Pixelworks' (PXLW) CEO Todd DeBonis on Q4 2016 Results - Earnings Call Transcript

| About: Pixelworks, Inc. (PXLW)
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Pixelworks, Inc. (NASDAQ:PXLW) Q4 2016 Earnings Conference Call February 2, 2017 5:00 PM ET

Executives

Todd DeBonis - President and Chief Executive Officer

Steve Moore - Chief Financial Officer

Analysts

Brian Alger - ROTH Capital

Jaeson Schmidt - Lake Street Capital

Jessica McHugh - Dougherty & Company

Richard Shannon - Craig-Hallum

Operator

Good day, ladies and gentlemen, and welcome to Pixelworks’ Fourth Quarter 2016 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. 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 today. With me on the call is Todd DeBonis, Pixelworks’ President & 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 and fiscal year 2016.

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 2, 2017 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, 2015 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, and net income loss per share. These non-GAAP measures exclude stock-based compensation expense, additional amortization of a non-cancellable prepaid royalty as well as certain charges related to the Company's announced restructuring in the first half of 2016.

We use these non-GAAP measures internally to assess our operating performance. The Company believes that 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.

With that said, I will now turn the call over to Todd for his opening remarks.

Todd DeBonis

Thank you, Steve, and good afternoon to everyone on today’s call. As outlined in today’s press release, we achieved another consecutive quarter of meaningful improvement to both our top and bottom line results.

Fourth quarter revenue increased 17% sequentially and 19% year-on-year to $16 million, reaching the high-end of our guidance range. Gross margin expanded 500 basis points over the prior quarter and OpEx was well contained during the quarter.

As a result, Pixelworks achieved profitability in the quarter on both the GAAP and non-GAAP basis for the first time in over three years. Additionally, we generated $3 million in cash from operations, which significantly exceeded our stated goal earlier in the year to achieve cash flow breakeven by the fourth quarter.

The profitability and cash flow generated in Q4 demonstrate the significant progress we have made over the last few quarters to enhance our operating model and dramatically improve the company’s underlying fundamentals.

Importantly, I want to emphasize that these results do not reflect the pulling of the EOL or End of Life revenue. And that we are now fully booked to recognize in the first half of 2017.

I will let Steve provide the details on our updated EOL revenue expectations. However, the contribution from these End of Life products will ultimately add approximately $8 million in non-dilutive capital to our balance sheet over the next two to three quarters.

For those of you that have been following Pixelworks for a while, this is a different company than even one year ago. As we look back over the past year, we took a number of important steps that have fundamentally changed the business. Most notably, we meaningfully reduced our expense run rate and we also streamlined our product portfolio to focus our sales organization on high-value, higher margin products enabling the company to substantially increase its strategic focus.

With this stronger foundation now in place, our goal going forward is to deliver year-over-year revenue growth excluding the anticipated EOL contribution while maintaining a goal of profitability throughout 2017.

Now, let’s shift to an update on the underlying businesses and respective end-market commentary. First, in our projector business, order patterns and overall demand was strong across a wide group of customers reflecting a continued normalization of the market following the previous inventory and supply chain disruptions experienced in early 2016. Additionally, our most recent indications would suggest that the supply chain remains relatively tight with potential slack inventory being below average and at a healthy level as we enter 2017.

Also, I’d like to mention our completed streamlining of this business one last time, which included the EOL for certain legacy projector chips in our portfolio. Consistent with prior expectations, we have experienced nearly universal acceptance of our proposed product transitions aimed at converting customers towards higher value products. This results in a net favorable impact to ASPs and margins over the intermediate to longer term.

Consistent with both our comments, last quarter and our first quarter guidance, our interpretation of recent customer order patterns and inventory in the channel, we continue to expect and model internally for an effectively normal revenue cycle with a typical seasonality in 2017.

Now, turning to the mobile business, with the level of activity as well as the quality of engagements with prospective mobile OEM customers has increased noticeably over the past several months, following the additions we made to our sales team in the second half of the year.

Revenue contribution from mobile was still modest in Q4 but slightly higher compared to prior quarters. As we continue to shift volume product in support of multiple ASUS devices.

