some resolution, it's a little difficult for us to have as much visibility as we typically do. But what we're seeing right now is pretty good demand and certainly demand better than we saw in the first half of the year and so that's why we're guiding second half over first half. On a quarter-by-quarter basis we'll keep you posted as we move forward, because it's difficult for us to have good visibility right now.

Kevin Cassidy, Analyst (Stifel)

Okay, thank you very much for the clarity.

Casey Eichler, Chief Financial Officer

Sure.

Operator, Operator

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

Ross Seymore, Analyst (Deutsche Bank)

Hi guys, thanks for all the color in these uncertain times, so I appreciate you trying to give us a little more of a crystal. To that point, I know Casey you said you were comparable with what the Street expectations were before. Just trying to size the pull-ins here; is it fair to say that if the Street was at $49 million to $50 million, you're thinking kind of $2 million to $3 million to hit the midpoint is the pull-in side of the equation, or is there other things that are moving, like new design wins or something else that's helping your business above the current expectations?

Casey Eichler, Chief Financial Officer

Yeah, most people had us starting to have some revenue growth in the second quarter, thus the $48 million to $49 million you were talking about versus what we just did. And the incremental above that—again, it’s hard to have perfect visibility—but clearly a good piece of that is pull-ins that we're starting to see into Q2. Exactly how much of that is pull-ins is hard to pinpoint, but it’s clear that a large portion of that additional amount above where the Street was is pull-in related.

Ross Seymore, Analyst (Deutsche Bank)

Got it, and then can you give any more color on the confidence you have in the back half of the year still being bigger? Obviously you have a lot of drivers there, but it seems like it will be less so to Kevin's question given that you have the higher base in the second quarter. Can you just talk about some of the things that you have confidence in that will create that increase into the second half?

Casey Eichler, Chief Financial Officer

Well, as I said, our CV products remain on target and online. We’ve got some of the other products and some of the things that Fermi discussed in the call today that we think are going to really start to be contributors, and generally some of the markets that have been soft are starting to come back a little bit. Auto has lightened up a little, security growth has spun a little, and when you listen to our customers they were seeing growth start to come back a little stronger in the second half, so those are good signs. Now again, if all of a sudden we're not allowed to ship products or if customers can't get their supply chain straightened out, obviously that's very disruptive and we can't control that, but barring something like that, I feel pretty confident and pretty good about what we are hearing from our customers today.

Dr. Fermi Wang, President and CEO

And also, let me add one more thing. Before the discussion of this potential ban, Casey and I felt comfortable with our previous guidance, which means that Q2 should be a little better than Q1 and the second half will be better than the first half. We were comfortable even before this discussion about the Hikvision/Dahua situation.

Ross Seymore, Analyst (Deutsche Bank)

Got it. Thanks guys. I appreciate it.

Operator, Operator

Our next question comes from Joe Moore with Morgan Stanley. Your line is now open.

Joe Moore, Analyst (Morgan Stanley)

Great, thank you. My question is on the pipeline of automotive wins, particularly in China. You guys have talked about OFilm, Momenta, Baolong, Longhorn now. It seems like there's a lot more design wins coming from China than I would have expected. Can you talk about why you're getting so much traction in that region? It seems harder to get companies in the West to press release those activities.

Dr. Fermi Wang, President and CEO

Right, first of all I really think that HELLA's endorsement helped us in China because a lot of Chinese customers are waiting to get a platform they can use that highlights our CV22 platform. That gives confidence to Chinese vendors who are looking for solutions. In China people are more aggressive and they really want to get products they can ship in 2020 and 2021 in significant volumes, and there are not many good solutions out there. With endorsement from HELLA, and as we continue to demonstrate progress we've made in our CV chips—performance, low power consumption and image quality—that helps us establish credibility. The engagement with Momenta reflects that the Chinese automotive industry is more aggressive to try new solutions; their time to market and time to revenue is shorter. So that combination of technical performance, partnerships and Chinese market dynamics is driving traction.

