Ambarella, Inc. ($AMBA)

Welcome back to this afternoon session at the BofA Global Tech Conference. I'm Vivek Arya from BofA's semiconductor semi-cap equipment team. I'm really delighted to have Fermi Wang, the Chief Executive Officer of Ambarella, join us. And like always, I'll start with a few of my questions, but please feel free to raise your hand if you'd like to bring up something. Fermi, welcome back. Really delighted to have you at our conference again.

Thank you.

Really looking forward to this fireside.

So before we get into kind of the nitty gritty of the quarter, maybe help us, Fermi, in kind of framing your edge AI opportunity? Which are the areas that you think Ambarella's value proposition kind of best stands out? How are you investing in those areas? Like what is the right way investors should think about Ambarella at this point?

I think we definitely focus on edge AI, as you said, but I think really, what we are offering is a very extensive road map on the silicon side and very mature software stack for our customer whoever -- it doesn't matter what kind of application they want to. They can program their application on top our video processor as well as AI inference engine and quickly turning it to a product. So that extensive road map, mature software is what really differentiates against our competitor at this point. And we can, of course, go through the details. We have better power efficiency and much better video quality. Those are also important, but just looking at the breadth of our offering in terms of the silicon point of view and the mature software in terms of models and other things, SDK point of view, I think that's definitely our main differentiation.

Got it. Now investors would say, well, there's a lot of alternatives in the market. There are many companies who -- whether it's Qualcomm or NVIDIA or others who kind of play up and down the stack, right, as low power as being in a mobile device to obviously as high power as being in a data center server. So how would you help us kind of rank Ambarella, right, your attributes, your differentiators versus the Qualcomms and NVIDIAs of the world?

Right. So I think for that, I want to emphasize that when we design silicon, we design -- we talk about this, say, algorithm first. When we design just any silicon, we think about application. We think about how to implement most efficient architecture for both silicon and software point of view to address that application. Instead, I think our competitors are thinking about programmable architecture, GPUs or app processor to serve a totally different kind of workload. So from that point of view, that's where we can really optimize not only power efficiency die size almost all of that around this target embedded AI, I think that's a major difference. Yes, we're much smaller. But if you look at high company with $3 billion, $4 billion market cap can compete with NVIDIA and Qualcomm. It's really about technology we're offering.

Okay. And if you were to help us segment the 2 big areas, right, automotive and IoT that Ambarella plays in, what is the right kind of formula we should think about projecting growth for the next 3 to 5 years?

Right. Maybe I'll talk about this year first. Last year, we talked about IoT growth faster than auto. But this year, although the growth rate is similar, but I think we just talked about auto, we have a solid growth this year. And in fact, that we're going to have a record revenue for automotive this year. And that will show you that although that a lot of people are focusing on our autonomous driving market, but our other automotive market has really become a solid growth engine for us, including financial fleet. In that financial fleet, there are many things, including telematics or fleet management as well as other DMS and type of location. This is an area that really grows nicely to us. And then on the IoT side, it's really where we have several important growth engine for us. Everybody is talking about robots, well, everybody agreed it's segmented. It's going to take a while to grow. But if you really look at it down the road, I fundamentally believe that when I retire, it's going to be a robot taking care of me, not my son. From that point of view, I really wish and I think I want to do everything I can to make this product become available to everybody. But I also believe with GenAI technology and the right silicon architecture, we will get there. But however, it takes time to get there. But if you look at short term, that in the robotic application, I think the biggest opportunity for us short term is drones. And we are seeing a lot of consumer drone commercial drone opportunity out there, which really differentiate based on, first of all, we need to be really good at perception, we need to be good at fusion and the decision-making, which is really similar to the technology we develop for autonomous driving. So that is one area we feel excited. The other thing I will feel excited on the edge AI side is, of course, there are a lot of different applications, but there's one new application we call the edge infrastructure. It's really that people are going to aggregate a lot of different sensors and using a box to really upgrade the existing infrastructure to gen AI level of AI performance. Just to give you an example, we talked about this before, in this hotel floor, there's, I don't know, 20 different let's call them traditional cameras. Maybe some of that has AI performance, some don't. But to upgrade those cameras to be GenAI ready, it's not easy. You need to change all the camera or you can plug in appliance that aggregate all the video feed into that box and suddenly, all camera can be enabled by GenAI, running the AI on the appliance. So there are many different applications popping up in the last few years -- just months or few quarters that we think has a lot of growth potential. But I think the key is, today, all the investments focus on data centers and the edge, it really takes time. For example, how you're going to run a really large language model on a chip, which consume 2 to 5 watts and deliver high-performance running 1 billion parameters ChatGPT-type or small LLM models on 2-watt to 5 watt chip and selling for $30, $40. That is a challenge, and we provide a silicon solution and the customer on their way to put their solution on top of that. So we are enabled a market that does not exist before because that the mutation of silicon architecture and models just didn't exist until just recently.

