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Steve Moore - CFO

Bruce Walicek - President & CEO

Analysts

Krishna Shankar - Roth Capital

Pixelworks, Inc. (PXLW) Q4 2013 Conference Call February 6, 2014 5:00 PM ET

Operator

Good afternoon and welcome to the Pixelworks Incorporated Fourth Quarter 2013 Financial Results Conference Call. At this time, all participants are in a 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, February 6, 2014. I would now like to turn the conference over to Mr. Steve Moore.

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, 2013.

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, February 6, 2014, 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, 2012, and subsequent SEC filings for descriptions 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 discussion of certain measures and financial information in GAAP and non-GAAP terms including gross margin, operating expenses, net income loss and net income loss per share. These non-GAAP measures exclude stock-based compensation expense and additional amortization of a pre-paid 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 income 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 our fourth quarter financial results and provide our outlook for the first quarter of 2014.

Bruce Walicek

Thanks Steve. Good afternoon everyone and thank you for taking the time to join us today.

2013 was a year of significant progress for Pixelworks, as we finished up the year on a strong note with momentum across our product lines, and partnership initiatives. It was also an important year for validating our thesis of the growing importance of Video Processing technology and the need for video quality for all screens, as the megatrend of increasing resolutions across all displays accelerates.

Overall revenues for 2013 came in at $48 million, and while the year started on a sluggish note, 2013 had a strong finish with second half revenues and profitability up strongly over the first half, and we enter 2014 with significant momentum and an expanding set of opportunities.

2013 was a pivotal year for the company as we completed a number of key milestones that significantly improved our business, financial position and demonstrated our leadership in video.

In Q3 we closed a significant licensing partnership for our advanced video display technology, which validates Pixelworks' leading position in providing innovative video solutions. This is a major validation of our innovation, technology and expertise, and reinforces our thesis regarding the growing importance and need for video processing.

During the year, we completed key milestones on our co-development partnership to develop a highly integrated next generation SOC, as we delivered initial prototype samples in Q3 and taped out the mass production version in Q4.

We also completed a $10 million equity offering in Q3 that strengthened our balance sheet, significantly improving the financial strength of the company and putting Pixelworks in the strongest financial position in years.

We ramped the PA168 advanced video processor into volume production, leading the transition to Ultra HD 4K large screen displays.

We continued to see strong adoption of our Topaz platform for the projection market and expanded its capabilities with the launch of our VueMagic mobile application for Topaz based projectors.

And finally, we demonstrated our technology to improve the viewing experience of mobile screens, at Computex and CES, and positioned the company to ride the third wave of display technology requirements as the industry continues to create increasingly demanding display resolutions through 2014 and beyond.

Turning to the results for the fourth quarter of 2013, Q4 was another solid quarter, as revenues of $15 million were up 10% year-over-year, driven by growth in our product business which grew 12% sequentially, as well as the successful execution of our licensing and our co-development partnerships.

All other non-GAAP metrics came within the range of guidance, and we generated positive EBITDA, cash flow, and delivered basic earnings of $0.06 per share. Book-to-bill was greater than one, reflective of a seasonal strength and increasing visibility due to an improving overall environment at our customers'.

And during Q4, we taped out the mass production version of the advanced SOC we are developing under our co-development partnership, and we have delivered mass production samples for testing and qualification.

This is a critical milestone on this project and we are on track for volume production to begin in the first half of this year, which we believe will result in significant market share gains and be a key revenue driver for 2014.

We shipped volume production of the PA168 video processor, which includes our patented halo free technology, and handles the most demanding large screen 4K Ultra HD video quality problems. The PA168, which is based on our 6th generation video processing technology, makes the most of this new resolution standard by developing the best video quality in the industry. Traditionally this type of dedicated video processing pipeline has only been applied to large screens, but we believe the time has come to apply this technology to all screens.

Pixelworks has a long track record of delivering innovative video processing solutions for large screens and this year we will translate that expertise and innovation to mobile screens as well, and we are on track to deliver products in the first half of 2014.

6th generation PA168 level technology, is just one of the technologies we have in our video IP portfolio, and we continue to experience a solid licensing pipeline, which is indicative of the growing importance of our advanced video processing technology. With a portfolio of over 120 issued patents and a 15 year legacy of innovation in video, we intend to pursue an aggressive technology roadmap in 2014 and will continue to focus on developing our Intellectual Property in the critical areas of next generation video processing.

At the Consumer Electronics Show in January this year the clear overriding theme was the increase in resolutions across all screens from 4K Ultra HD large screens to high resolution mobile screens as well.

Resolutions are rising for all displays, and the products with highest resolutions are setting the bar for every other device in their category.

