Pixelworks, Inc Q3 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to Pixelworks, Inc. Third Quarter 2022 Earnings Conference Call. I will be your operator for today's call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, instructions will be given for the question-and-answer session. This conference call is being recorded for replay purposes. I would now like to turn the call over to Brett Perry of Shelton Group, Investor Relations.

Thank you, Andrew. Good afternoon and thank you for joining us on today's call. With me on the call are Pixelworks' President and CEO, Todd DeBonis; and Chief Financial Officer, Haley Aman. The purpose of today's conference call is to supplement the information provided in Pixelworks' press release issued earlier today announcing the company's financial results for the third quarter of 2022. Before we begin, I'd like to remind you that various remarks we make on this call, including those about projected future financial results, economic and market trends, and competitive position, constitute forward-looking statements. These forward-looking statements and all other statements made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. All forward-looking statements are based on the company's belief as of today, Monday, November 7, 2022. The company undertakes no obligation to update any such statements to reflect events or circumstances occurring after today. Please refer to today's press release, our annual report on Form 10-K for the year ended December 31, 2021, and subsequent SEC filings for a description of factors that could cause forward-looking statements to differ materially from actual results. Additionally, the company's press release and management statements during this conference call will include discussions of certain measures and financial information in GAAP and non-GAAP terms, including gross margin, operating expense, net loss, and net loss per share. Non-GAAP measures exclude amortization of acquired intangible assets and stock-based compensation expense. The company uses these non-GAAP measures internally to assess our operating performance. We believe these non-GAAP measures provide a meaningful perspective on core operating results and underlying cash flow dynamics. We caution investors to consider these measures in addition to, and not as a substitute for, nor superior to, the company's consolidated financial results as presented in accordance with GAAP. Also note throughout the company's press release and management statements during this conference call, we refer to net loss attributable to Pixelworks, Inc. as simply net loss. For additional details and reconciliations of GAAP to non-GAAP net loss and GAAP net loss to adjusted EBITDA, please refer to the company's press release issued earlier today. With that, it's now my pleasure to turn the call over to Pixelworks' CEO, Todd, please go ahead.

