As mentioned in our report comment, sales were completely in line. The EBITDA loss of SEK-22m (adjusted for a non-cash effect of SEK4.8m in social security charges from share incentive programs) was a bit higher than our expected SEK-18m, but we believe costs are fully in control (see further below). The growth in Behavorial Research was 46% (29% organic), which aligned with our expectations. Behavorial Research is not in itself relevant to our investment case, but it is an important short-term driver for reaching break even. The automotive q/q growth was 28%, corresponding to SEK 7m higher revenue than Q3’23 (see the graph below). However, since there are several unknowns, such as NRE and AIS, in the total automotive revenue, we do not know the pace of the license sales growth. Some of the increase is clearly due to AIS sales, which is growing quickly from zero.

We believe the market reaction to the report has been hesitant due to the balance sheet. The cash of SEK 80m might look low in relation to the burn rate of 49m, but Smart Eye has 162m in available liquidity when including its credit lines. Our view is that Smart Eye could have easily obtained a several times larger credit facility than 50m. The credit line is just viewed as good insurance by the company, i.e. Smart Eye is not looking to use the credit facility. It could use it, and increase it on short notice, but it wants to do neither at this point. The CEO did a solid earnings call, backing up the optimistic CEO statements in the report. On the call, he reiterated the objective of reaching break-even during 2024. We believe this is for a good reason. Most upcoming car models should be new versions of existing models where there are long historical volumes that are not expected to change much, meaning they are reliable to use in calculations of the future. If there were any doubt in the mind of Smart Eye’s management that break-even would not be reached, unlike what was announced, we believe the company would have executed savings by now, but there are no such signs.    

Another issue for the stock market was the statement that interior sensing (IS) requires a lot of investment. While Smart Eye lowered the cost base by c10% compared to one year ago and of course wants to go back to the previous level, whenever possible, the IS statement is not related to Smart Eye’s coming OPEX. It was rather a way of expressing its economic moat (see the next paragraph) and commenting on the recent consolidation in the market where Xperi Fotonation is being acquired by Tobii. While Tobii now becomes a significant threat for the future, it is positive that one of the competitors disappears. Xperi is, in our view, the most serious competitor in IS, but it is also interesting that Xperi sells the Fotonation business because it sees better opportunities in other markets. We have a hard time understanding what markets could grow better than the regulatory-driven DMS and IS markets. One should also, in this context, note that Xperi (now Tobii) is a solid number three on the market, suggesting a large gap up to numbers one and two (Smart Eye and Seeing Machines), especially for entrants.
 
Other competitors entering the space need to make major investments not only in IS but also in DMS. Smart Eye has already ramped those costs, and can also offset them against existing and future revenue from signed contracts. DMS investments will likely come down in the future, and be transferred to IS. Smart Eye will invest the profits from DMS in IS, but given the margins, there is room for that, plus generating excess cash on top of that. In our view, the return on investment for IS looks good, given Smart Eye’s strong positioning in the area.

The automotive y/y growth was 121%, corresponding to sales of SEK 31m, but as mentioned we do not know how much is from NRE and AIS. In terms of geographies, the Korean car models (KIA-Hyundai) are progressing faster than expected, while Europe (probably Audi) is slower, and the US is in between these two. Volvo and Polestar will have a 100% DMS penetration, and for GM, we expect all level-2 autonomy cars to have DMS. In Nissan, DMS will be optional. We believe it will not have as high take rate as BMW had, but it is yet to be seen.

Do we know exactly what the ramp-up will look like, and what quarter is the big one? No. But we do know that the launch and volumes of the 315 design wins will mirror the Mobileye curve relatively well(see below). Smart Eye currently has a lot more design wins than Mobileye had during the same time in its journey, which we assume is because the DMS mandate came faster in time than Mobileye’s AEB mandate. Mobileye sold chips in addition to its software, so the ASP, and therefore the nominal value of sales, is not comparable, but the growth trend and ramp-up clearly is. The reason that Smart Eye’s growth is flattening out around year 14, which is the year 2028 for Smart Eye and year 2020 for Mobileye, is mostly related to us being prudent and assuming quickly falling market shares and ASP, although there are no such signs thus far.

As a reminder, in 2024, type approval for new car models in the EU requires DMS. Carmakers could, of course, postpone new models due to various reasons, but typically all car models are renewed on average every 6-7 years, and there is a limit to how much of the lineup can be changed in a single year. Last, Smart Eye has not seen any effects related to the Red Sea situation thus far, and we do not expect it to disturb the ramp-up.

Interior sensing (IS) nominations are coming now. Ease of integration, where SEYE is strong, will be even more important. The first IS design win is something the Smart Eye CEO has teased about for quite some time now. We believe it is imminent, and already won on a tier1 basis. We assume the premium OEMs are first in line, such as Mercedes, Volvo, Audi, etc., followed by larger OEMs within 2-3 years. The automotive industry is constantly trying to squeeze prices over time, but IS will have up to 100% higher ASP than DMS. All in all, we find it likely that the contract value for the first IS deal could be well over SEK 500m.

IS is largely safety-related, and covers aspects such as pets or children left behind, seat belt detection, and deployment of airbags depending on how people are sitting. Also one should note that DMS and IS come hand in hand. It is hard to think about IS without DMS, and DMS can be configured in over 20 different ways, once again demonstrating the complexity, and how hard it is for new entrants.

In terms of upcoming design wins, we believe virtually all OEMs have made a first round of selection of DMS provider, perhaps with the exception of one or two Asian OEMs. However, every OEM is expecting regulation in the near future in the US, Japan and China as well. Moreover, most OEMs have a number of different platforms. Since Smart Eye has won platform number one for about 20 OEMs, we believe it has a very good chance of winning platform numbers 2, 3 and 4 as well. Being selected as a supplier for the first platform of the OEM means the ability to build a strong relationship. In addition, the integration costs and challenges etc. for this specific OEM are known by Smart Eye and the tier-1 for the procurement of the next platform, giving them an edge.  

During the quarter, Smarty Eye received its largest contract ever, and the first as a tier-1-software vendor. The trend is facilitated by software-defined vehicles (“computers on wheels), which makes it possible for car OEMs to use a handful of ECUs and attach all sensors and software to them. This is not a Smart Eye-initiated move in the value chain to e.g. bypass its customers, in order to make more money. The tier-1 markup on the software is, as far as we understand it, negligible. The pull is instead coming from the OEMs who find the tier1 software vendor structure easier and faster, as it is easier being directly affiliated with the company that controls the algorithms. Not every OEM wants to immediately jump on this bandwagon though, so there will be two types of solutions for a long time.  

We make a few minor changes to our estimates following the year-end report. We lower our sales for 2024e by 7%, primarily related to DMS sales in Q1e-Q3e (see the table below) since we do not know the exact launch of some key models. Except for some modelling housekeeping, our estimates remain largely unchanged.