Got it. How would you kind of urge investors to think about Ambarella's growth rate opportunity over? Like is it a 10%, 15% kind of growth opportunity? Is it 15%, 20%? The reason I ask the question is that traditionally, more consumer-based products have grown at a slower pace. And now when we think about AI, people always think about 30%, 40%, 50% kind of growth rate. So help us -- help calibrate us on what is over the next 3 to 5 years, what is Ambarella's growth rate opportunity? .

Yes, 30%, 50% is talking about data centers, but there's no edge AI market that grow that fast. When we look at our SAM, our SAM rental growth at 18%. So that's really the limiting factor. Do I believe that's going to grow faster in the future? Absolutely. But however, we haven't seen that turning curve yet. And I think we are waiting for many things to happen on silicon, software, our customer software and models, everything need to come together and enable new applications. So I think we haven't reached that point. But today, this year's guidance is 10% to 15%. Next year, our Street, I think some analysts looking at 15% as that's reflecting the reality. But if you look at the SAM, we think that can definitely -- we should grow faster than the same in the near future.

Got it. Okay. Makes sense. Are there certain product category -- so auto is easy to understand, right, and you mentioned all the growth in ADAS and AV and whatnot. But when it comes to IoT market, right, because you're larger -- what are kind of the form factors that you think will help you outgrow your SAM?

Well, let me just give you various examples that one of our customers, their form factor is a box, maybe it's just this big, and they need to put in 8K P60 video running AI performance on the 4-watt system power. Just think about that, right? It's challenging enough for any kind of silicon, but we are probably one of the very few can deliver that kind of performance at the power envelope. But this is not one unique application. This is really -- when you look at any edge AI application, most of them are battery-powered. So it's not just a form factor limitation. It's really that your -- how long you can run an equipment is based on the power efficiency of your silicon system and the battery size, right? The battery size is fixed, and then you have to really control your silicon, which has to run billion parameter perimeter GenAI model, while give others -- for some product have to be 2 to 3 hours. Some product has to be 8 hours, for example, the wearable camera. So this is really the limitation. How you drive performance per watt is going to be the key metric for edge AI applications.

Got it. Recently, on your earnings call, you mentioned that you had signed a long-term agreement with Hanwha. So can you walk us through what kind of led to that element, what kind of products are included? When will we start to see the benefit of that agreement?