Thanks, Brett, and welcome to everyone joining us on today's call. Starting with our reported results, we delivered another solid quarter with revenue at the midpoint of guidance and growing 16% year-over-year during what continues to be a very challenging environment for the broader semiconductor industry. The Pixelworks team has continued to execute despite the various macro challenges, and this quarter marks the sixth consecutive quarter of double-digit year-over-year growth in both our Mobile and Projector businesses. Total revenue year-to-date is up 38% over the first nine months of 2021, and we expect to close out 2022 with full-year growth in excess of 25%. Despite inflationary cost pressure throughout the year and our mobile growth contributing to an increasing portion of our total business, we've maintained healthy gross margins that were at 50% in the third quarter. Additionally, both OpEx and EPS for the quarter were better than the midpoint of guidance, reflecting our careful cost management and attention to improving bottom-line results over time. In addition to our solid operating performance, during the quarter, we closed a strategic investment in our Shanghai subsidiary at nearly two times the valuation of the previous investment round. Our ability to execute this transaction in the current environment highlights the recognition and growing opportunity for our visual processing technology across Asia. It also enabled us to further strengthen our balance sheet in support of driving continuous momentum in our mobile business and our growth initiatives for the TrueCut Motion platform. Turning to updates on our primary end markets, as expected, mobile business was down sequentially from the record quarter revenue we posted in the second quarter, primarily reflecting the start of a broadly acknowledged inventory correction in smartphones and weaker consumer demand in China. With that said, we maintain solid growth year-over-year with mobile revenue increasing more than 25%, which represented the seventh consecutive quarter of year-over-year growth, and year-to-date, our mobile revenue was up 44% compared to the first nine months of 2021. Although the pace of new smartphone launches by mobile OEMs has slowed with various planned models either being pushed out or canceled as the industry focuses on working down excess component inventories, we have maintained a high level of engagement activity and continue to secure new designers. As a result of the current market dynamics, we've experienced certain customer programs that were originally targeted for our latest X7 processor to now incorporate our X5 Plus solution as part of the efforts to either reduce existing component inventory and/or minimize the total BoM cost of devices. While this differs the opportunity to penetrate the market with our X7, in October, Vivo launched the iQOO Neo 7 smartphone incorporating an upgraded Pixelworks X5 visual processor, with the goal of delivering a more captivating gaming and video experience. Built on MediaTek's Dimensity 9000 Plus flagship 5G mobile platform, iQOO Neo 7 utilizes our patented mimic technology with a high efficiency interrelation algorithm to boost low frame rate gaming content to high frame rates of up to 120 frames per second. In addition to our Motion engine, now being adapted for optimal performance on 21 popular mobile games, we have worked closely with iQOO to incorporate a unique set of built-in visual effects and enhancement modes. These modes or gaming filters give the end user full autonomy to choose between preset visual styles or create their own custom filter by adjusting individual visual quality parameters. Earlier in the quarter, we also added Sharp as a first-time customer in mobile, with Sharp's launch of the Aquos Sense7 Plus smartphone. Primarily targeted for consumers in Japan, this device is based on Qualcomm Snapdragon 695 5G mobile platform featuring an impressive 6.4-inch IGZO OLED display, with a 10-bit color depth and 1,300 nits peak brightness. As a result of our collaboration and the incorporation of our X5 Plus Advanced Visual processing solution, the Aquos Sense7 Plus enables five times video frame insertion or up to 120 hertz and also supports variable refresh rate. Stepping back year-to-date, our mobile visual processor solutions have been incorporated in smartphones launched by three of the four Tier 1 OEMs and their respective affiliate brands in China, including Vivo iQOO, Oppo, Realme, OnePlus, and Honor. More broadly, our technology has enabled devices launched this year by ASUS and Sharp. Effectively, all of these models by these OEM customers were either directly targeted at or marketed as supporting advanced visual quality for higher frame rate mobile gaming at low power. Together with our efforts to spearhead an engaged ecosystem for mobile gaming through ongoing collaboration with multiple leading game engine platforms and design studios, Pixelworks has distinguished itself within China as a technology leader in the area of mobile visual processing. This recognition is creating expanded opportunities for our technology, both in the form of deeper strategic engagements with AP platform vendors and increasing inbound interest from IC design firms to license and incorporate certain Pixelworks visual processing IP into their next generation solutions. We are currently in late stage discussions on multiple prospective licensee engagements. One point I'd like to emphasize about any prospective deal involving IP licensing is that they are carefully evaluated and subject to key engagement criteria. Most importantly, we will not pursue a licensing arrangement which risks existing market potential that we could otherwise address directly. In other words, we believe these current prospective deals are incremental opportunities to further monetize our technology. Turning to an update on the TrueCut Motion platform, we're excited to see the successful rerelease of Lightstorm Entertainment's Avatar this September, the first globally available title remastered with TrueCut Motion. Our tools were used on every frame of this iconic moment, allowing cinemas to play at 4K resolution in high dynamic range with the motion look tuned shot by shot to achieve exactly what the filmmaker intended. This rerelease was seen in 47 markets worldwide, achieving a gross box office sales of over $76 million, further cementing its position as the highest grossing movie of all time. We can now confidently say that we have a global TrueCut Motion cinema ecosystem in place. As part of our previously announced multi-license agreement with Lightstorm Entertainment, today we are actively working to replicate the same level of success with the rerelease of Titanic, which is slated to hit theaters in early February. With growing momentum on the content side of the ecosystem, our team's focus is now on securing a global entertainment ecosystem. Shifting to the Projector business, revenue grew single-digit sequentially and increased 10% year-over-year, reflecting the highest quarterly revenue in more than two years. Although customers have more recently indicated some improvement in their ability to source other key projector components, such as timing controllers and panels, the extremely tight supply environment and long lead times for components earlier in the year hampered projector OEMs from meeting total end demand. So far, this demand is still present, and our projector customers believe they will no longer be supply constrained by early next year. Also notable within the Projector business, our co-development project with our largest projector customer remains on track, and we expect to complete the development work on this next-generation SOC by year-end. Upon completing the development work, we are entitled to receive a contract milestone payment, which will be recognized as a credit to R&D and meaningfully reduce our reported OpEx for the fourth quarter. As a reminder, we anticipate this new SOC to be in production in late 2023 and continue to ramp support for an increasing number of our lead customers' projector models. Finally, I want to highlight a recent strategic action we took in our Video Delivery business to end the life of a series of legacy ICs. As a reminder, we acquired this business as part of the ViXS Systems in the second half of 2017. It has been comprised of several transcoding ICs that we've primarily sold into consumer applications in Japan, as well as OTA devices here in the US. Another area these transcoders are used in is video delivery infrastructure. These specific applications often require unique packaging and are generally much lower volume, making them increasingly difficult to source and supply efficiently over time. As a result, we've implemented an EOL, or end of life on a certain portion of these transcoding ICs, which will result in a one-time increase in Video Delivery revenue in the fourth quarter. In summary, we are executing well in the face of many macro-related headwinds and continue to pursue strategic actions to mitigate the near-term impacts of the current environment. We have kept our inventory in check and at healthy levels. We have been prudent on costs and spending, including limiting any incremental new headcount, and we've added cash to the balance sheet at a very attractive valuation, with minimal dilutive impact to shareholders. During the quarter, we also completed the planned conversion to a joint stock corporation as part of our preparation for our Pixelworks Shanghai subsidiary for a local listing on the stock market in China. The structural change brings us one step closer to Pixelworks Shanghai beginning the CRSC's tutoring process and ultimately submitting its formal application for the logo. While we remain cautious about the near-term macro environment and consumer demand, we are in a strong financial position to fully execute on our growth initiatives and fully extend Pixelworks' technology leadership into our target markets. With that, I'll hand the call to Haley to review the financials and provide our guidance for the fourth quarter.