Joe Moore, Analyst (Morgan Stanley)

Okay, great. And is the competitive dynamic in the Chinese market different than here? Here we talk about Mobileye and FPGAs and things like that. In China is it the same? We hear about AI inference-related startups—are those a different competitive set there?

Dr. Fermi Wang, President and CEO

There are many AI companies or startups trying to do inference engines like we are, but I still think that our main competitors are companies we've talked about in the past: Intel, Mobileye, NVIDIA and also traditional companies like TI. On the CV22 and CV25, we believe our CNN performance will establish us as having strong performance versus those competitors, and our existing customer relationships in China definitely help us. Mobileye and NVIDIA, although very large and strong, generally have higher price points in China, and that helps us gain traction. So in China we are competing with Intel, MediaTek, TI and other established players as well as some local startups, but our combination of performance, power and customer relations gives us advantage.

Joe Moore, Analyst (Morgan Stanley)

Thank you very much.

Operator, Operator

Our next question comes from Adam Gonzalez with Bank of America. Your line is now open.

Adam Gonzalez, Analyst (Bank of America)

Yeah, thanks for taking my question. Just a quick one. Can you quantify what your overall exposure to China is? I think we have a pretty good sense of what it is in security, but trying to think beyond security and automotive and continuing that as well. Thanks.

Casey Eichler, Chief Financial Officer

Sure. In the security case, security overall is about 60% of our revenue and the professional side of that is about two-thirds, with consumer security being one-third. Of that two-thirds professional segment, the export business is the biggest piece, which probably represents a meaningful portion of that revenue. When you roll all of that up, there is a decent piece of our professional security business that is tied to export customers in China, but most of the business inside China is dominated by our competitor HiSilicon.

Dr. Fermi Wang, President and CEO

In the auto space, for our OEM car recorder business, I would say China, Japan and Korea are significant, and China is probably roughly 50% of that business. That gives you an idea about our China exposure.

Adam Gonzalez, Analyst (Bank of America)

Great, thanks for the color. And then on autos, Fermi, you gave some color on the timing of the three waves of the CV ramp and you said auto would be material in calendar '22 and '23. Can you give an update on what you expect some near-term drivers to be in autos between now and that CV ramp? What's going to bridge the gap between today and when CV becomes material?

Dr. Fermi Wang, President and CEO

When we talk about 2022–2023 for a large auto CV ramp, that is the larger-scale ramp. However, I think we'll see some Chinese CV ramp earlier than that timeframe. A lot of Chinese engagements we announced may start shipping in 2020–2021, although the initial volumes won't be high, they will give us momentum. Before the big CV wave, there is another wave from ADAS, particularly DMS—driver monitoring systems. We see huge momentum in DMS moving to neural networks with our CV25 chip for the next generation, so we expect DMS revenue in 2020–2021. Before that, video products such as recorders will continue to be the biggest business and continue to grow—the total penetration rate is still low in China and we expect growth over the next two to three years. In addition, surround-view systems and smart parking systems using CV for object detection and parking solutions will add revenue in the next couple of years. Those ADAS and DMS deployments, plus Chinese CV revenue, will help bridge the gap toward the larger automotive CV wave in 2022–2023.

Operator, Operator

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

Quinn Bolton, Analyst (Needham & Company)

Hey guys, I was trying to better understand your thoughts around the impact of the tariffs and the potential bans on security cameras and the current ban on Huawei. You said prior to those events you were comfortable with annual consensus estimates. Once those events happened, you saw about $2–$3 million of pull-in into the July quarter. Do you see any risk to the second half from overall tariff uncertainties, supply chain tightening, inventory adjustments and potential bans if some entities are placed on the U.S. Entity List?

