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Pixelworks, Inc. (NASDAQ:PXLW)

Q2 2014 Earnings Conference Call

July 30, 2014, 5:00 PM ET

Executives

Bruce Walicek - President & CEO

Steve Moore - CFO

Analysts

Krishna Shankar - Roth Capital

Operator

Good day, ladies and gentlemen, and welcome to Pixelworks Second Quarter 2014 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, we will conduct a question-and-answer session. As a reminder, this conference call is being recorded for replay purposes.

I would now like to turn the call 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 second quarter ended June 30, 2014.

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, July 31, 2014, and we undertake no obligation to update any such remarks 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, 2013, 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 loss, and net loss per share.

These non-GAAP measures exclude stock-based compensation expense and additional amortization of a 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 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 our second quarter financial results, and then provide our outlook for the third quarter of 2014.

Bruce Walicek

Thanks, Steve. Good afternoon, everyone, and thanks for joining us today. Q2 2014 was another outstanding quarter of growth, as revenues of $15.2 million were up 59% year-over-year, driven by accelerating growth in our product business, which grew 42% sequentially.

All other metrics were solidly within the range of guidance, and we generated positive EBITDA and cash flow from operations for the quarter.

The strong start to 2014 continued in Q2 as overall book-to-bill was significantly greater than 1, with bookings at their highest level since 2009, reflective of good visibility going into Q3, driven by strong product demand, and the continuation of a strengthening overall environment at our customers.

During the quarter, we hit a number of key milestones, but most importantly, at Computex in June, we introduced and delivered silicon samples of our first device in a family of mobile video processors, code named Iris.

Iris is the industry’s first mobile video processor designed to bring the cinematic experience of large screens to mobile screens while enhancing system performance and lowering power consumption. It represents the culmination of several years of work to leverage Pixelworks’ technology and expertise in large screen applications to create the best video quality in mobile devices, and it positions the company to address a large market opportunity and ride the explosive third wave of video as resolutions and video consumption rise across all screens, increasing the importance of advanced video processing.

Historically, the level of dedicated video processing found in Iris, has only been applied to large screens, but we believe the time has come to apply this technology to all displays and Iris is seeing tremendous interest as companies begin to recognize the importance of video to the differentiation of their products.

By re-targeting our display processing and MEMC technologies for low power mobile devices, Pixelworks was able to produce this mobile video quality breakthrough, and Iris also offers several important system advancements that improve the overall mobile viewing experience.

Iris not only optimizes all aspects of the display that affect video quality, but it also incorporates contrast management and back light control for optimal viewing in any lighting condition.

Additionally, Iris works at the system level, improving battery life and freeing up valuable system resources, allowing designers to significantly reduce overall system power, improve performance, and enhance image quality to create the optimal viewing experience.

Each quarter that goes by reinforces our thesis of the growing importance of video processing driven by the explosive growth in mobile video, as the industry is beginning to recognize the need for video quality in mobile devices.

Video consumption on mobile devices is growing rapidly as consumers increasingly view their favorite content on their laptop, Ultrabook, tablet, or smartphone, and bypass the traditional TV screen. Recent studies confirm this trend, as changing patterns of viewing content drive explosive growth in mobile video.

Daily time spent on mobile devices is now outpacing TV in the U.S. for the first time and shifting demographics increasingly favor video consumption on mobile devices as well. A recent study by Rhythm Media noted that 72% of their overall audience watched video on a smart phone and 62% on a tablet, with 90% of Millenials viewing video on a smartphone and 77% on a tablet.

And Cisco’s Visual Networking Index Forecast points to the explosive growth in mobile video in the coming years. It notes that video is rapidly becoming the Internet’s killer app with video traffic predicted to leap to more than 63% of all Internet traffic by 2017, driving higher bandwidth requirements throughout the video ecosystem, and the study predicts that mobile video will increase 14-fold between 2013 and 2018 and account for over two-thirds of the world’s mobile data traffic and that there will be over 10 billion mobile-connected devices by 2018.

Sports are becoming a critical driver of the need for video quality as the real time nature and fast motion of sports content is especially in need of improvement. A study of 2014 World Cup soccer fans by Openwave Mobility noted that video quality was one of the main impediments to increased mobile video consumption.

As mobile screens become the first screen consumers watch, the same focus on video quality that has been applied to large screen projection and TV applications is now being brought to mobile screens, and mobile displays suffer from the same problems as large screens as higher resolution magnifies video quality issues, diminishing the consumer experience.

With the increase of resolutions and media consumption growing across all screens, users are demanding the best visual experience for their content, regardless of the screen they're viewing it on. In fact, we just released the first in a series of white papers that examine the dynamics of how individuals perceive high resolution on video displays.

The first paper in the series High Resolution Displays and Moving Images is now available on our website at pixelworks.com, and this white paper series is a compilation of independent research conducted by Pixelworks, as well as third-party research and articles that collectively advance the knowledge of how high resolution is perceived.

Also this quarter, Pixelworks will be speaking at the DisplaySearch Emerging Display Technologies Conference on August 5, in San Jose, California, where we will explore the benefits of high resolution screens, and how to achieve optimal performance to provide a satisfying, high quality video viewing experience.