Thank you, Todd. Revenue for the third quarter of 2022 was $17.6 million, down 8% sequentially from $19.1 million in the second quarter and representing an increase of 16% from $15.2 million in the third quarter of 2021. Our top-line results for the quarter were driven by a combination of continued strong year-over-year growth in our mobile business and sustained customer demand in our Projector business, with Projector revenue once again reaching the highest quarterly level since the onset of the pandemic. The breakdown of revenue in the third quarter was as follows; revenue from Mobile increased more than 25% year-over-year to approximately $6 million, which represented just over 34% of total revenue in the third quarter. Similar to recent quarters, sales of our integrated circuits were the largest contributor to mobile revenue this quarter. Revenue from Projector was approximately $9.9 million, increasing 5% sequentially and 10% year-over-year, again reflecting sustained customer demand. Video delivery revenue was approximately $1.6 million in the third quarter. Non-GAAP gross profit margin was 49.8% in the third quarter of 2022, compared to 49.3% in the second quarter of 2022 and 53.1% in the third quarter of 2021. Non-GAAP operating expenses were $12.2 million in the third quarter compared to $12.9 million last quarter, and $10.1 million in the third quarter of 2021. On a non-GAAP basis, third quarter 2022 net loss was $3.2 million or a loss of $0.06 per share compared to a net loss of $3.3 million or a loss of $0.06 per share in the prior quarter and a net loss of $2.2 million or a loss of $0.04 per share in the third quarter of 2021. Adjusted EBITDA for the third quarter of 2022 was a negative $2.1 million compared to a negative $2.4 million last quarter and a negative $1.6 million in the third quarter of 2021. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $57.6 million. The sequential increase primarily reflected $10.7 million in net proceeds from closing the transaction to transfer approximately 2.7% of Pixelworks' equity interest in our Shanghai subsidiary to new private equity investors. This increase was partially offset by cash used in operating activities. Shifting to our current expectations and guidance for the fourth quarter of 2022, we anticipate fourth quarter total revenue to be in a range of between $16 million and $18 million. At the midpoint of this range, total revenue for the full year 2022 would represent annual growth of approximately 27.5% over 2021. Non-GAAP gross profit margin in the fourth quarter is expected to be between 56% and 58%. The anticipated sequential increase reflects a more favorable product mix composed of an expected increase in licensing revenue and an increase in revenue related to the end of life of certain legacy chips sold into the Video Delivery market. In terms of operating expenses in the fourth quarter, we currently expect to achieve a planned milestone related to our co-development agreement. As with previous treatment, the milestone payment will be recognized as a credit to R&D reducing our anticipated reported operating expenses in the fourth quarter. Taking this credit into account, we expect operating expenses to range between $10 million and $11 million, and on a non-GAAP basis. Lastly, we expect fourth quarter non-GAAP EPS to range between a loss of four cents per share and income of $0.01 per share. That completes our prepared remarks, and we look forward to taking your questions. Operator, please proceed with the Q&A session. Thank you.