Right. First of all, for people who are not familiar with Hanwha, Hanwha is a Korean company that sells USD 60 billion revenue per year. It's a huge company. And they have a retail, they are banking, they have drones, they have robots, you name it. They have quite a diversified product portfolio. I think what they are trying to do is I think their Chairman looked at us and said we need to go to have edge AI, but they don't -- he doesn't want to allow each of their group develop their own edge AI. So they say, how do we have a solution that we can have a unified solution for the edge AI moving forward? And while the group is called Hanwha Vision, which has been our customer for the last 15 years selling enterprise security camera. So they were assigned by the -- because they are really the first group inside Hanwha trying to deploy edge AI solutions. So they were assigned to evaluate a solution that it can be accepted as the group level edge AI solution. And for us -- so basically, they are asking for product portfolio wide enough to address multiple different opportunities and also software mature enough that can quickly enable different applications I think that's really our strength. In fact, the first question I asked at the beginning, that was the reason they choose us. But at the same time, we would like to work with them because they present huge revenue opportunity for us. But more importantly, I think that working with a company like Hanwha really give us not only the scale but also how easy to forecast our revenue in the future. We talk about working with different companies. You really have better way to forecast revenue. So all these things is reason that we want to work with Hanwha. So I think there is definitely a strategic value for both sides to come to the conclusion on this. And the other thing I think is driving this decision is really for anybody who want, any company want to build their own silicon. In fact, Hanwha was doing their own silicon before. The cost just become prohibitive on that. When you go to 4 nano and 2 nanometers for data centers, it's easier to justify. But when you come to edge AI, the silicon price is anywhere between $20 to $50. Trying to build their own silicon paying $100 million just to do 1 silicon for 2 nano doesn't take sense. So I think there are many reasons. And in fact, this is this is our second kind of agreement that we achieved in the last 12, 18 months. And there are more engagement that we talk about. It's really the same concept. People want to have a differentiation on their product line. They don't want to pay for their own silicon but they want to have some secret sauce in the silicon, and we can help them to build that. And with that, we get a better relationship with the customer and the more guarantee on the revenue. It's a win-win for both sides.

Got it. And I think you mentioned, is it $800 million over 10 years? How do you see that profiling over the next 10 years?

Right. Hanwha Vision is a customer today. I can say that their revenue with us is roughly mid-single-digit percentage of our total revenue. So from that point of view, they are not the largest customer for us but a sizable customer. But however, from there, they multiple ways to scale up our revenue. First of all, like I said, they are doing their own silicon. We only have less than 50% total market share. For us, we can probably assume that we want to get better market share moving forward quickly. And also that all the new chip we're going to get is going to be higher ASPs. And that's something what should happen in a short period of time. More importantly, I think most of the other Hanwha Group can use Hanwha Vision's camera to plug into their product. For example, today, it's not about the form factor of the camera. It's really about what kind of software and the model you run on it. So any Hanwha Vision camera, if you swap out the models and the software running on it, which we can easily enable, you can enable retail application, you can enable drone security, you can do many things even with simple factor that Hanwha Vision generates. So we think that there's a quick path to revenue also to help other, enable other applications by using Hanwha Vision's existing product line. But then the last one is, really, this is a multi-generation commitment for both sides. So we will help them to build a solution they can use. When multiple generation, when the second generation come up, we definitely can address even bigger TAM or SAM for Hanwha. So that's really the progression of getting more revenue from Hanwha.

Understood. So just for the near term, do you think that is kind of already reflected in this and next year expectation? Or could that be upside, too?

I don't think that's been factored in just because consuming -- we just talked about. But we probably start thinking about how to reflect that in our future. But next year is really about really gain shares on the existing product line, right? So I won't say immediately reach to higher level but next year, we should some positive impact to our total revenue.

Got it. The 10% to 15% growth rate for me is that constrained by supply in any way? There's a lot of cost inflation, right, in many of the end markets that you serve from memory or other things, right? So how much of this 10% to 15% is gated because of supply or other inflationary aspects in your business?

It's definitely not limited by our supply. It's really the market condition, particularly on the memory side that continue to bother almost all our customers. Our annual guidance from Q1 to Q2 didn't change. That reflects that we consider all of possible scenarios. We think that's a prudent way to give the guidance. But we continue to tell the customer, in fact, customer gives a very consistent feedback they still can buy memory. It just became extremely expensive. What that means is, in the future, they probably have to pass those actual cost to the customer. So from that point of view, others impact the demand and so whether people can continue to secure DRAM supply moving forward. I think those questions we don't know the answer yet. So that's definitely something we factor into our consideration.

Got it. This is a little bit of a very near-term question. We saw that when your results were kind of in line, you guided somewhat better, you outlined this LTA. There was a volatility with the stock the next day. The market has 50 different reasons for being volatile. What do you kind of ascribe that to? And what do you think is kind of underappreciated and missed by investors right now?