Today large screens are beginning their move to 4K Ultra HD resolutions with mobile screens just now moving to Full HD and rapidly transitioning to 2K retina like resolution with pixel densities of over 400 pixels per square inch. These high resolution screens have two to four times more pixels than today's Full HD displays, resulting in an exponential increase in the number of pixels to be processed. Higher resolution magnifies video quality issues, and it's clear that high resolution mobile displays suffer from the same video quality problems as large screens.

At the show in January, we demonstrated our seventh-generation technology, designed to improve the video display quality of high resolution mobile displays to key industry partners and customers. We provided a number of compelling side by side demos that illustrated the power savings, performance, and video quality benefits of our technology for mobile video.

While the capabilities of these high resolution displays are ahead of the quality of the content that can be delivered, we believe the time has come to apply large screen video processing technology to mobile devices and close the video quality gap with innovative video processing solutions designed specifically for mobile devices.

Video consumption on mobile devices is growing rapidly as the third screen mobile display is rapidly becoming the first screen consumers reach for to view their video content.

Here are a few examples that point to the trend. The online TV service Hulu reports that 2013 marked a watershed moment as roughly 50% of its now 5 million Hulu Plus subscribers are streaming video exclusively on mobile devices.

NBC is using the 2014 Winter Olympics to drive TV Everywhere services that allow cable and satellite TV subscribers to view live competition on mobile phones or tablets. And a recent market research study released at CES noted that 53% of consumers believe mobile devices like smartphones and tablets will replace television sets as the preferred way to watch TV and movies over the next eight years.

High resolution content is coming as well, indicated by the number of 4K content initiatives from Netflix, Sony, Amazon, Comcast and others that were announced at CES, and the growing amount of user generated content from the 4K capture cameras from Sony, GoPro, and others that are now available.

Video is a critical element driving the transformation of an expanding number of mobile devices, as more and more video is created and distributed, more devices are capable of displaying video, and more people are consuming video on a growing number and variety of screens.

According to DisplaySearch, the number of TVs, tablets, smartphones and Ultrabooks being sold will grow to beyond two billion devices by 2017 and all of these devices will be capable of playing video.

With the increase of resolutions and media consumption rising across all screens, users are demanding the best visual experience for their content, regardless of the screen they're viewing it on.

Screen resolution and display quality are key product features that increasingly will determine brand and product differentiation, as manufacturers compete for market share. Pixelworks has a long track record of solving the most difficult video quality problems for large screens, and because this is our sole focus, and we do it better than anyone, we are in the position to deliver the innovative solutions customers need to close the video quality gap for next generation high resolution displays.

In our projection product line, we demonstrated the power of the Topaz platform at CES with a number of compelling demos that showed its performance and mobile content sharing capability.

Mobile connectivity is a key feature for next-generation projectors, and our VueMagic app is designed to offer wireless connectivity for mobile devices to Topaz based projectors.

Topaz is receiving wide adoption, and we have an exciting road map of features and capabilities coming in 2014 for VueMagic that will continue to enhance the Topaz platform and provide value to our customers.

In closing, 2013 was a great year of progress and we finished the year on a positive note with a strong Q4 and we enter 2014 with significant momentum and an expanding set of opportunities.

During the year we achieved a number of key milestones that significantly improved our business, financial position, and validated our leadership in video processing technology. And we have positioned the company to address a large, fast growing market opportunity as we demonstrated our seventh-generation technology for mobile applications, and are on track to introduce products in the first half of 2014.

Now, I'd now like to turn the call over to Steve to review the financial details of the quarter.

Steve Moore

Thank you, Bruce. Revenue for the fourth quarter 2013 was $15 million, compared to $15.3 million in the third quarter of 2013. As Bruce mentioned, revenue during the quarter reflected increased chip revenue across the company's product lines compared to the third quarter, offset by sequentially lower licensing revenue.

The split of our fourth quarter chip revenue by market was: 67% digital projection, 25% TV and panel, and 8% embedded video display. Licensing revenue was $3.2 million in the fourth quarter, compared to approximately $4.8 million during the third quarter of 2013.

Revenue from digital projection in Q4 was up 20% sequentially to $7.9 million on strong demand across our customer base.

Revenue from TV and panel grew for the third consecutive quarter, increasing to $2.9 million in the fourth quarter. The ongoing ramp of our PA168 for Ultra High Definition televisions and positive seasonal demand continued to support growth in this market.

Embedded video display revenue in Q4 was approximately $900,000.

Non-GAAP gross profit margin was 57.8% in the fourth quarter, compared to 61.6% in the prior quarter. The sequential decline in gross margin was primarily driven by lower licensing revenue.

Non-GAAP operating expenses were $7.1 million in the fourth quarter, compared to $7 million in the third quarter of 2013. Operating expenses for both the third and fourth quarter of 2013 include a reimbursement credit to research and development expense as the result of achieving certain milestones related to our previously announced co-development agreement.