We are just at the beginning of a multi-year trend of increasing display sizes, resolutions, and video consumption across all screens, and Pixelworks has a long history of delivering innovative video processing solutions for large screens, and have now brought that expertise and innovation to mobile screens as well, building on a 15-year legacy in video and a portfolio of over 120 issued patents, our latest technology represents the culmination of over a decade of video processing innovation.

As one of the last independent companies solely focused on video quality, we are continuing to drive an aggressive technology road map, especially for low power applications and continue to see increasing demand for video processing technology and licensing opportunities for all of our technology.

For projected and panel large screen display applications we continued to ship volume production of the PA168 during the quarter, which includes our patented halo free technology, and tackles the most demanding video quality problems in monitors and Ultra-HD TVs, and during the quarter we began shipping the mass production version of the advanced SOC for large screen applications we developed under our co-development partnership. This is a significant milestone on this project and we expect to ramp production in the second half of 2014 and beyond.

At Infocomm in Las Vegas in June, we demoed our latest VueMagic hardware and software solutions that transform how presenters engage with their audience and increase collaborative sharing of information in business and education environments.

VueMagic software provides wireless connectivity for mobile devices to Topaz-based projectors and adds features such as live video, as well as advanced content sharing capabilities.

We also introduced VueMagic Mate, which is a small Topaz-based dongle that transforms any display into a connected collaborative environment by enabling the features of VueMagic software. This product expands the market opportunity for Topaz to address the entire installed base of non-Topaz projectors, as well as extending our opportunity to large screen panel displays used in business conference rooms and digital signage applications.

Using the VueMagic app on mobile devices, multiple users can project information on a shared display, highlight key points or add additional information. VueMagic works over WiFi on smartphones, tablets, PCs and Ultrabooks and gives presenters the ability to interactively engage as a team.

We have an exciting roadmap of features and capabilities coming in 2014 for VueMagic that will continue to enhance and expand the Topaz platform and provide value to our customers.

In closing, Q2 continued the strong start to 2014 with overall revenues up 59% year-over-year driven by product revenues that were up 42% sequentially, and bookings at their highest level since 2009. At Computex in June, we introduced and delivered silicon samples of our first device in our Iris family of mobile video processors.

And during the quarter, we began shipping the mass production version of the advanced SOC for large screen applications we developed under our co-development partnership. We introduced exciting VueMagic software and VueMagic Mate that extends our market opportunity for our Topaz platform.

And finally, we strengthened our Board of Directors with the addition of David Tupman who has a long track record of success in mobile products and brings a unique customer perspective to Pixelworks.

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

Steve Moore

Thank you, Bruce. Revenue for the second quarter of 2014 was $15.2 million, up 12% sequentially and up nearly 59% year-over-year. The increase in revenue during the quarter was driven by strong chip sales, particularly in the projector market.

The split of our second quarter chip revenue by market was; 74% digital projection, 26% TV and panel. Digital projection revenue was $11.1 million in the second quarter, compared to $7.3 million in the prior quarter, as new products began to ramp in line with previous expectations. Revenue from TV and panel, which also includes Ultra-HD Monitors, totaled $4 million in the second quarter, compared to $3.3 million in the prior quarter.

Licensing revenue was approximately $100,000 in the second quarter, compared to approximately $2.9 million during the prior quarter.

Non-GAAP gross profit margin was 51% in the second quarter, compared to 60.1% in the prior quarter. The sequential decline in gross margin was primarily a result of a higher percentage of chip revenue in the quarter.

Non-GAAP operating expenses were $8.7 million in the second quarter, compared to $8.8 million in the prior quarter.

Adjusted EBITDA was a positive $182,000 for the second quarter, compared to a positive $464,000 in the prior quarter. A reconciliation of adjusted EBITDA to GAAP net loss may be found in today's press release.

On a non-GAAP basis, we recorded a net loss of $1.5 million, or loss of $0.06 per share, in the second quarter of 2014. This compares with non-GAAP net loss of $786,000, or loss of $0.04 per share, in the prior quarter.

Moving to the balance sheet, we ended the second quarter with cash and cash equivalents of approximately $20.9 million, compared to $21.9 million at the end of the first quarter. The company has no long-term debt and similar to the previous quarter, the company had a balance of $3 million on its working capital line of credit.

Other balance sheet metrics include days sales outstanding of 24 days at quarter-end, compared to 29 days at the end of the first quarter, and inventory turns during the second quarter remained in line with the previous quarter at approximately 12 times.

Looking ahead to the third quarter of 2014, we expect revenue to increase to a range of $16 million to $18 million, driven by a continued increase in chip sales. We expect gross profit margin for the quarter to range between 49% to 52% on a non-GAAP basis and 48% to 51% on a GAAP basis. In terms of operating expenses, we expect the third quarter to range between $9 million and $10 million on a non-GAAP basis, and $10 million and $11 million on a GAAP basis.

And finally, we expect non-GAAP third quarter net income of between breakeven and $0.11 loss per share, and we expect a GAAP net loss of between $0.05 and $0.16 per share.

