Good day, ladies and gentlemen, and welcome to Pixelworks, Inc.'s First Quarter 2023 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'd now like to turn the call over to Brett Perry with Shelton Group, Investor Relations.

Thank you, Liz. 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 first quarter of 2022. Before we begin, I'd like to remind you of 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 beliefs as of today, Tuesday, May 09, 2023. 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, annual reports on Form 10-K for the year ended December 31, 2022, 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, as well as the tax effects of the non-GAAP adjustments. The company uses these non-GAAP measures internally to assess operating performance. We believe these non-GAAP measures provide a meaningful perspective into core operating results and underlying cash flow dynamics. We caution investors to consider these measures in addition to and not as a substitute for the superior truth of 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, we refer to net loss attributable to Pixelworks, Inc. as simply net loss. For additional details and a reconciliation 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 DeBonis. Please go ahead.

Thank you, Brett, and good afternoon. Welcome to today's call. Following our 27% revenue growth in 2022, we recognize that revenue will see a significant decline in the first quarter due to an inventory correction in the wider smartphone market and expected seasonality impacts in the projector market. Our first quarter financial results were in line with previous guidance. We believe Q1 marks the lowest point of the correction for our mobile business. By the end of March, inventory levels of our mobile ICs were notably below normal, paving the way for renewed growth in the second quarter. The mobile market has seen various comments from major suppliers regarding smartphone demand. Instead of reiterating the general market sentiments, we'll highlight how Pixelworks stands apart from others. Our sector has indeed experienced an inventory correction as numerous suppliers overproduced and both the distribution channel and smartphone OEMs built up excess inventory due to lower-than-expected demand in 2022, which has continued into the first quarter of 2023. Consequently, many component suppliers expect it may take until the end of this year to manage that inventory. However, Pixelworks was constrained in capacity throughout 2022, allowing us to manage our inventory conservatively. As a result, unlike many others, we are currently shipping to meet customer demand and replenish our channel partners' inventory. Regarding demand from China's smartphone OEMs, opinions vary about the speed of recovery in China, but industry commentary generally suggests that global smartphone demand is not as robust as hoped, which points to longer inventory digestion periods. While the broader mobile market may show softer demand, the flagship and premium segments where we primarily operate are outpacing the overall market. Our customer models featuring our visual processors are surpassing initial forecasts. Since February, we have received additional orders and higher demand from mobile customers for both existing models and upcoming mobile programs. Several tier one customers have agreed to expedite fees to align with their updated demand profiles. To summarize our mobile successes this year, we have been included in six premium smartphone models launched by several multi-generational customers, including OnePlus and Realme, both sub-brands of OPPO, as well as Honor and Asus ROG. These models showcase several wins with our latest generation visual processors, Soft Iris, X5, and X7. At the start of the year, OnePlus launched the OnePlus 11 and OnePlus Ace 2 flagship smartphones, which were among the first to include our X7 visual processor. These devices offer the industry's first combined solution for ultra-low latency motion engine, low power super resolution, and always-on HDR. These features are now optimized for over 100 popular mobile games. In February, Realme, one of the fastest-growing 5G smartphone brands, introduced the Realme GT Neo5 smartphone with our X5 Plus visual processor. The Realme GT series continues to utilize Pixelworks' technology for display differentiation, coupled with innovations like 240-watt fast charging. Asus, one of our first mobile customers, has also launched the ROG Phone 7 series leveraging our HDR enhancement, color calibration, and DC dimming technologies. Additionally, Honor released the Magic 5 series smartphones, including the Magic 5 Pro and Magic 5 Ultimate, both featuring our advanced X5 Plus visual processor. The Honor Magic 5 Pro, once launched, received acclaim with an impressive score of 151 on DXOMARK's display test, ranking number one globally for smartphone display performance. Alongside our mobile OEM collaborations, we are developing an advanced mobile gaming ecosystem. After our initial partnership with Unity, we are expanding engagements with other leading gaming engines, including Unreal and various custom gaming studios. Together with the unique visual performance offered by our X7 visual processor and rendering accelerator SDK, we are gaining traction with major mobile gaming studios. We announced two collaborations: first with Gala Sports for the Total Football soccer simulation game, which, after its initial launch in China, became a top downloader in the sports games category; the second recently with Nuverse for Crystal of Atlan, developed using the Unreal 4 engine. Both games utilize our rendering accelerator SDK alongside our X7 processor to deliver a remarkable 120 frames per second visual experience with low power use. These engagements and initiatives are further bolstering the recognition of Pixelworks. Looking ahead to the second quarter and beyond, we have a strong pipeline of tier one mobile OEM programs and recently secured design-in and production orders with our fourth tier one mobile customer, with shipping to start this quarter and the first product launch scheduled for Q3. Coupled with existing design-ins across other tier one OEMs, we anticipate renewed momentum in the second half of the year. Turning to TrueCut Motion, as we've communicated, it represents a full ecosystem rather than a standalone solution. We continue building out this ecosystem. Moving from the traditional 24 frames per second to cinematic high frame rate will take time, but our TrueCut Motion grading technology is already integral to how top films are being showcased in premium theaters. Recent releases, including Avatar re-release, James Cameron’s The Way of Water, and Titanic have utilized our TrueCut Motion platform, contributing to their box office success and growing demand for high-quality large-screen content. Currently, TrueCut is the only comprehensive high frame rate solution recognized by Hollywood, enhancing its inbound engagement opportunities. We are also working on establishing TrueCut Motion within the home entertainment ecosystem, where streaming providers seek unique video experiences for higher-tier subscriptions. The interest from leaders in the motion picture industry indicates a significant opportunity for our TrueCut Motion solution. Regarding the home and enterprise market, revenue declined in the quarter due to weaker demand, reflecting seasonal adjustments as Japanese OEMs reduced inventory. After a prolonged supply constraint for projector components, customers are starting to see improvements in their supply chains, but we expect OEMs will need at least until the second quarter to fully resolve remaining imbalances. We are on track with our co-development project and expect to deliver initial samples of the next generation SoC this quarter, which will trigger the next milestone payment and contribute to R&D credits. Upon production release later this year, this new SoC is anticipated to be a major revenue driver for the projector business into 2024 and beyond. Another noteworthy achievement from the quarter is our successful strategic investment in Pixelworks Shanghai, which closed in February. This transaction valued the subsidiary at over $500 million while we retained a 78% equity interest. The proceeds are reflected in our quarter-end cash balance of $62.8 million, which aids our growth initiatives and capitalizes Pixelworks Shanghai for a planned public listing on the Star Exchange in China. We have engaged CITIC Securities, a top investment bank in China, to guide us through the listing process. We expect to commence the formal tutoring process this quarter. In conclusion, I am proud of our team’s efforts to manage through macro and specific end-market challenges this quarter. Our careful inventory management has positioned us for faster recovery compared to many peers, and our bookings support robust sequential revenue growth in mobile, with early improvements in the projector market. While uncertainties remain in the global economy, we feel optimistic about the rest of the year. We are well-capitalized to pursue our growth initiatives and focus on our aggressive new product roadmap while expanding ecosystems for both advanced mobile gaming and the TrueCut motion platform. Now, I’ll hand the call over to Haley for a financial review and our guidance for the second quarter.