As we discussed in prior quarters, the chip created as a part of this co-development agreement is expected to result in revenue beginning in the first half of 2014.

Adjusted EBITDA was $2.7 million for the quarter, compared to $3.5 million in the third quarter. A reconciliation of adjusted EBITDA to GAAP net income/loss may be found in today's press release.

On a non-GAAP basis we recorded net income of $1.3 million, or $0.05 per diluted share, in the fourth quarter of 2013. This compares with net income of $2.1 million, or $0.10 per diluted share in Q3.

Moving to the balance sheet, we ended the quarter with cash and marketable securities of approximately $20.8 million, compared to $21.5 million at the end of the previous quarter. The company has no long-term debt and a balance of $3 million on its working capital line of credit.

Other balance sheet metrics include days sales outstanding of 29 days at December 31, compared with 15 days at the end of the prior quarter, and inventory turns of 12.9 times in Q4 compared to 11.3 times in the third quarter.

Guidance. Looking forward to the first quarter of 2014, we currently expect revenue to reflect normal seasonality and be in the range of $12 million to $14 million. At the midpoint this would represent growth of over 50% compared to the year-ago March quarter.

 

We expect gross profit margin for the quarter to range between 57% to 59% on a non-GAAP basis and 56% to 58% on a GAAP basis.

In terms of operating expenses, we expect the first quarter to range between $8.5 million and $9.5 million on a non-GAAP basis, and $10 million to $11 million on a GAAP basis. We will not record any R&D reimbursement credits in the first quarter of 2014.

And finally, we expect a non-GAAP first quarter net loss of between $0.02 and $0.09 per share; and we expect a GAAP net loss of between $0.09 and $0.18 per share.

That concludes my comments. We will now open the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we have a question from the line of Krishna Shankar with Roth Capital.

Krishna Shankar - Roth Capital

Yes, Bruce and Steve congratulations on a nice 2013. And as you look for the first quarter for 2014, you indicated normal seasonality and you did also say that the co-development project was sort of in the production ramp stage. Can you talk about the revenue profile beyond Q1 as this major customer ramps up their products? And also what kind of demand trend you're seeing for your TV chip in the Ultra High Def TV marketplace?

Bruce Walicek

Quite a number of questions there but the Q -- we don't give guidance beyond Q1 but we have indicated that we do expect a ramp starting in the first half of the year for the co-development chip. And we've said a number of times that that chip will result in significant revenue, in the last half of the year, although we do expect revenue within the first half of the year related to it.

The general demand from both our projection customers and TV customers is seasonally normal, strong given the season and we continue to work on design wins in those areas.

Steve Moore

Yes, there is normal consumer cycle in terms of seasonality and then at least for our Japan customers listen the first calendar quarter is their fiscal fourth quarter which is typically a seasonally weak period for them at the end of their fiscal year as well.

Krishna Shankar - Roth Capital

And then can you give us an update on the recent $10 million IPV licensing deal? How the milestones for that project are coming along and what you will recognize there in terms of revenues in the first quarter? And Bruce, you also said you had a healthy pipeline. Can you perhaps comment a little more on the nature of deals that you may have in the pipeline?

Bruce Walicek

Yes, let me get the last one first. We don't break that out and we kind of don't really go into detail as to who those people might be or what the configuration of those deals might be. But I just I guess I make that comment in -- with regard to what we're seeing in the marketplace in terms of kind of the demand, what I call the demand for video processing technology. But I think that it's really sort of indicator and a testament to the importance of being able to really produce efficient, low power high quality video on a growing number of platforms not just the large screens as well. So I think we're seeing opportunity across all those streams and in various forms. I also mentioned that we have a nice portfolio, video IP in addition to what I would call 168 class IP as well.

Steve Moore

From that the $10.3 million license and services deal we had indicated earlier that we expected most of that to be recognized over six to nine months and we're now through six months of that. So we do expect another tranche of it within the first quarter.

I would indicate that we do have other licensing opportunities and deals that we continue to work on and would also expect to recognize within 2014.

Krishna Shankar - Roth Capital

And then my final question. At CES you had some good demos of the mobile video processor chip; can you talk about the timeline for but in terms of getting that prototype to set up a production pit box and the opportunity there for design wins and revenues?

Bruce Walicek

Yes, so as I mentioned in my commentary we're expecting to introduce products, silicon products into the market in the first half of the year. I would characterize where we are, is on track with that development. And I think we've been heartened by the level of reception and level of interests that we have in bringing a solution like this to mobile platform as well. So we're pretty excited about it.

Operator

And there are no further questions at this time.

Bruce Walicek

Thank you all for tuning in and we'll look forward to talking to you on our Q1 2014 earnings announcement conference call. Thank you.

Operator

This does today's conference call. You may now disconnect.

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