Image source: Ambarella.
Though Ambarella's (AMBA +1.88%) strong fiscal second-quarter 2017 results earlier this month easily exceeded expectations, shares of the video processing chip specialist declined modestly as the market digested the fact that it had already jumped more than 70% in the three months prior to its report. For that incredible bounce, Ambarella can largely credit its equally impressive fiscal Q1 results in early May, as well recent optimism surrounding its impending return to year-over-year growth as headwinds in the wearable camera market are expected to fade.
To better understand whether Ambarella's recent pullback is merited, and to more effectively gauge the current health of its business, I think Ambarella investors would be wise to dig deeper. One great way to do so is by digging in to Ambarella's subsequent quarterly conference calls. To help get you started, here are five of the most important points Ambarella management discussed during this quarter's call.
1. Supply shortage issues will be resolved soon
During our last earnings call, we discussed that a possible impact of the Japan earthquake on the supply of Sony image sensor to our customers and to our revenues and results. Close on impact has been felt during Q2 and continue into Q3, we believe that most supply issues will have been resolved by the end of the third quarter. -- Ambarella CEO Fermi Wang (all quotes credited to Seeking Alpha)
Recall that three months ago, management warned that the April earthquake in Kumamoto, Japan, had shut down the primary factory that produces Sony image sensors. And because as much as 48% of Ambarella's revenue depends on its customers' ability to acquire sufficient inventory of those sensors, Ambarella estimated the shortage could impact the timing and scope of demand for its chips for "several quarters."
As it turns out, Ambarella managed to exceed expectations in Q2 despite suffering lost or delayed revenue estimated in the range of $2 million to $4 million related to this issue. And the market is rightly relieved to hear the situation will be largely resolved by the end of Q3.
2. On competitive advantages in the drone market
Our A12, A9SE and H2 SoC families all offer 4K video resolution, high quality photography and then features such as high dynamic range processing and electronic image stabilization. Our ability to run many of these functions simultaneously provides us with a sustainable competitive advantages versus competing solutions. They are also failing to compete on video quality, features, power consumption and the total solutions costs. As a result, Ambarella is increasing its market share in all drone categories where HD or Ultra HD video is a requirement. -- Fermi Wang
It's no mystery the drone market is growing by leaps and bounds, and around this time last year, Ambarella confirmed the drone market already comprised around 10% of its total revenue. But keeping in mind that GoPro (GPRO 4.54%) -- Ambarella's largest customer in the wearable camera space -- is poised to formally introduce its very first drone later this month, combined with the significant design wins Ambarella already has in the drone market, it's no surprise the company is touting the competitive advantages of its all-inclusive drone platforms.
3. New traction in the automotive market
In the automotive market, Ambarella has traditionally provided camera SoC solutions for video camera recorders or best cams for aftermarket sales. We are now seeing revenue and the new design wins for video camera recorders that are being offered either as a dealer fit option or an integrated option in new OEM car models. Most of these new opportunities are in China, but also began shipping SoC to new European OEM models during the quarter. -- Fermi Wang
Make no mistake: It's especially intriguing that Ambarella is not only maintaining its solid aftermarket-centric automotive design wins, but also making inroads with video camera recorders meant as either a dealer fit option or integrated into new OEM cars. It makes sense that Ambarella would want to ensure its technology plays a central role as vehicle cameras become more ubiquitous. What's more, later in the call, Wang noted that because of higher specification requirements for automotive-grade chips, both ASPs and gross margin for the OEM automotive camera business tend to be "a little higher" than those of Ambarella's aftermarket products.
4. Drivers of gross margin improvement
Gross margin in the quarter was higher than anticipated, primarily due to the benefit received of approximately $955,000 from the recovery and sale of inventory previously written down as a result of loss in the manufacturing process. In addition, a strong mix of higher end products in the drone and auto market and less than expected revenues from the low end of the China Professional Security market contributed to a higher margin mix of revenues in the quarter. -- Ambarella CFO George Laplante
More specifically, Ambarella had some chip inventory that previously didn't pass tests at the highest specification and therefore went into what Laplant calls a "yield loss bucket." But when Ambarella finds opportunities to put those perfectly usable chips to work in products requiring lower specification, it is able to recover them, put them back through quality-assurance tests, and sell them, bolstering gross margin in the process. Combined with an otherwise favorable product mix in Q2, investors were left with a happy surprise this quarter in the form of greater-than-expected profitability.
5. A return to growth despite headwinds
While future revenue was impacted by the wearable sports camera market and Sony sensor supply issues, we expect to retain some growth in Q3 [...] for the holiday season. With strong design momentum in security IP cameras, home monitoring cameras, and with new opportunities in the OEM automotive and the virtual revenue applications, we believe we are well positioned for continued growth driven by multiple markets. -- Fermi Wang
Finally, investors should be happy Ambarella still anticipates returning to year-over-year growth through a rebound in the wearable sports camera market and supported by its supplemental market opportunities. While wearables previously accounted for as much as 30% of Ambarella's revenue -- with the majority of that coming from GoPro -- demand from GoPro fell to the low single-digit range as a percent of Ambarella's total revenue at the start of this year.
To be fair, that decline wasn't Ambarella's fault but rather a result of demand for GoPro's aging HERO 4 product line plummeting. Assuming GoPro hasn't switched its products to a competitive video processing chip solution -- an unlikely development that would almost certainly have been reflected in Ambarella's forward guidance -- it seems safe to assume Ambarella should have little trouble fulfilling this promise after GoPro brings its HERO 5 and Karma drone products to store shelves.