As part of our recent activity, we have been increasing the sampling of our third generation Iris processor with a targeted list of select Asia OEMs. The level and scope of our discussions with these OEMs has advanced significantly. And I’m more convinced than ever that we have the right people and sales team in place today and they are focused on the right levers to drive incremental adoption of Pixelworks’ mobile technology.

More specifically as part of these engagements with OEMs, we’re actively pursuing a number of potential new opportunities on mobile devices. And as stated last quarter, our current sampling of the third generation chip gives us a potential to win designs on higher unit volume mobile devices, some of which are targeted for launches in the second half of 2017.

Although feedback to date, from these OEMs continues to be both constructive and encouraging. I want to be clear that it is still too early to declare victory. Regardless of the outcome of these existing engagements, we’re continuing to develop advanced new features and functionality to enhance the value proposition of our Iris processors while simultaneously working to minimize the common designing hurdles accounted by mobile OEMs.

Importantly, as we continue to make meaningful progress on our dual go-to-market strategy aimed at monetizing Pixelworks’ technology beyond pure device sales. As discussed on previous calls, we believe that seeding intermediate to longer term opportunities through proactive conversations with potential partners as well as other players in the ecosystem is complementary to our device strategy.

Although many of these conversations are still in the early stages, today we are actively engaged with a diverse set of future potential partners and/or customers across the broader mobile and video streaming ecosystem. These include ongoing discussions with mobile SSC companies, DDI and panel manufacturers and creators of original video content as well as companies looking to deliver high quality over-the-top streaming video to almost any device connected to the internet.

It is too early to note which or if any of these conversations might be the commercial engagements. However our plan is to begin highlighting some of the Pixelworks’ technology behind a few of these applications over the next couple of quarters.

To conclude my remarks, we exited 2016 with very solid results and we’re starting off 2017 with better fundamentals in place than the company has had in a number of years. Even more encouraging, I’m confident we have every indication that the year ahead will be a profitable growth for Pixelworks.

In our core projector business, we fully expected delivery year-on-year growth with a bias towards higher margins and we’re also well positioned to capture incremental market share throughout the year. And in mobile, although it is always difficult to predict the exact timing of technology adoption, I can tell you that we have a highly accomplished group of individuals that are very focused and excited about converting current engagements into revenue generating customers.

As 2017 unfolds, I look forward to updating you on our progress, on driving broader adoption of Pixelworks technology across a greater number of customers and video centric applications.

With that, I’ll turn the call over to Steve to review our fourth quarter financials and guidance for the first quarter in more detail. Steve?

Steve Moore

Thank you, Todd. Revenue for the fourth quarter of 2016 was $16 million compared to $13.7 million in the third quarter. The sequential improvement in Q4 revenue primarily reflects increased sales of chips sold into our digital projection market as the demand strengthened and the market returned to more normal order patterns from the previous quarter’s supply channel disruption.

The breakdown of revenues during the fourth quarter was as follows: revenue from digital projection was approximately $14.4 million; mobile revenue was approximately $390,000; and revenue from legacy chips sold into the TV panel market was approximately $1.2 million.

Non-GAAP gross profit margin was 53.6% in the fourth quarter of 2016 compared to 48.6% in the third quarter of 2016. Gross margin was higher quarter-on-quarter primarily due to a more favorable revenue mix specific to products sold into the digital projection market.

Non-GAAP operating expenses were $7.3 million in the fourth quarter of 2016 compared to $6.8 million in the third quarter of 2016. Adjusted EBITDA was $2.1 million for the fourth quarter of 2016 compared to $670,000 in the third quarter of 2016. A reconciliation of adjusted EBITDA to GAAP net income loss may be found in today's press release.

On a non-GAAP basis, the Company reported a net profit of $1.2 million or $0.04 per diluted share in the fourth quarter of 2016 as compared to a non-GAAP net loss of $430,000 or a loss of $0.02 per share in the prior quarter.

Moving to the balance sheet, we ended the fourth quarter with cash and cash equivalents of approximately $19.6 million, an increase of $3 million from the end of the third quarter largely reflecting positive cash flow from operating activities during the fourth quarter.

