Ambarella's Worst Business Segment in 2016

By Steve Symington Markets Fool.com

For better or worse, it sure has been an eventful year for video processing chip specialist Ambarella, Inc. (NASDAQ: AMBA). First, shares plunged more than 40% through mid-February as the market's historically painful start dragged down many other high-flying tech stocks. And Ambarella stayed depressed through the better part of May, primarily as the company laid out disappointing expectations early on for what has easily proven to be its "worst" business segment in 2016.

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Chips in wearable cameras have proven a troublesome segment for Ambarella this year. Image source: Ambarella, Inc.

The "winner" is...

That segment is wearables. Or more specifically, Ambarella's chips that are destined to play a key role enabling video processing capabilities in wearable cameras.

And if you're wondering why the weakness in wearables, look no further than action camera specialistGoPro (NASDAQ: GPRO), sales to which have previously represented as much as 30% of Ambarella's annual revenue.

Of course, that was all well and good as GoPro regularly crushed Wall Street's expectations in the several quarters following its own mid-2014 IPO, helping Ambarella shares skyrocket to all-time highs by mid-2015. But when demand for GoPro's aging camera lineup began to show signs of waning in late 2015 -- a development that was notably first reflected incautious forward guidance from Ambarellathat September -- modest growth from Ambarella's smaller supplemental markets including IP security, automotive, and flying cameras had trouble picking up the slack.

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A (temporary) light at the end of the tunnel

But shares began to rebound this past June, when Ambarella kicked off its new fiscal year on a high note. Fiscal first-quarter revenue declined 19.5% year over year, to $71 million, while adjusted net income was more than cut in half, to $11.4 million, or $0.34 per share. This might not sound impressive, but Ambarella's guidance for that quarter called for revenue to be in the range of $55 million to $57 million, with adjusted net income of $8 million to $10 million.

Furthermore, Ambarella achieved that beat despite earthquake-related supply shortages and the ongoing weakness from wearables. And finally, Ambarella management suggested that the stubbornly weak wearables market was poised to rebound in the second half of this year -- an assertion that seemed to fly in the face, by the way, of swirling rumors that GoPro was considering whether to switch to another video chip supplier starting with its yet-to-be-unveiled HERO5 line of cameras.

Fast-forward to today, however, and renewed concerns over -- you guessed it -- wearables have resulted in yet another pullback from Ambarella's recent highs. Shares have fallen around 15% over the past month as of this writing on the heels of Ambarella's fiscal third-quarter 2017 results released on Dec. 1, 2016.

That's not to say those results were bad. In fact, Ambarella's quarterly revenue returned to growth, climbing 7.8% year over year last quarter, to $100.5 million, once again well above guidance and marking the first time Ambarella has exceeded a nine-figure benchmark in a single quarter.

Within that, Ambarella even noted it had seen strong year-over-year growth in the wearable camera, IP security, and automotive segments, with growth driven largely by its now-confirmed inclusion in the production ramp of GoPro's HERO5 products.

Where Ambarella stands now

However, with worrisome echoes of last year ringing true, shares fell yet again as Ambarella offered conservative forward guidance. As CFO George Laplante explained:

Although we expect to return to growth for the full year of fiscal year '18, our current visibility of Ambarella inventory levels held at our primary consumer product customers indicates there is a potential for a negative impact to revenue in the early part of fiscal year '18. Whether we realize such an impact and the scope of any impact will largely depend upon the holiday sell-through in these markets. Once we have a better understanding of the holiday sell-through and the related impact on our customers' year-end inventory levels of our chips, we can be more specific in our annual guidance for next year.

As I notedin my earnings recap at the time, Laplante was obviously referencing GoPro in that statement. And this wasn't entirely surprising considering only a month earlier GoPro had used its own quarterly report to warn investors that not only had production issues led to lower-than-expected launch volumes of its newest products, but that also meant GoPro would have trouble keeping up with demand in the crucial holiday season.

To be fair, GoPro did follow up that warning with good tidings earlier this month, detailing a strong start to the holiday season including a 33% increase in units sold on GoPro.com between Thanksgiving and Cyber Monday.

But as Ambarella management has already noted, it's still too early to declare victory in the ongoing rebound in wearables, and the company needs to see that GoPro's latest products can sustain those positive trends through the duration of the season. So until that happens, it seems clear that wearables is once again Ambarella's "worst" segment of the year.

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Steve Symington has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ambarella and GoPro. The Motley Fool has the following options: short January 2019 $12 calls on GoPro and long January 2019 $12 puts on GoPro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.