Story Stocks^®

Ambarella (AMBA), a manufacturer of computer vision chips for advanced driver-assistance systems (ADAS), security cameras, and IoT applications, is plunging lower after issuing weak Q3 revenue guidance that badly missed expectations. The company did beat Q2 EPS estimates, mainly due to its solid cost containment efforts, but the better-than-expected earnings performance is being clouded by a gloomier outlook that's characterized by increasing inventory reduction actions at its customers.

• For the fourth consecutive quarter, revenue declined on a yr/yr basis, falling by about 23% to $62.1 mln in Q2. During the earnings call, CEO Fermi Wang specifically called out weakness in its consumer IoT business, which has a significant presence in China -- a market that he described as weaker than other markets. Furthermore, Mr. Wang added that AMBA experienced a further push out of demand from a large customer, adding to the alarm.
• These pockets of weakness are making AMBA's customers' efforts to reduce their inventory more difficult. Consequently, the company doesn't expect to see a recovery in 2023, leading it to issue downside Q3 guidance of $50 mln +/- 4%. At $50 mln, AMBA's revenue would be down by nearly 40% in Q3, marking its worst yr/yr decline in more than five years.
• AMBA is anticipating a return to growth in 2024 as inventory levels normalize and as demand within the automotive end market remains strong. An expanding list of design wins with major auto OEMs -- such as those with Continental and Bosch -- should drive stronger top-line growth next year.
• The company's lineup of SoCs in the AI inference market is also poised to become a more substantial contributor to revenue in the coming years. On that note, AMBA began to port Meta Platforms' (META) Llama 2 code generation model for AI with its CV3 chips this quarter. Importantly, CV3 chips carry significantly higher ASPs than the typical video processing chip with SoCs ranging from $50 to more than $400 per SoC.
• During this downturn in demand, keeping a tight lid on expenses will be critical. In Q2, AMBA did a good job on this front with non-GAAP operating expenses coming in at $46 mln, below its prior guidance of $48-$50 mln. 

The magnitude of AMBA's Q3 revenue guidance miss caught market participants off guard. While the longer-term outlook remains bright, thanks to the company's exposure to the auto and AI markets, the weakening IoT business and mounting macroeconomic pressures in China are potent headwinds that will weigh on AMBA's results in the near/intermediate term.