Other balance sheet metrics include day sales outstanding of 18 days at quarter end compared to 26 days at the end of the third quarter. Inventory returns during the fourth quarter increased to 10.1 times, compared to 8.7 times in the prior quarter.

Turning now to guidance, for the first quarter of 2017, we expect revenue to increase to a range of between $22 million and $23 million. This range reflects our expectation for a sequential decline in projector revenue that is consistent with typical seasonality in our core digital projection business offset by approximately $9 million in End of Life revenue. We expect revenue from mobile to be roughly flat with the last quarter.

EOL revenue in Q1 2017 will be approximately $2 million higher than previously expected due to additional orders that we received and accepted after the original EOL deadline. For Q2, we continue to expect EOL revenue in excess of what we would otherwise be our normalized quarterly revenue to be approximately $5 million as previously discussed. Note: we do not expect any meaningful EOL revenue after Q2 2017.

We expect gross profit margin for the first quarter to be in the range of between 53% and 55% on both a GAAP and a non-GAAP basis. In terms of operating expenses, we expect the first quarter to range between $9 million and $10 million on a GAAP basis and between $8 million and $9 million on a non-GAAP basis. Operating expenses will be higher in the first quarter of 2017 compared with our expected run rate in subsequent quarters primarily due to additional expenses we plan to incur related to the development of the next generation chip.

As a result, we expect first quarter GAAP net income to be in the range of between $0.05 and $0.12 per diluted share and we expect non-GAAP net income to be in a range of between $0.08 and $0.15 per diluted share.

With that, we will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Brian Alger with ROTH Capital. Your line is open.

Brian Alger

Hi guys, good afternoon. Congratulations.

Todd DeBonis

Hi Brian.

Brian Alger

A remarkable turnaround guys, this is obviously better than, frankly I dared to hope for. Just a clarification, in the fourth quarter you had a little bit of revenues still coming from the TV market. As we go forward, is that part of the End of Life products that were phasing out?

Todd DeBonis

Yes, anything that was TV, panel, monitor would be considered End of Life. In Q4 that was about $1 million, $1.2 million I believe. We will see through the end of Life process revenues in Q1 and Q2 related to it. But after Q2 we’ll see no more of that revenue.

Brian Alger

Right, okay. Just understood. And then of the $9 million in the first quarter, is that all product that used to be in the TV embedded space or was some of it owing to the transition and of the projector space and to call the higher value products?

Todd DeBonis

It’s both. The projector market included chips that we’ve been selling for more than 10 years. And all those legacy chips have replacement chips that have better functionality and often are at a higher ASP but focusing mostly on better functionality.

Brian Alger

Okay, great. And shifting gears to the more exciting part Todd, you had a little bit of commentary with regards to the progress in the mobile space and engagements that you currently have underway. Can we push that a little bit, it sounded like you already at least have towards the sales funnel some opportunities that could trigger in the second half?

Todd DeBonis

We are chasing opportunities that if they were converted, the phone OEMs intend is to release them in the back half of 2017. We have not won them yet, more engaged.

Brian Alger

Are these, can you maybe give a characterization of the type of products or are these low-end phones, high-end phones, high volume niche in any sort of?

Todd DeBonis

Yes, I think I previously commented that for the functionality we’re adding, and partly what we do is really bring out the visual capabilities of a higher end display, those higher end displays would not be in a low-end phone. So by definition of what we do and the value-add we bring, we are targeting higher end of the market for smartphones.

Brian Alger

Great. Well, obviously keep up the good work. It’s been impressive thus far.

Todd DeBonis

Thank you.

Operator

Thank you. Our next question comes from the line of Jaeson Schmidt with Lake Street Capital. Your line is open.

Jaeson Schmidt

Hi guys, thanks for taking my questions. Just kind of following up on that last question on the mobile side. Could you just kind of give us some color around what the main push-back tends to be from your customers on integrating your technology?

Steve Moore

Sure, power consumption.

Jaeson Schmidt

And that really is the only kind of push-back you’re seeing out there?

Todd DeBonis

We see lots of push-back you said what the main push-back was. You want me to be more specific I’ll give you specific answer if I can.

Jaeson Schmidt

Okay. Just shifting to OpEx then, Steve, how should we think about OpEx trending this year?