Thank you. Our first question comes from Suji Desilva with ROTH Capital.

Hi Todd, hi Haley. I was hoping you could talk about the delivery, how much revenue benefit you'll see from last time buys in the fourth quarter?

I can let Haley answer that, but I won't specify the exact amount; she'll provide you with that information.

Yes, I think for Video Delivery revenue in the fourth quarter, you can expect it to increase over 100%.

Got it. And congratulations on the Shanghai equity valuation; it's certainly progressing well. What percentage are you considering potentially selling before the IPO? That could also be a source of funding for your team, right?

Well, I mean, listen, so this particular financing was a unique financing. One thing that we did with this financing is we actually sold our equity, Pixelworks Inc.'s ownership equity to a new round of investors versus a dilutive event to all the investors in Pixelworks Shanghai. And so the net cash from that financing actually all came back to the US to Pixelworks Inc. And so that was nice, because we want to make sure not only do we have a great balance sheet, but we want to have a great balance sheet for both here in the US, but also for our China subsidiary, and making sure that both are properly financed for their strategic goals. And so I would say, we were very focused on that event. And that event had to be completed before we completed the conversion to the joint stock corporation. It was a lot in that financing. We are now post conversion, pre-IPO. It doesn't prevent you from doing financing. There are some limitations about doing financing in this particular window. I haven't really thought about how much we would still like to own after we finance the public offering and we will still control a large percentage of the subsidiary post-financing.

Okay, that's helpful. Looking ahead to the gross margin guidance for the fourth quarter, what areas are driving the licensing benefit? Is it coming from Mobile or TrueCut?

We're not going to break that out at this time. As you know, we've had software licensing in the past, as well as some TrueCut licensing. On the earnings call, I mentioned IP licensing from our Mobile group, and we now have inbound interest for IP licensing. All of these would still be included in our Mobile revenue. While we may share how much of the Mobile revenue was from licensing after the quarter ends, we are not planning to provide individual breakdowns at this point, Suji.

Okay, that’s helpful information. Todd, last question regarding the broader trend of introducing new model designs, specifically replacing X5 designs with X7 to manage that inventory. I’m interested in understanding the potential margin impact of processing X5s compared to the bump we might see from the newer X7 models; any insights on that would be appreciated. Thanks.

I would say that our trends indicate we have already launched an X7 phone with Realme, and several new phones designed around the X7 will be launched in early 2023 or are currently in the design process. Looking at our pricing for these models compared to the X5, there is currently not a significant difference in the gross margin profile.