Right. But if you look at what happened before the earnings in the previous 40 days, our stuff jumped $40 also, right? So in kind of that people build out expectation, I think everybody expecting that semiconductor company go to raise their guidance, right? So when we didn't, I think that's probably reflected on the people buying short term, selling short term. So I really don't think those people who trade in that period reflect our long-term investors' view. I really think that for the people who are buying our stock really appreciate, first of all, people need to appreciate GenAI because it's not -- if there's a home run in that GenAI story today, but they have to believe that with our technology, we will become one of the few players that survive through this -- well, we continue to play in this market when they become big.

Got it. As you look at next year, Fermi, are there opportunities for you to outgrow your SAM? Or is it too early to kind of think about that?

Well, I think there are a few things we should consider. First of all, we talk about our 2-nanometer chip, CV8, which is much higher ASP than our company, corporate-wide ASP. So from the ASP point of view, it should provide a growth areas. So definitely, our CV7, our first 4-nanometer chip, will ramp up next year, too. So from that point of view, it should help, right? But however, at the same time, the biggest challenge for me is to forecast how fast our customers will ramp up those new products based on CV7, CV8, how the memory impact to that. So I won't -- we haven't provided any guidance for next year yet, but I just want to give you the pluses and minuses that we are considering right now.

Got it. That's fair. And I think you have another LTA or semi-custom, right, at 2 nanometer. Could you help us understand what that is and when that start to impact your financials?

Right. So we add a little bit more information this time. The chip is our first 2-nanometer chip called CV8. It was taped out in January, and we'll be back to our office in a few weeks. The first 2-nanometer chip, we're going to -- all of the indications so far is that no process will be able to ramp up in production in second half of next year. In fact, second quarter next year. And that's how we want to ramp up or test out our chip and make sure that our customer can -- if they want to, they can be put out in the second quarter next year. So that's the plan. And that 2-nanometer chip is related to one of the customer willing into sign up a long-term commitment with us. And so that -- they definitely help on the NRE side but also get some benefit from that, which we haven't disclosed the detail yet.

I see. Got it. Okay. And then recently, we saw your inventory dollars rose quite a bit. So how much of that is just because of supply chain is tight and you probably need to take product whenever you can versus preparing for some ramp over the next few quarters?

I think it's definitely both, but I would say one thing. Samsung just informed us that their foundry supply will be tight next year, particularly on the 4-nano and 5-nano process node. The reason for that is definitely you see their announcement, they are seeing extra customer comes in at. So from that point of view, Samsung basically informed us that with a good intention, hey, I know that we have a partnership, we want to really give you the best service. So give us your PO commitment so we can secure those commitments for you. So that's the conversation we have. So from that point of view, we think it's prudent to build up a little inventory just in case there's upside from our customer and making sure that we can support some upside. But I really don't think that our inventory growth on the current point, you'll probably drop a little bit slowly, but definitely, that's the range we're going to stay at for a while.

Got it. Okay. In general, are you seeing any other inflation pressures? I think your gross margins are kind of back towards the lower end of the 59% to 62%. How much of that is a reflection of kind of the cost inflation? How much of that is a reflection of just pricing, mix or any other product factors?

Mix is always the biggest one for changing our gross margin. But I think we guide to 59% to 62% of long-term guidance. And this quarter, we guided 59.75%, which is the same as the previous 2 quarters. I really think that from the cost side, foundry hasn't raised a price, but other supply chain raised the price, not in a significant way, but definitely is consistent with the feedback you heard in the market. Supply chain definitely tightened up and they are raising place. It's just something we deal with. And our thought is that if the price goes to a point, we need to pass that to our customer, but we haven't reached that conclusion yet. But eventually, if the trend continues, I won't be surprised that our supply chain is going to continue to be very tight in the next year.

I see. Beyond video as a modality, how do you think about other modalities as you look at edge AI? Because I assume that as you think about robotics, something that could help all of us in our old edge, it will require a lot more modality.

Absolutely. In fact, we support many modality already. Other than video, we support of audio, radar, GPS, LiDAR, we support all of that. But I just want to point out, there's no other modality required as much passing performance like video, right? So that's why if you use video as one of the modality, the performance of system is dominant by video requirements, particularly on AI performance point of view. Nothing else even come close. So from that point of view, we basically trying to address -- and because our customer come to us for video processing, although we didn't talk about our support for other modality that much, but in our HD cable support almost all of that. In fact, even for the -- all the AI models, we support a lot of the non-video models like audio model, radar models, LiDAR models and as well as the non-video LLM models. All of that are supported by our SDKs today.

