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Pixelworks, Inc. (NASDAQ:PXLW)

Q4 2012 Earnings Call

January 31, 2013, 05:00 pm ET

Executives

Steve Moore - VP & CFO

Bruce Walicek - President & CEO

Analysts

Krishna Shankar - ROTH Capital Partners

Operator

Good afternoon and welcome to the Pixelworks Incorporated Fourth Quarter and Full-Year 2012 Financial Results Conference Call. At this time, all participants are in listen-only mode. At the conclusion of today's conference call, instructions will be given for the question-and-answer session. (Operator Instructions) As a reminder, this conference call is being recorded today, Thursday, January 31, 2013.

I would now like to turn the conference over to Mr. Steve Moore. Please proceed.

Steve Moore

Good afternoon and thank you for joining us. This is Steve Moore, Chief Financial Officer of Pixelworks. With me today is Bruce Walicek, President and CEO. The purpose of today’s conference call is to supplement the information provided in our press release issued earlier today announcing the company’s financial results for the fourth quarter ended December 31, 2012.

Before we begin, I would like to remind you that various remarks we make on this call, including those about our projected future financial results, economic and market trends and our 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, Thursday, January 31, 2013, and we undertake 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, 2011 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’s statements during this conference call will include discussions of certain measures and financial information in GAAP and non-GAAP terms, including gross margin, operating expenses, net income loss, net income loss per share. These non-GAAP measures exclude stock-based compensation expense, gain on sale of patents, gain on sale of marketable securities and additional amortization of prepaid royalty.

We use these non-GAAP measures internally to assess our operating performance. The company believes these non-GAAP measures provide a meaningful perspective on our core operating results and underlying cash flow dynamics, but we caution investors to consider these measures in addition to, not as a substitute for, nor superior to, the company's consolidated financial results as presented in accordance with GAAP. Included in the Company's press release are definitions and reconciliations of GAAP to non-GAAP net income loss and GAAP net loss to adjusted EBITDA, which provide additional details.

Bruce will begin today’s call with a strategic update on the business, after which I will review Q4 financial results and discuss our outlook for the first quarter of 2013.

Bruce Walicek

Thanks Steve. Good afternoon everyone and thank you for taking the time to join us today. 2012 was a year of solid progress for Pixelworks despite the headwinds of a difficult macro environment and a contracting semiconductor industry. Overall revenues for 2012 came in at $60 million, down 8% versus 2011 driven by a difficult global consumer and education spending environment.

Despite these headwinds, 2012 was a significant year for demonstrating the value of Pixelworks’ technology and capability as we closed 12 million of licensing and co-development deals. In first half of 2012, we closed a significant licensing and partnership for our advanced video display technology, which combined with our penetration of the top tier customer base, validates Pixelworks’ leading position in providing innovative solutions in video processing.

Also in 2012, we achieved another key milestone as we engaged in a significant customer funded co-development project to develop a highly integrated next-generation chip that will result in significant revenue and market share gain in 2014 and beyond. In both of these engagements, Pixelworks was selected because of our industry leading video processing technology and product execution capability.

In our PA series product line for large screen display applications, during 2012 we shipped volume production of our PA136 to Tier-1 customers and captured the first wave of 4Kx2K resolution Ultra High Definition design wins to Tier-1 customers. In the second half of the year, the first 84 inch 4Kx2K Ultra Definition display from industry leader LG Electronics was introduced to the market with Pixelworks’ leading video processing technology based on the PA138.

In Q4 2012, we introduced the PA168 which is started for Ultra HD 4Kx2K applications such as TVs panels, monitors and projectors and this quarter we delivered mass production units of the PA168 and expect volume production to build into 2013 and positively impact the second half of the year. The PA168 video display processor is designed to meet the demanding performance requirements of new high resolution 4Kx2K screens and Pixelworks’ technology handles the most demanding and difficult video processing problems to create the best video quality in the industry.

These displays establish the latest standard for immersive viewing delivering truly remarkable picture quality with 8 million pixels per frame. Pixelworks’ PA168 raises the bar for video processing technology featuring Halo Free performance and the ability to eliminate unperceivable pixels to deliver more realistic images. The depth and richness of the Ultra Definition experience is a revolutionary improvement over today’s full high definition displays and Pixelworks is pleased to be working with leading Tier-1 manufacturers that have chosen our technology to power the latest state of the art Ultra HDTVs and we believe we are the leader in this market with multiple Tier-1 engagements for the PA168.

In terms of what we see for the business going forward, I would like to call your attention to three major trends that are developing in the industry; all these trends interrelate to each other and how they affect their business. The first trend we are seeing is the dramatic increase in display resolutions. At CES this year, higher resolution screens were everywhere and the clear overwriting theme of the show was that we are at the beginning of a massive shift to higher resolutions across all displays. This shift is analogous to the major transition from standard resolution CRT Analog displays to high definition black panel digital displays a decade ago for much more (inaudible). Just as a point of reference, the new 4Kx2K Ultra HD screens have four times the number of pixels of today's full HD displays.