Thank you. And our next question comes from the line of Sam Peterman with Craig-Hallum.

Hi, Todd, Haley, thank you for taking my question. I want to inquire about mobile. I've noticed many companies in the industry suggest that the fourth quarter might be where mobile sales in China reach their lowest point, with a possibility of some growth in the first and second quarters of next year. I'm interested in your perspective on inventory trends in China regarding phones. Additionally, concerning your Mobile business, it seems you are forecasting a decline in Mobile sales quarter-over-quarter in December. It would be great if you could elaborate on where you see that segment in the fourth quarter.

First, I think I understood the question regarding the mobile market. We noticed a slight improvement in sell-through in the third quarter compared to the second quarter. However, the second quarter faced challenges due to Shanghai's lockdown and significant consumer fear. We anticipate that the fourth quarter will outperform the third, and the first quarter's performance will largely depend on changes in COVID policy. If restrictions ease, we could see consumer demand pick up. Currently, mobile OEMs have surplus finished goods inventory, but their primary challenge revolves around components. They previously operated in a constrained environment, leading them to stockpile inventory and order many components. Depending on the components available, they need to utilize existing inventory and incorporate it into new models. If an OEM chooses not to write off any inventory, they will rely on their current components, which may limit differentiation in new models compared to previous ones. In our case, our distributor has minimal inventory left, as most has already been sold to OEMs. One OEM has a significant amount of X5 inventory, prompting them to launch more models with X5 than originally planned to deplete that stock. Other customers, however, have no leftover inventory and are shifting to X7 and our next-generation solutions. Therefore, I’m not particularly concerned about obsolete inventory. My main concern is when demand returns strongly enough for OEMs to clear their various inventory levels, allowing them to adapt their marketing strategies for new phones. Some OEMs may capture market share early, while others may take longer to adjust. I don't expect this situation to resolve by the end of Q4; it may extend into Q1 or even Q2 of next year.

Okay, that's helpful color. Thanks for that, Todd. I guess also on Mobile; just broadly, with X7, maybe some of those designs are being pushed out, but can you talk about, I guess, just what you're seeing from OEMs, in terms of the enthusiasm for differentiating phones based on gaming performance, is that focus shifting at all with the macro being weak? Are you still seeing just as strong of interest in engagement with mobile gaming being a key factor?

The OEMs we work with operate globally and don’t have a significant presence in the U.S., with their primary market being China. Honor is the most focused on China, while Xiaomi has a stronger international presence. Nonetheless, all have a substantial share of their business there. The mobile gaming sector in China remains an important area they wish to enhance in their premium phones. Our success in ecosystem engagement has been notable, particularly with mobile gaming content providers who are keen on developing more immersive versions of their games for mobile devices, not just desktops. They’re facing challenges such as system performance, heat management, battery life, and frame rates, which makes our solutions appealing to help them achieve a richer AAA gaming experience. Expanding our ecosystem of content will lead to more games supporting our platform, increasing interest from our OEM partners.

Got you. Thanks for that Todd. If I can ask one more just quickly on TrueCut. You had a nice comment in the press release about it, but I'm curious, just with Avatar having been released and getting to see some of the reviews of that. Can you talk about how, I guess, like engagement in the industry has been since that? Whether that's with other content creators or with streaming services or anything like that, any follow there would be great?

We have two main activities happening with the team. Our small team at TrueCut is very busy. They are focusing on enabling third parties through our announcement with Pixologic and engaging with others to help bring TrueCut Motion grading to content creators, rather than managing everything ourselves. In our initial collaborations, people have preferred to work directly with us. All the work on Avatar was done by Pixelworks employees, as well as the ongoing projects for Titanic and other content. We have a capable team, albeit small, that is dedicated to content creation and producing quality films. Additionally, we have another team focused on demand creation, which has two main aspects. First, there has been significant studio engagement following the release of Avatar. Second, we are working hard to establish our presence in the streaming and device ecosystem. We have created movies that look exceptional at high frame rates and 4K HDR in theaters, and we aim to ensure that the same content looks great for home entertainment. However, we have not yet licensed any content for TrueCut Motion streaming, and we are actively working on this.

