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Ambarella Gives Investors Hope, but It Needs to Walk the Walk

Harsh Chauhan, The Motley Fool

Ambarella (NASDAQ: AMBA) investors have been an excited lot this year thanks to the company's recent design wins. But those projects might or might not come to fruition, so it wasn't surprising to see investors celebrate and send the stock up substantially after the company delivered a fourth-quarter earnings beat.

Ambarella delivered adjusted fourth-quarter earnings of $0.14 per share on revenue of $51.1 million. Those numbers compared favorably to Wall Street's expectations of $0.04 per share on $50.9 million in revenue. But a closer look at the results suggests that the chipmaker's latest report doesn't in fact call for such a celebration.

A close-up of a camera lens aperture.

Image source: Getty Images.

Still in the dumps

Ambarella had already set the bar very low, so beating the consensus estimate wasn't all that impressive. Moreover, its fourth-quarter revenue was down 28% annually, and gross margin fell 4.3 percentage points year over year to 60%. As a result, the bottom line suffered, as adjusted earnings fell substantially from last year's $0.47 per share.

Ambarella's outlook wasn't that great, either. The company expects first-quarter fiscal 2020 revenue of $47 million at the midpoint of its guidance range. It didn't give earnings expectation for the quarter, but it clarified that gross margin will fall in the range of 59% to 60%. And the top-line estimate is well behind the $56 million figure that analysts were expecting.

The company's gross margin forecast is also substantially lower than the prior-year period's result of 61.8%. This means that Ambarella is set to deliver yet another quarter of bottom-line erosion the next time it reports earnings. In all, it's difficult to see why investors are happy with Ambarella's latest round of results.

However, there seems to be one factor that is probably driving up investor confidence.

Ambarella's decline is slowing down

Ambarella's outlook suggests that its first-quarter revenue will decline 17.5% year over year at the midpoint of its guidance range. That's a steep drop, but it's not nearly as bad as what the company has been delivering over the past couple of quarters.

Ambarella is seeing improvement as it's gradually reducing its reliance on the legacy consumer electronics business, which was the sole reason behind the drop in its revenue both in the past quarter and for the fiscal year. At the same time, the company's automotive and security camera businesses witnessed single-digit revenue increases last year.

Ambarella now gets 50% of its revenue from the security camera market, while the automotive business supplies 20% of the total revenue. That's a good thing, as demand for security cameras is predicted to increase at an annual pace of nearly 13% through 2025. Meanwhile, the use of cameras in the automotive space is expected to grow at an even faster rate of 19% in the coming years to support advanced driver assistance systems (ADAS).

Ambarella is trying to cut its teeth in these markets with its computer-vision chips that it claims will bring advanced and intelligent features to security cameras and automotive systems. Not surprisingly, management spent a lot of time on the latest earnings call detailing the partnerships and design wins that it has secured for its computer-vision products.

In fact, one of Ambarella's Chinese customers is moving its computer-vision chip from the design win phase to the engineering phase. Encouraged by such developments, Ambarella management believes that company will be able to get its revenue growth back on track in the second half of the fiscal year.

According to CFO Casey Eichler:

With a gradual ramp in [computer vision] revenue from the professional security camera market and expected return to growth in our automotive business and less impact from the declining consumer electronics business, we anticipate quarterly revenue to be stable in the first half and return to growth in the second half of fiscal 2020.

This upbeat sentiment seems to have given Ambarella investors confidence in the company's ability to turn its business around this year. However, the company's consumer electronics business is expected to decline for the next two to three years. This means that Ambarella's security and automotive businesses will have to grow at a pace fast enough to offset the decline in the consumer side of the business.

However, much of that prospect hangs on the adoption of the company's computer vision chips by customers in real-world applications. If Ambarella's chips don't find a way into security and automotive cameras that sell well, the company will find it difficult to deliver on its guidance.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Ambarella. The Motley Fool has a disclosure policy.