And now we’ll move to the second trend which is resolutions are increasing not only in large displays, but in small ones as well. This time the trend of higher resolution displays is happening across all screens, stationery and mobile alike, driven by the capability of new display technology packing more pixels in to left space, while at the same time these displays are making the transition from simple video playback devices to the communication and computing platform as well.

Again, example of these trends, the current Retina displays in Apple’s iPad 3 which is 2Kx1K resolution and contains 1 million more pixels than today's leading 1080p full HDTVs. That device did not exist three years ago and already has found a new category generating tens of millions of units worldwide. We are in the middle of a convergence of the PC, TV and phone which is generating new product categories in these models and they all have one thing in common; consumers are increasingly using these products to watch video.

And that brings me to the third major trend which is that video is becoming (inaudible) application. Industry research from bandwidth providers, switching manufactures and communication chip makers all point to the same thing. Across all these screens video content consumption is going up and has been consumed on a wide variety of mobile and stationery screens. There are plenty of statistics to quantify this trend, and one that find is specially graphic is from Cisco and they predicted in just three years video will make up over 85% of all internet traffic and that it would take over 6 million years to watch it all. That gives you an idea of what’s coming as these three trends of high resolutions, more video content and more opportunities to view that content collide. The quality of the digital user experience will increasingly become a key element in product quality and brand differentiation.

So we have this gigantic tsunami of pixels that are headed for the entire ecosystem, the video content creation, distribution and delivery and how that affects our business. At this year’s Consumer Electronic Show in Vegas, advanced large ultra HD TVs from tier one customers incorporating our technology were permanently displayed on the floor, and we are pleased to be working with leading tier one TV manufacturers that have chosen our video and display technology to power their latest state of the art ultra high definition TVs.

These are the very largest screens at this point and we are solving industry’s most difficult video display issues on the grand of scale. Higher resolution of course means more noticeable video quality problems and video quality problems associated with higher resolution larger screens are now migrating to small ones.

As customers become exposed to higher video quality on HD and Ultra HD screens, they will naturally demand an experience similar to the high resolution they are used to on whatever screen they are viewing. This next wave of pixels will require advanced approaches to video processing that address not just feeding a higher resolution screen but also taking into account the issues of size and power consumption.

All of these issues point to a need for a holistic approaches to video processing that will address all these problems and as the technology leader and last independent company in the industry creating the highest quality visual user experience, we believe these trends are increasing the value proposition with Pixelworks’ video and display processing technology and we intend to focus our efforts to take advantage of that.

In our projected product line in 2012, we expanded the Topaz family of solutions across the spectrum of the projection market by introducing several new members. The PWC868 and PWC878 for the mid range and high end of the market as well as the Topaz Lite series for the [$500] value segment. And in Q4 we further expanded Topaz family by introducing the PWC858 which is specifically targeted for really big products.

Pixelworks projector solutions enable advanced applications in the business, consumer and education segment and in 2013 we will be adding additional numbers to the Topaz family and enhancing our software suite to enable mobile and wireless connected applications. We experienced outstanding tier one design win traction in 2012 and expect the Topaz family to contribute positively to grow in 2013.

In closing, 2012 was a year of significant progress to Pixelworks despite macro economic headwinds. We demonstrated a value of Pixelworks’ video and display technology by closing $12 million of licensing and (inaudible) deals. We expanded our Topaz family of projector products and we introduced our next generation video display processor, the PA168 for Ultra HD displays which was adopted by industry leader LG Electronics and others to power their flagship products.

We are at the beginning of a massive trend to high resolutions and video consumption across all screens and in 2013 we will focus on applying our video and display processing technology and innovation to all displays to enable the highest quality video experience.

Now, I would like to turn the call over to Steve to discuss the environment and review the financial details of the quarter.

Steve Moore

Thank you, Bruce. Revenue for the fourth quarter 2012 came in at the low end of guidance as the lack of visibility noted in our Q3 2012 conference call continued into Q4. Total revenue for the quarter was $13.6 million compared to $16.3 million in the third quarter and $16.8 million in the year ago quarter.

The sequential and year-over-year decline in revenue was primarily due to soft macroeconomic conditions across product lines, coupled with seasonal weakness. We splitted the fourth quarter revenue by market with 70% digital projection, 17% TV and Panel and 13% embedded video display.

Licensing revenue was negligible during the quarter compared to approximately $600,000 in the third quarter. Revenue from digital projection was down 1.3 million sequentially to approximately 9.5 million in Q4 as customer suggested inventories due to softer demand.

Revenue from TV and panel was down approximately 1 million sequentially to 2.3 million in Q4, primarily as a result of seasonality, amplified by the slow macroeconomic environment. Embedded video display revenue in Q4 was approximately 1.8 million. Non-GAAP gross profit margin was 49.9% in the fourth quarter compared to 49% in the previous quarter and 48% in the fourth quarter of 2011. The improvement in gross margin was largely the results of the favorable product mix. Non-GAAP operating expenses were at the low end of the guidance coming in at 9.2 million in the fourth quarter as we continue to focus on tight expense management. This compares to 7.7 million in Q3 and 9 million in Q4 2011.