Okay, thanks Todd. That's it for me.

Great. Thanks, Sam.

Thank you. And our next question comes from the line of Nicholas Doyle with Needham & Company.

Hi everyone, this is Nick Doyle filling in for Raji Gill. I appreciate the insights you provided on my previous question regarding enhanced markets. I would like to ask about the Projector business and its various factors as we move into next year. Customers are expected to face fewer supply constraints, but we also have the challenge of the macro environment affecting production. Additionally, we anticipate the new System on Chip possibly being released towards the end of the year. Could you provide more details on the direction of that business? Last quarter, you indicated that the fourth quarter would see a leveling off. Any further information on that would be helpful.

Thank you for the question, Nick. I appreciate it. Regarding the Projector business, we usually see a pattern where Q3 is our strongest quarter and Q1 is the weakest, primarily because most of our Japanese customers operate on a fiscal year ending in March, leading them to reduce inventories ahead of that quarter. However, this year, we experienced some deviation from that trend. Looking ahead to next year, there may be some balance as our customers have developed a demand for systems that couldn't be delivered previously. If we combine the number of devices we've shipped to our OEMs in a quarter, it's clear they have built up some demand due to previous shortages of at least a quarter's worth of shipments. This shortage primarily stems from other component vendors rather than ourselves, as we have managed our supply chain effectively. We are beginning to see this situation improve. The key question remains: with the current macro environment weakening, will that demand persist until it is met, or will it diminish as supply constraints ease? We don’t have clear indicators on this yet. So far, demand has remained robust. Even with the end of zero COVID policies in China, there has been a reasonable recovery in Projector demand there. The U.S. market has also been strong, but we wonder if that will continue as the economy slows down. Europe has begun to decline, likely because of ongoing issues there. This will impact the outlook for Projector in the first half of the year. It doesn’t appear catastrophic; it could be positive, but it's too soon to say definitively. As for the new SOC, we will begin customer sampling in the first half of the year, but it takes time for them to ramp up. They have identified several high-volume programs to accelerate, but even with quick progress, it will take at least six months from the time we provide approved silicon for those models to start ramping up. The earliest we might expect to see volume ramping would likely be in Q4, maybe a bit in Q3, but mostly Q4 of 2023.

Okay, that makes sense. Thanks. Just to point out a detail, the gross margins increased quarter-over-quarter, but the non-GAAP gross margins were about 20 basis points lower. Is that mainly due to mix?

It's mixed. In Q2 and Q3, we experienced a strong mobile business on a comparative basis. In Projector, we passed through all the price increases seen across the industry; the supply chain has faced price hikes from fabs, assembly, and testing, among other areas. In our Projector and Video Delivery businesses, we absorbed all those costs. In the Mobile sector, we passed on most but not all of those increases. We aimed to achieve a broader attach rate in mobile without pushing the limits to the point of affecting usability. As a result, margins in Mobile have compressed slightly. Increased mobile business results in downward pressure on our overall gross margins. We believe the supply chain's price hikes will begin to stabilize; whether they decrease will depend on demand — particularly how full some SaaS facilities can remain. If they can maintain full capacity without reducing prices, they will. However, if they can't, we may start to see supply prices decrease, which should benefit us in mobile. Ultimately, what will significantly help us overall is if we can enhance our offerings through licensing and other areas we've discussed previously, particularly software licensing.

Thank you.

Thank you. I'll now hand the call back over to management for any closing remarks.

Nope. Thanks to the analysts for some good questions. Thanks everybody else for attending. We'll keep you posted on our progress. Thank you for your time.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating and you may now disconnect.