Thank you. Revenue for the first quarter of 2023 was $10 million, matching the midpoint of our guidance. The decline compared to previous periods was mainly due to lower demand in mobile, influenced by an industry-wide inventory correction in smartphones, as well as typical first-quarter seasonality in the projector market. Additionally, we saw a decrease in video delivery revenue following high sales of certain end-of-life products in the fourth quarter. For the breakdown of our first-quarter revenue, mobile accounted for approximately $3.3 million, while home and enterprise revenue was around $6.7 million. Home and enterprise now combines revenue from projector and video delivery markets, with projectors making up about 90% of this revenue in the first quarter. We expect this trend to continue in future quarters. Our non-GAAP gross profit margin was 44.1% in the first quarter of 2023, down from 53.3% in the fourth quarter of 2022 and 53.2% in the first quarter of 2022. This change in gross margin was attributed to a mix of products and a reduced absorption rate due to lower revenue. Non-GAAP operating expenses were $13.6 million in the first quarter, compared to $10.8 million in the previous quarter and $11.6 million a year ago. Operating expenses in the fourth quarter included a $2.5 million credit related to our co-development project. Excluding that credit, first-quarter operating expenses were consistent with the fourth quarter of 2022. On a non-GAAP basis, we reported a net loss of $8.2 million or a loss of $0.15 per share, compared to a loss of about $800,000 or a loss of $0.01 per share in the prior quarter, and a net loss of $3.5 million or a loss of $0.06 per share in the first quarter of 2022. Adjusted EBITDA for the first quarter of 2023 was a negative $7.8 million, compared to a negative $1 million last quarter and a negative $2.2 million in the first quarter of 2022. Regarding our balance sheet, we started the quarter with cash and cash equivalents of $62.8 million. As mentioned previously, during the first quarter, we completed the sale of our equity interest in our Shanghai subsidiary, contributing to the increase in cash at the end of the quarter. Cash used from operations was partially offset by the purchase of two mask sets during the quarter. Looking ahead to the second quarter of 2023, based on current order trends and backlogs, we expect total revenue to be between $12.5 million and $14.5 million. At the midpoint of this range, this would represent a sequential growth of approximately 35%, largely driven by anticipated increases in mobile IC sales. Non-GAAP gross profit margin in the second quarter is expected to be between 40% and 42%, reflecting a favorable product mix, including a higher revenue contribution from mobile. The lower gross margins in the first half of 2023 are due to increased material costs, some of which we chose not to pass on to mobile customers during a weaker demand period. As demand and unit sales for ICs grow in the second half of 2023, we plan to pass on higher material costs to customers, resulting in improved margins, especially in mobile. We aim to return gross margins to near 50%. For the second quarter, we expect non-GAAP operating expenses to range between $11 million and $12 million, as we plan to achieve a milestone related to our co-development agreement. This milestone payment will reduce our anticipated operating expenses for the second quarter. Lastly, we expect second quarter non-GAAP EPS to range from a loss of $0.08 to a loss of $0.12 per share. That concludes our prepared remarks, and we look forward to your questions. Please proceed with the Q&A session.