Steve Moore

Well, Q1, we’ve guided to a higher number, mid-point about $1 million higher from last quarter. That is now our run rate level. And we would expect our run rate levels to be perhaps a bit higher than Q4 but more in Q4 kind of range. There is certain lumpiness depending on what we wind up doing in chip development. But largely we have an understanding of where our expenses are, where they’ll be, what remains to be seen is what chip we’re going to do at what time later in this year. But from a modeling standpoint I would stick with that information.

Jaeson Schmidt

Okay. Thanks a lot.

Todd DeBonis

Thanks Jaeson.

Operator

Thank you. And our next question comes from the line of Jessica McHugh with Dougherty & Company. Your line is open.

Jessica McHugh

Hi there, congrats on the quarter. Thanks for taking my questions. Could you just talk about Todd over the next 12 to 18 months what are the major demand drivers for the Iris chip?

Todd DeBonis

Our Iris mobile processors?

Jessica McHugh

Yes.

Todd DeBonis

Well, as what ASUS is trying to do and what other Marquee tablet manufacturers are doing on how they market display technology and video technology, we are seeing the need or at the need, the wish of Marquee smartphone manufacturers who want to differentiate their phones with the same video and display imaging capabilities. And so, our processor provides those benefits.

Some of the features we offer on our processor, but not all can be offered either by on the apps processor side or on the DDI side. And so, the still manufacturer is figuring out the best, how much of the features and functionality we add, do they need to have in the next phone. And whether they can suffice with what’s being offered without adding Iris.

But if they want all of those features and they want the support that they get through a Pixelworks’ engagement, the only way to do it is to put our chip, and there is really no competition for our bridge chip period.

So that’s what it comes down to. And you will see launches as soon as within two to three months of Marquee smartphones that my bet is they will be highlighting some of these display features and functionality we’ve been talking about for probably 18 months. It’s starting to come out.

That doesn’t mean there are processors in enabling those features but that does mean that the market has finally arrived.

Jessica McHugh

Okay, great. And then could you also talk about the gross margin strength and what’s driving that?

Steve Moore

Sure. In Q1, we’ve got it to much higher gross margins than we’ve experienced in the past. And that’s being driven by a number of things. One; is the ASPs somewhat stronger, due to the restructuring and that will continue.

The other is just the level of revenue causes an absorption effect that will be experienced as long as our revenues during the $20 million level. I think at a more normal projector run rate and just their regular run rate we will not be seeing our gross margins in this range but we will be seeing them above our former range which last year we almost always forecast $48 million to $50 million and started to creep up to $50 million to $52 million. I think the $50 million to $52 million is solid and can be improved on that particularly with volume causing bit of absorption.

Jessica McHugh

Okay. Thank you very much.

Operator

Thank you. Our next question comes from the line of Richard Shannon with Craig-Hallum. Your line is open.

Richard Shannon

Well, hi Todd, thanks for taking my questions as well. I’m going to follow-up on a couple of questions that Jaeson asked you a little bit ago. I think Todd, you responded with this first one regarding the biggest issue is power consumption. I’m curious if that is an issue that’s holding people back, I guess you mentioned some engagements that could come to the forum in the second half of the year?

Are you planning other ways to solve those issues or are they not as big of a deal for this particular set of customers or just to understand how you overcome that issue where with your current Iris chip?

Todd DeBonis

I said that it was a headwind I didn’t say it completely prevented us from getting design wins. But this is - what it becomes is if you look, if you’re designing a smartphone that has a cost structure of I don’t know between $250 and $400 and you’re going resell between $400 and $600, right.

As the system designer you want to come out with camera display, processing, memory capabilities, audio capabilities that match with other Marquee phones. And you want to do this and offer a day of use as long as possible. And as the screens get bigger you can put bigger batteries in them. But there is a limit to large screen, large screen, you start to hit a limit where it’s considered a tablet right, and people don’t want to have this large device that they carry around with them every day. So, there is probably a theoretical limit, I think the high volume is upwards of 5.5 inches, right.