Operating expenses in the third quarter of 2012 were positively impacted by a reimbursement credit to research and development expense from our co-development agreement with the customer, due to the achievement of certain milestones. Fourth quarter 2012 research and development expense did not include a reimbursement of credit. We expect to complete all the milestones related to this agreement and realize the remaining 3.5 million of reimbursement credits during 2013. It should create as it is a part of this co-development agreement is expected to result in significant revenue beginning in 2014.

Adjusted EBITDA was a negative 1.3 million in Q4 compared to a positive 1.4 million in the third quarter of 2012. The reconciliation of adjusted EBITDA to GAAP net loss maybe found in today’s press release. On a non-GAAP basis, we recorded a net loss of 2.8 million or $0.15 per share in the fourth quarter. This compares with a non-GAAP net income in the third quarter of 320,000 or $0.02 income per diluted share, and a net loss of 1.3 million or $0.07 loss per share in the fourth quarter of 2011.

Moving to the balance sheet, cash and marketable securities ended the quarter at approximately 13.4 million versus 15.6 million at September 30, 2012. At quarter end the company had no long-term debts and a zero balance on its working capital line of credit. Other balance sheet metrics include day sales outstanding at 25 days at December 31, compared with 21 days at September 30 and inventory turns of 7.3 times in Q4 compared to 7.6 times at the end of Q3.

Guidance; going into Q1 visibility continues to be lower than normal as customers work through an industry wide inventory correction, coupled with worst than normal seasonality. Based on these factors, we expect revenue to be lower than typical seasonality in the range of 9.5 million to 10.5 million. Going forward, we expect Q1 to be the trough with a return to sequential revenue growth in Q2 2013 based on the return to normal order patterns and second half growth driven by Topaz and PA168 products.

We expect gross profit margin for the quarter to range between 50% and 52% on a non-GAAP basis and 48% to 50% on a GAAP basis. We expect operating expenses in the first quarter to range between 9 million and 10 million on a non-GAAP basis and 9.5 million and 10.5 million on a GAAP basis. This guidance reflects that we do not expect to achieve a research and development credit milestone in Q1 2013. And finally, we expect to record a non-GAAP net loss between $0.18 and $0.28 per share and on a GAAP basis we expect the net loss per share of between $0.22 and $0.32. That concludes my comments, and we will now open the call for you questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your question comes from the line of Krishna Shankar with Pixelworks. [ROTH Capital Partners] Please proceed.

Krishna Shankar - ROTH Capital Partners

In the trough what kind of data points do you have to suggest that Q1 could potentially be the trough, and how quickly with some of the new products such as the 4Kx2K TV chips and then the next generation projector chips and how quickly will the ramp up starting in Q2?

Bruce Walicek

Yeah, thanks, Krishna. I think we have seen the seasonal pattern a couple of years running now and really based on what our customers are telling us in terms of working through the over into a situation experience in Q4 and sort of when they expect to have that work through, they are telling us roughly they are back on track going in the Q2. So it sort of seen the seasonal pattern couple of times it tends to be combined with sort of an inventory connection across and I think specifically we are seeing this centered around lot of Japanese customers as well. So specifically.

Krishna Shankar - ROTH Capital Partners

And would you see similar recovery in both the projector on the TV market or do you expect one to lead the other. And can you also talk about the prospects when new licensing in IP royalty streams going forward?

Bruce Walicek

Yeah, I think we will see it from both categories what is, it what is going to be a driving especially the TV category would be the PA168. I think we will begin to see some volume in Q2, but we see the volume ramping in the second half of the year. The PA168 the dollar content of those systems in 4Kx2K is about five to six times the dollar content that we had in systems with the PA136. So we will have the dollar content increase in addition to new products ramping.

Krishna Shankar - ROTH Capital Partners

And can you elaborate on your comments for high resolution video processing on tablets, small screens and what your activities are there, whether you can talk a little more about your development chip or licensing efforts.

Bruce Walicek

Sure. We are seeing as I mentioned in the commentary I think we are seeing a broad transition to higher resolution screens across just about all screens for the most part and I think we are just at the beginning of that trend. I guess we are not announcing products at this point right now. I think what we are discussing is how the relevant to video processing is pervading across not only large screens but the small screens as well and our technology and its importance in solving and creating great video quality. I think we are seeing that as a requirement across a lot of systems. We have a lot of interaction with the marketplace and need and requirements for video processing technology that we are encouraged by and I think as I mentioned on 2013, our intention is to focus our efforts on bringing our technology to solve those problems across all screens.

Operator

I would now like to turn the conference back over to management for closing remarks.

Bruce Walicek

Thanks everyone for joining us and we’ll look forward to discussing our Q2 2013 results with you on our next call.

Operator

Ladies and gentlemen that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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