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

Question-and-Answer Session

Operator

(Operator Instructions) And at the moment I’m showing one question coming from Krishna Shankar from Roth Capital. Krishna, please go ahead.

Krishna Shankar - Roth Capital

Bruce, and Steve, congratulations on the good results and outlook. I had a couple of questions on Iris. It’s very good to see the momentum and interest level you are seeing in the Iris mobile video processor chip. Can you talk about the timeline for the production ramp of the Iris chip and any design wins that you might have there in the mobile market?

Bruce Walicek

Design cycles in this market, and again, this includes smartphones, Ultrabooks, and tablets and each of these segments have a little bit different of a timeline but roughly they are the same. They are anywhere from six to nine months to 12 or much plus months depending on what kind of product, what kind of customer, so forth and so on.

So, I think we’ve always sort of said in terms of revenue and mass production, this is sort of [2050] [ph], but we’re seeing extreme interest in Iris right now and I’m very excited about sort of the initial feedback of the launch because it’s only a couple of weeks old right now.

Krishna Shankar - Roth Capital

And then, can you talk to the licensing and royalty pipeline, what you might have in terms of potential licensing opportunities over the near term and longer term also?

Bruce Walicek

I think I mentioned on the conference call we’re seeing sort of the increasing interest in licensing. I think in terms of sort of our opportunity set, it has certainly grown from the last time we talked to investors. Again, I want to frame potential licensing deals, they can range from below a million dollars to the kind of things that we’ve seen, that we’ve had the 8K before which are in the large range.

We have a range of video processing technologies that are encompassed by a number of different techniques and so forth that we bring together to really bring that video quality to a system. Sometimes there is pieces of this, or sometimes there is a holistic license that happens as well, so quite a wide range, but I’d say that we’ve seen increasing interest across segments in terms of our technology.

I think it’s a testament to a lot of the trends that I talked about, the intensifying need for this, based on the trends that we’re seeing, we talk about in this conference call just driving the demand for our technology.

Krishna Shankar - Roth Capital

And with regard to the 8-K that you filed in December regarding the large licensing contract, do you have any update on that in terms of activity with that strategic partner, the potentials for additional licensing or royalty or other kinds of revenues with that large strategic partner?

Bruce Walicek

I’m not going to single out any customers that we’re talking to or any talks that we have. I think that it’s fair to say that it’s well known who the big impact players are in the industry across these different segments that we focus on, I’d say we’re seeing really good interest on a number of fronts and corners of the various sort of market segments that we’re interested in from meaningful customers, I would say, in the industry, and I wouldn’t comment on any specific one. We’re seeing a lot of interest from various corners of the industry from meaningful customers.

Krishna Shankar - Roth Capital

The third quarter forecast guidance that you gave us does not include any significant IP licensing or royalty revenues in it?

Steve Moore

I think, Krishna, that you can come to that conclusion from a forecast standpoint. As you know, our IP revenue has been lumpy, will continue to be so. We do have some in our internal forecasts, but given the margin range that we gave, you can conclude that there is not a large amount. That would not preclude that from happening, but we chose not to include it in the guidance.

Krishna Shankar - Roth Capital

And then, turning to your large screen business, it sounds like your – you’ve just entered mass production of the custom platform for the large screen customer and can you talk about the potential ramp of that, how that’s going and then the outlook for the holiday season in terms of large screen TVs and 4K resolution?

Bruce Walicek

I think -- we’re pretty excited about that one. That was a very long project. It’s been a real great success for our customer and for Pixelworks, and as I mentioned, if that all schedules right on time and we sort of began mass volume production in the – begin to ship mass volume production in Q2.

I think we’ve been saying consistently over the last number of quarters as we talked about this that it will ramp in the second half of 2014 and beyond. This has been layered into products and so forth, so we’ll continue to see good acceptance of this for the balance of this year and into next year.

In terms of the season, it’s kind of early to predict. I think I will say and I’ve made this in the comments as well, that we’ve seen a pretty strong environment and I compare that relative to the last two or three years where – I think I said this last quarter too as well, where we saw a pretty significant weakening environment. I think we’ve seen sort of so far this year in 2014, the opposite of what we experienced last year in 2013.

Krishna Shankar - Roth Capital

So you are seeing good demand for your kind of large screen, the PA168 high-end TV processor chip globally from both the top tier OEMs in all regions, Japan, Korea and the U.S.?

Bruce Walicek

I’ll just talk about it across the application set. You talked a little about projection, but I mean it’s across sort of our large screen application set and yes we’re still seeing good success and opportunities in that segment as well as 4K begins to broaden out beyond TVs into monitors and other types of applications as well.

And again, I’ll point that we have a product line of video processors for large screen applications that are also not 4K as well, and those go into a lot of different type of applications like digital signage and things like that, so we’re still seeing a lot of good success there and pretty stable environment in those products.

Operator

Okay. Thank you. I would now like to turn the call back to management for closing remarks.

Bruce Walicek

Thanks everyone for joining us. And we'll look forward to talking to you on our next conference call. Thanks.

Operator

Okay. Ladies and gentlemen this does conclude your conference. You may now disconnect. And have a great day.

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