When you’re designing those kinds of phones, there is a limit on how big the battery can be and then how the larger the PCB the smaller the battery, so there is a trade-off. So, the device, the PCB and when it goes on the PCB is Manhattan real-estate or probably New York real estate today or San Francisco real estate, right, it’s very expense real estate.

And so, you are trying to convince the person that’s designing that phone that the features and functionality your device brings are worth giving it the real-estate because that means other things don’t go in that real-estate, right, there is trade-off requirements so that’s part of it.

The other part of it is, do they - do you contribute to a day of use in power consumption? And are the benefits that you bring worth the trade-off on the power consumption. So it’s not just Pixelworks that battles the fist. It’s anybody that’s putting what I will call discretionary ICs down on that PCB.

Now there are non-discretionary ICs, the RF guys, my old company had the luxury of selling into a market that you have to have certain devices to communicate, same thing with Qualcomm, with their modems.

So, but people that are putting discretionary technology on the board you have to go and convince these people that the market sees the benefit of the value-add you’re bringing and it is worth them to give you some of that real-estate and some of their day of use on the power consumption.

And so that is our responsibility. Now there are two ways for that to happen. One; is the market itself and leaders in the market and you guys know who the leaders are, right. Come out and say these technologies are important worth including them in our next generation phones and then everybody else follows, it’s a must have.

So, something like Pixelworks waits for that to happen okay, and we’re an alternative or a better alternative for the followers to support or we go out and try to convince the market or some of the market to be leaders.

For the last year, we have been trying to convince the market to be leaders. I’m hoping in 2017 we’re going to get a little back-draft from some of the leaders and innovators in this business. So, hopefully that articulated it for you and you understand the challenge we have there.

Richard Shannon

That certainly makes a lot of sense. Todd, to that last point, you’ve been clear as you’ve come in to lead the company and reconstructing your sales force, the focus mostly on Asian OEMs. Outside of the big Korean maker I guess particularly looking at China they’re not necessarily, historically viewed as leaders in technology although I think that maybe changing. Do you see some of these previously ME-2 companies mostly in China to become one of those leaders?

Todd DeBonis

So, I’ll tell you outright, I’ll call names out, Huawei is a technology leader. Oppo and Vivo are becoming technology leaders. LG has innovated in the past they may do so again, right. And the two big guys are Samsung and Apple. For the most part and last couple of years, only - primarily innovation came at Apple, Samsung started to deliver it.

With the Note 7, they did add these capabilities or some of these capabilities and they were the first company to offer the ability to view HDR content in conjunction with Amazon Prime on the Note 7, the only smartphone that allowed it. So, you couldn’t, any smartphone you pick up, if you go to Amazon Prime and look at their content, you can’t view UHD, HDR content because you haven’t been proved as a phone.

The Note 7 was the only phone approved as of the end of 2016. Shame it was pulled from the market, it was a beautiful phone. Samsung and Apple are the leaders. They’re the guys that innovate but they also spend money on their own technology, we’re focused elsewhere.

It doesn’t mean we wouldn’t do business with those guys, but it may be in a different form of our Iris processor.

Richard Shannon

Okay. Fair enough. Todd, those were great feedback. I appreciate hearing that from you. Maybe just one last question from me more for Steve, actually maybe Todd this was in your prepared remarks. But I think you said you expect to be profitable each quarter this year, seems pretty easy with in the first half, I just want to confirm that you expect that in each of the quarters in the second half as well?

Steve Moore

I think what Todd said was that our goal is to be profitable throughout the year. And that is certainly our goal but we’ve not given guidance to that.

Richard Shannon

Okay. Fair enough. I think that’s all my questions for now. Thanks for taking them. Thanks guys.

Todd DeBonis

Thank you.

Operator

Thank you. And I’m showing no further questions at this time. I’d like to turn the call back to management for closing remarks.

Todd DeBonis

Listen, thanks. It’s been an interesting quarter we did have some things go favorably for us in the quarter that made the turnaround happen a little bit quicker than we anticipated. I think we’re in a good position. I feel good about our prospects in 2017. There is still lot of work to do. Thanks for joining the call. We’ll hopefully update you with some more good news in the future.

Operator

Ladies and gentlemen thank you for participating in today’s conference. This does conclude the program. And you may all disconnect. Everyone have a wonderful day.

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