Casey Eichler, Chief Financial Officer

That’s definitely a concern, and that’s why we didn't give guidance on Q3 and Q4. The only thing we said so far is that before this discussion we were comfortable, and after that we commented that we see Q2 pull-ins. We assume that if this geopolitical situation continues, we'll see continued pull-ins into Q3 until a ban starts. I hope it won't, but if it does, we would be putting more risk on our Q3 and Q4 outlooks. With so many uncertainties at this point, we just don't want to give any guidance for Q3 and Q4.

Quinn Bolton, Analyst (Needham & Company)

Got it. Regarding exposure to some Chinese security OEMs that could go on the Entity List—you mentioned in the prepared remarks that maybe Hikvision could go on that list. If only one entity goes on the list rather than multiple entities, would you be willing to share what the exposure specifically is to Hikvision versus Dahua, or would you prefer not to get to that level of specificity?

Dr. Fermi Wang, President and CEO

We are not making any assumptions at this point. Both Hikvision and Dahua were mentioned in media reports and we are running different scenarios assuming one, none or both. At this point we haven't given any estimate of potential impact; we want to wait until the situation becomes clear, then we will address the potential impact to us. The biggest question is whether any listing would apply to Ambarella solutions, which are developed and manufactured outside of the U.S., so we will have to see the specific restrictions.

Casey Eichler, Chief Financial Officer

To add to that, should companies like Hikvision or Dahua get added to a list, the first thing we have to determine is whether the Ambarella solutions, which are developed and manufactured outside of the U.S., are subject to the restrictions. Without knowing the specifics, we’re digging into that. Two things would have to happen: one, the company would have to be put on such a list and two, we would have to determine whether that impacts our products based on our supply chain and product origins.

Quinn Bolton, Analyst (Needham & Company)

Understood. Not to make all my questions about the potential ban, I wanted to shift to professional security. Do you have an estimate of the number of AI-based cameras that would ship perhaps in calendar 2019 and 2020 to help us think about unit TAM for CV adoption? I know you expect material revenue from CV in 2020 in professional cameras.

Dr. Fermi Wang, President and CEO

Right now Hikvision has shipped many AI-based cameras. In calendar 2018 they said they shipped roughly 1 million units. In calendar 2019 their forecast showed they wanted to ship roughly 3 million AI-based cameras. We haven’t given any specific indication for calendar 2020 yet. Between Hikvision and Dahua, we believe they'll be aggressive in AI cameras. Outside China, we have at least one customer that will be ramping up AI cameras, and we believe five of our CVflow customers will start shipping professional security cameras by the end of the year. From the demand side, adoption depends on product pricing and customer go-to-market strategies, so we are waiting for more visibility from our customers about their sales rollout of those products.

Quinn Bolton, Analyst (Needham & Company)

Understood. Thank you.

Operator, Operator

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

Matt Ramsay, Analyst (Cowen)

Thank you very much, good afternoon. Fermi, just quickly on the longer term: you continue to announce new CV chips based on the CVflow architecture. What level of software investment are your customers making on top of the CVflow architecture? Is that your investment, the customer’s investment, any NRE payments you might be getting? How is the software development on top of your platform going for CV?

Dr. Fermi Wang, President and CEO

That’s a good question. One thing we noticed about AI and CV development is that software investment is significant for both customers and us. We mentioned that more than 50 customers and partners have ported their neural networks to our CV platform using our tools, and most customers port anywhere from two to ten of their networks onto our platform, with most networks porting in a couple of days. That shows efficiency and that many customers are ready for this technology. After porting their neural networks, customers verify that our performance and power and video quality match our stated expectations. For example HELLA ported their software to our CV22 platform in less than three months, including new networks and applications, which shows how quickly customers can integrate. Regarding NRE, for most of our automotive engagements we do charge NRE in exchange for support—software support, hardware support and ongoing system support. Some of those NREs will show up in our financials and will continue to do so in the future.

Matt Ramsay, Analyst (Cowen)

Got it, thanks. One follow-up: you mentioned consumer home security as a second leg of CV adoption. Can you talk about opportunities you're seeing from a home security standpoint and how close they are to transitioning to CV?