First question comes from the line of Rajiv Gill with Needham.

Yes, thanks for taking my questions and congrats on really good momentum in your business. In the mobile phone market for the second quarter and kind of what you're saying throughout the year, Todd, you're bucking a lot of the trends that you're seeing in the China handset market and what a lot of suppliers have been indicating that the correction is steeper and the recovery in the China handset market's going to take longer than expected. You guys are really bucking that trend. So, I guess my first question is one, you had managed your channel inventory pretty effectively last couple of quarters. Maybe you could talk a little about that in terms of way your channel inventory is, and then in terms of the rebound that you're seeing in with your customers, can you talk about where the inventory levels are that the customers are sitting on and just clarity on how you're able to kind of diverge from both trends.

Thanks, Rajiv. Overall channel inventory started significantly down as we entered Q1. We projected for mobile throughout Q1 and some of Q2. By February, it became evident that the new programs we were part of were ramping up more quickly than I expected, indicating we would deplete our inventory likely by April. Therefore, while I was there in February, we began increasing orders to our supply chain through our foundry and assembly and test. The positive news is that, given our unique position, accessing short-term capacity was not an issue this time. However, as we moved into March, the programs were performing better than forecasted, leading customers to expedite orders for items in work-in-progress due to depleted inventory. We had multiple tier one clients for various programs under both X5 and X7, who were paying expedite fees for us to accelerate production through our foundry. Currently, the channel is quite lean. With our guidance, we could potentially exceed the midpoint if we receive expedited wafers sooner than expected, which poses a challenge. The demand is extending into Q3. It's still early, and we have new models launching in the second half of the year that will contribute to this demand. We are hopeful, but we want to see if this trend continues with consumers and how the Chinese market will respond. For now, we remain optimistic.

Great. Appreciate it. And for my follow up, the gross margins you kind of talked a little bit about some of the puts and takes in the near term. Now that you're seeing a pickup in X7, which have higher ASPs I'm just curious how you're thinking about the pricing environment over the next couple of quarters. Thanks.

Yes, great question. The X7 has a higher average selling price, but it also includes many new features and is larger than the X5. Even though we set a higher price, it has a lower margin compared to the X5, which we did intentionally to boost its adoption. Initially, we anticipated that supply chain price increases would level off, but it is clear that they haven’t fully normalized, and some new price hikes have continued into 2023. We will no longer absorb these costs, so we will be passing on price increases to all our customers across all markets starting in the latter half of this year.

Our next question comes from Suji DeSilva with Roth Capital.

Hi Todd. Hi Haley. Regarding the new smartphone programs, were any of these paused during the lockdowns, and are they now resuming? It sounds like they are coming back fairly aggressively. Are these programs primarily for the X7, or is it a mix of both?

It was a mix of the two. When we ended 2022, there was some X7 inventory available, but primarily it consisted of X5. I initially thought it would take us six to eight months to deplete the X5 inventory. Some of the expedited orders are for X5 devices. The models I mentioned that included X5 experienced such strong demand that we quickly reduced our excess inventory and started expediting new wafer production, and the same applies to X7. Certain models of X7 also had high demand, which allowed us to push through our inventory and expedite wafer production as well. It's important to clarify that all this demand is based on models that have already been released. Over 95% of this demand comes from models launched in late December or early January. This is not a case of older models revitalizing demand; these are entirely new models. Customers approached these new models cautiously, having been less conservative the previous year. In our particular situation, we had four or five different models that exceeded their initial forecasts. Once it became clear they were outperforming the forecasts, customers, who had originally planned for a 26-week timeline, began expediting orders within eight weeks. The closer we get to the requested delivery date, the more challenging it becomes for us to expedite, while it's easier to do so further out.