Got it. A few months ago, we had heard the U.S. institute a lot of restrictions on Chinese drone manufacturers. Is that a source of upside? Have you already started to see some of that upside? Or is that benefit still to come?

We haven't seen a lot of movement on the volume yet. But definitely, this is going to help the U.S. drone market -- I mean, U.S. supplier in this market. So we're looking forward to see impact at this point. But so far, we haven't seen a lot of major move because the reason for that is this regulation change only impact to the drones that haven't been shipped yet. There are a lot of drones that in the market already get FCC approval, they are not impacted by this new regulation. So maybe the next generation we'll start seeing an impact.

How large can that market be? And I mean, I would imagine that they may have started to at least engage with you, right, from a design win perspective?

Absolutely. In fact, in our script, we talk about this time, we have 15 robot design wins, which includes several drone design wins in there. And cumulatively, we talked about $100 million of revenue pipeline in there. So definitely a significant momentum that we're seeing there. But however, just like I said, getting a drone into a production, particularly from a consumer drone or commercial drone, the design cycle is a little long, and we are just in the middle of that. And also a lot of shipments today are not at impacted. So we are watching the effect after the regulation gets really becoming implemented in the market, it will be some significant impact, but we haven't seen the results yet.

I see. Fermi, maybe talk to us about what your software strategy is, right? Because you have made a lot of investments on the software side. How is that providing stickiness to the platform? Or do the customers just want broad interoperability and then they are the ones who decide which models to run on which platform?

Right. So that's a great point. Let me spend a little time on that. We spent 5 years to develop some platform called Cooper platform. It's a platform that's almost 100% of our customers using today. And why is that? Because the feedback is really pretty positive for a few reasons. Why is -- that's a platform really help our customers easier to put not only the model but our software onto our platform. For example, we continue to add function to it. We just add agentic function on that so people can use agentic tool to help to write software on that platform. And just because of that, it becomes much easier. So you can see that we'll continue to help our customers to get easy to pull software over. That's one. In that SDK, we support 200 model architectures, not 200 models. Like HULO, we treat that as a 2 different architecture. So we support 200 model architectures. So let's just consider how much from our customer point of view. Really, if they have any specific model they are considering, they will find similar model or model guidance to compare. Just to give you an example how complete and through software stack is. But more importantly, any customer using Cooper SDK to build one product on one silicon, when they try to move the same software to different silicon, maybe higher performance, lower performance depends on the performance they have, it's extremely easy. It's almost like we're proud how the software works. And of course, you have to get a different performance based on the silicon you chose but the software development is clearly, the effort is really significantly reduced. So from a mature point of view and from a scalability point of view, our customers really appreciate the software that they become the biggest -- that's one of the reasons Hanwha appreciate because they have uses Cooper SDK for the last 5 years, and they see the progress. They really think that's the way to go. So from that point of view, that maybe that's another point we have to touch on is really we believe that we need to go to indirect sales model because with a robotic application we cannot go direct support to all the possible robotic implication out there. The only way we can do it is enable our software partners and distributors or system integrators to integrate and support customer from. And then our software need to support them and they use our software to put that. So the mature software of Cooper is critically important for that.

Got it. In the last some time that we have left, how do you think about your M&A strategy going forward? Like what would help Ambarella double your growth rate, right, over the next several years? Are there white spaces? Because edge AI is such a fast-growing market so how do you think about your opportunity to accelerate via inorganic means?

On the technology point of view, when I look at all the space we are in today, there's no really one big shiny object I need to have to really complement to my technology. I don't think that exists, but we continue to look for algorithm that can help. But however, I really think that if we have to reinvest heavily, that's indirect sales channel, anything that can speed up that because that's where we can scale revenue quickly. That's definitely the direction we are trying to get more support and help if there's a possibility.

Makes sense. Terrific. Thank you so much, Fermi. Really appreciate your time.

Thank you very much.