Dr. Fermi Wang, President and CEO

If you look at consumer security cameras, the biggest concern is alarm accuracy—most alarms sent to consumers are false and consumers often turn off alarms. The reason is AI in the cloud used low-resolution video, which limits accuracy and responsiveness. We believe pushing AI to the edge and applying CV on high-resolution video without much delay is the way to reduce false alarms. With our AI technology we can help our customers eliminate 90% or more false alarms. With fewer false alarms, alarm systems become useful and customers can monetize services. In consumer IP cameras, there will be two extremes: very low-cost basic cameras and higher-end cameras with AI features and higher margins. Our CVflow targets the higher-performance, higher-margin products. We are seeing many design wins, and that’s why we mentioned we expect to start seeing ramps in the second half of 2020 and meaningful revenue in 2021.

Matt Ramsay, Analyst (Cowen)

Thanks Fermi for the color, and all the best given the uncertainty out there. Thank you.

Dr. Fermi Wang, President and CEO

Thanks Matt.

Operator, Operator

Our next question comes from Suji Desilva with Roth Capital. Your line is now open.

Suji Desilva, Analyst (Roth Capital)

Hi Fermi, hi Casey, just a housekeeping question. What percent of revenue at this point is consumer legacy—diminimus at this point or still material?

Casey Eichler, Chief Financial Officer

We said we are entering the year with consumer legacy revenue in the high teens percentage-wise, and that should roll down over the next two to three years. There will be ups and downs and it will be lumpy, but over the course of the year you can see that decline from that point.

Suji Desilva, Analyst (Roth Capital)

Okay. My next question may be unfair. There's a lot of uncertainty, but a lot of guidance on the call about computer vision. Are we at the point where we can talk about calendar 2020 what percent of revenue CV might be, in run rate or qualitatively? If not, what are two or three things to watch that can drive CV as a material part of revenue in 2020?

Dr. Fermi Wang, President and CEO

I think it’s too early because our customers haven't reached mass production yet. The milestone to watch is when our customers start announcing their products—when they announce and start shipping and at what price points. We'll watch customer announcements as the key signal for revenue timing.

Suji Desilva, Analyst (Roth Capital)

When do you expect that wave of announcements to hit? Holiday season or…?

Dr. Fermi Wang, President and CEO

I think it’s going to be later this year or early next year. CES might be a good time to look at, but I expect a lot of announcements late this year.

Suji Desilva, Analyst (Roth Capital)

Got it. Thanks guys.

Operator, Operator

Our next question comes from Charlie Anderson with Dougherty & Company. Your line is now open.

Charlie Anderson, Analyst (Dougherty & Company)

Yes, thanks for taking my questions and congrats on the CV progress. Two quick ones: one, you mentioned the change in behavior from Chinese security camera customers and pull-in activity. Are you noticing any change in behavior or rhetoric from customers that are using HiSilicon that could potentially cut over to you? Second, if appetite increases for pull-in activity from Chinese security customers, how much could you serve that increased appetite? You mentioned some constraints in the supply chain.

Dr. Fermi Wang, President and CEO

On HiSilicon, we already are winning some customers that previously used HiSilicon. For example Hanwha Techwin was a HiSilicon customer and transitioned to us not only for CV but also for video product. Outside China we believe we are taking over some HiSilicon accounts and will ramp in the second half of the year. Another trend is Huawei's stated ambition to become a security camera vendor, which may impact HiSilicon's relationships—how that plays out is unclear. On capacity to serve pull-ins, Casey mentioned we have inventory and some headroom; we think we can handle more pull-ins so far. We have sufficient inventory to address a portion of pull-ins and suppliers willing to help with urgent pulls at wafer and packaging/test stages. However, if the geopolitical situation continues, it depends on the extent of ongoing pull-ins and potential pack/test capacity constraints and cost increases, which we are watching closely.

Charlie Anderson, Analyst (Dougherty & Company)

Great, thanks so much.