Okay, great. Todd, and then switching over to the projector market, just understand what's your updated view on end demand for '23 versus the typical year? I know it's obviously had a headwind starting the year. I'm curious what you're expecting in terms of where that demand starts to come back into normal or not this year?

We don't really want to give annual guidance, but I will say that right now we expect mobile to finish the year as a growth business year-over-year compared to '22, even with the trough we had in Q1. We still expect projector to probably be down low double digits, just 10% to 15% for the year right as the correction takes through. We don't give guidance on TrueCut. I do expect us to be through any inventory correction by the end of this year on projector, but we're expecting this back half of the year to be for mobile, the growth year-over-year growth business.

Our next question comes from Richard Shannon with Craig-Hallum.

Well hi Todd and Haley, thanks for taking my questions. Can you hear me?

We can, thanks Richard.

I got on a little late and I may have missed some comments here, so apologies for redoing some of this, but just want to make sure I understand on the guidance for the second quarter about the moving pieces here wasn't clear to me whether you expected any growth within the home and enterprise bucket. Whether that includes any last time buys or is it all of it coming from mobile?

No, no. Last time buys. The last time buys we had on the transcoding products finished up in the fourth quarter of '22. And we expect overall home and enterprise, which is projector and transcoding to be slightly up from Q1. So sequentially up and then we expect mobile to be significantly up.

Okay. And if I'm running my model here, Todd, almost in real time here, it seems like that's getting close to kind of doubling substantially then. Is that about right?

That is about right.

Okay. I might come back to that in a second here. One hit a couple other topics here, fiscal on gross margins. We had your number from the year, which I think makes sense here without passing through the cost, but as we think about your passing those through I'm not sure what kind of pace you're thinking of, but what kind of number could we think if you were trying to adjust this quarter for price increases, what could we see? Is this a couple points or few points or…

In Q2, we guided to a low margin because we provided ample notice for our price increases to customers, meaning that Q2 numbers do not reflect any price hikes. The growth in this quarter is purely from unit increases. In Q3 and Q4, we will implement price increases across all markets and customers, though the levels may vary. We are also working towards shifting our mix to become more mobile-centric, which is likely to continue in the future as it is a faster-growing segment compared to projectors in home and entertainment. We did not pass along all the price increases we absorbed, but we are now doing so. Our aim is to return to a reasonable mix that is still predominantly mobile-focused while achieving a corporate gross margin above 50%. We have not yet included any substantial revenue from TrueCut in our projections. Once the licensing business for TrueCut gains momentum, we will inform analysts of our revised corporate margin goals, which will be significantly higher than the low fifties.

Okay. Well, that is helpful. One last question for me, I'll jump out of the line, Todd. Obviously, you had a lot of nice milestones and events in your TrueCut business last year and you've been clear this is a long process developing an ecosystem. So assuming you sign up a streaming customer at any point in time, I'm not trying to apply a timeframe to this, but assuming you'd do that, what kind of milestones would you expect to be able to announce not only with the streaming customer, maybe before that with other ecosystem partners to make this a reality?

So, that's a good question. I think that's good for any investors that are listening on the call to see how do you keep an eye and see if we're hitting our milestones, given that we're not putting financial milestones in there. I would suggest that we are getting interest and strong interest in helping other studios deliver high frame rate to premium large format theaters around the world with new releases. So, you probably will hear some of that activity sooner than later. I think if people monitor us and see more content partners using our technology to deliver a better experience. I think that that's a telling tale. Upon announcing our first distribution partners streaming company to then want to deliver this premium format content to the home and entertainment world, you will quickly see us announce partnerships with device manufacturers that are on the other end of that home entertainment delivery. I think once you see that, that's zero to one. Then the next question is, does it expand beyond that first major distributor and those device partners and multiply to multiple streaming companies and multiple device partners? So that's how you that see it roll out, I think.

Okay. I'm sure we'll follow up on that in the future, but I think that's all the questions for me. Thanks a lot, Todd.

That concludes today's question-and-answer session. I'd like to turn the call back to management for closing remarks.

For those of you attending today's call, thank you for your time. I hope it was helpful. Look forward to giving you updates as the year progresses.

This concludes today's conference call. Thank you for participating. You may now disconnect.