Operator, Operator

Our next question comes from Richard Shannon with Craig-Hallum. Your line is now open.

Richard Shannon, Analyst (Craig-Hallum)

Hi Fermi, Casey. Thanks for taking my questions. Fermi, you mentioned success in auto recorders with 18 wins and 10 OEMs. Can you give perspective on that market so far in terms of your share, the volumes you're seeing with those customers, are they add-ons or default selections, and how that's going?

Dr. Fermi Wang, President and CEO

We mentioned 10 OEMs and 18 models; these are either options or defaults in OEM cars. Our estimation is total penetration of the car recorder market is probably roughly 10% in China based on available data, so there's potential market growth. If regulators require recorders as default equipment, that would help market growth significantly. Our advantages include video quality, power consumption and having auto-grade chips—AEC-Q level, ISO automotive quality—and a strong track record, which helps in this market.

Richard Shannon, Analyst (Craig-Hallum)

Okay, great. My follow-up: on a longer-term view for Level 4 and Level 5 opportunities, there's ongoing industry discussion about Lidar versus non-lidar approaches. What are you hearing about those trends and how does this play into stereo versus mono vision engagements?

Dr. Fermi Wang, President and CEO

We continue to believe Level 4 and Level 5 will be a long-term market for us. We will engage OEMs on R&D and low-volume production, which often involve NRE and partnership. Regarding lidar versus non-lidar, we didn't include lidar specifically in our core messaging; we believe stereo vision is a good complementary technology to mono cameras and can play an important role. We will work with customers who want to integrate lidar plus our CV chips. We try to remain sensor-neutral: if a customer wants stereo plus mono, or mono plus lidar, we will support it. We believe stereo processing can be as powerful as lidar, and when stereo processing works properly we can demonstrate dense point clouds and high sensitivity. We will continue to improve stereo processing and hope to demonstrate that stereo plus our mono camera capabilities can be the primary sensor suite for Level 4 and Level 5 in the future.

Richard Shannon, Analyst (Craig-Hallum)

Okay, Fermi, thank you for that detail. That's all my questions.

Dr. Fermi Wang, President and CEO

Thank you.

Casey Eichler, Chief Financial Officer

Thanks Richard.

Operator, Operator

Our next question comes from Gus Richard with Northland Capital Markets. Your line is now open.

Gus Richard, Analyst (Northland Capital Markets)

Yes, thanks for taking the question. Casey, in terms of the margin pressure in the current quarter, can you give a sense of how much of that is increased packaging costs versus mix?

Casey Eichler, Chief Financial Officer

This quarter, most of the margin impact was mix. Going into the future, if there continue to be more pull-ins, then we have to see whether that can be done without extra costs. Extra packaging and test costs would be more likely in Q3 and Q4. This quarter it was really all mix.

Gus Richard, Analyst (Northland Capital Markets)

Got it. When you think about the opportunity to gain share from HiSilicon versus the loss of opportunity because of tariffs and banning of customers, can you size those relative to each other? Is there more opportunity to gain share or more risk to lose business, or are they about the same?

Dr. Fermi Wang, President and CEO

I get asked this a lot and we have many models with different assumptions showing different results. Right now it depends on assumptions about how the situation evolves. Our approach is to wait for clarity—if there is a ban or restriction and it applies to our products, we'll be able to give a more precise answer. At this point the range of potential outcomes is quite wide.

Gus Richard, Analyst (Northland Capital Markets)

Do you have a range?

Dr. Fermi Wang, President and CEO

That’s quite wide.

Gus Richard, Analyst (Northland Capital Markets)

Thanks so much.

Dr. Fermi Wang, President and CEO

Thank you.

Operator, Operator

At this time I'd like to turn the call back over to Dr. Fermi Wang for closing remarks.

Dr. Fermi Wang, President and CEO

Yes, thank you all for joining today and looking forward to talking to you next time. Goodbye for now. Thanks.

Casey Eichler, Chief Financial Officer

Thank you.

Operator, Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day!