Steve Moore - CFO Todd DeBonis - President and CEO.

Richard Shannon - Craig-Hallum Charlie Anderson - Dougherty & Company Jason Smith - Lake Street Capital.

Good day, ladies and gentlemen, and welcome to Pixelworks’ Third Quarter 2018 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 Pixelworks’ CFO, Mr. Steve Moore. Please begin..

Good afternoon and thank you for joining us today. With me on the call is Todd DeBonis, Pixelworks’ 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 third quarter 2018.

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, November 1, 2018, 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, 2017, 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 and net income loss per share.

These non-GAAP measures exclude deferred revenue fair value adjustment, inventory step-up and backlog amortization, amortization of acquired intangible assets, stock-based compensation expense, restructuring expenses, discount accretion on convertible debt fair value, extinguishment of convertible debt, fair value adjustment on convertible debt conversion option and acquisition and integration cost.

With the exception of stock-based compensation, all of these adjusting items are related to the acquisition and integration of ViXS Systems. 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..

Thank you, Steve, and good afternoon to those joining us on today’s call. As reported in today’s press release, consolidated third quarter revenue was up over 11% sequentially and grew more than 14% year-over-year to $21.5 million, reflecting growth across all three of our end markets.

Gross margin and earnings per share were both at the high end of our guidance range, with gross margin expanding 200 basis points sequentially to 54.7% and EPS improving by $0.07 over the prior quarter.

In addition to delivering our commitment of ViXS being accretive to earnings in the third quarter, we were profitable on both GAAP and a non-GAAP basis and we generated over $3.5 million in cash flow from operations. Turning to updates of each of our end markets and starting with our core digital projector business.

Consistent with seasonal trends in the projector market, revenue was up mid-single-digits in the third quarter, which followed the significant sequential growth we reported in the second quarter. Customer demand and order patterns were broadly spread across several major accounts and channel inventories remained relatively lean exiting the quarter.

Additionally, we recently completed the final development milestone of our co-development agreement with our large projector customer, resulting in recognition of nearly all of the remaining $2 million offset to R&D expenses during the third quarter.

I am proud of our team’s solid execution on this multi-year development project, which generate sustainable long-term business from our co-development customer as well as intellectual property that can be leveraged across multiple other projector customers.

I want to emphasize that while we remained on track to release this next generation projector SoC for production by the end of the year, we anticipate our customer’s transition to this new chip across their product portfolio will be gradual and take place over the course of 2019 and into 2020.

Turning to video delivery, we had a very strong quarter with revenue growing 70% sequentially. As expected, this strength was primarily driven by the ramp in shipments of our XCode transcoders to consumer electronic OEMs in advance of the anticipated TV broadcast transition in Japan.

As a result of this growth, combined with our previous actions to streamline the business, the video delivery business was accretive to earnings in the third quarter.

As discussed on prior calls, Pixelworks is well positioned on multiple customer programs in Japan that incorporate our XCode family of processors in their next generation consumer devices specific to the anticipated rollout of the new TV broadcast standard in Japan, which supports over-the-air terrestrial broadcast in 4K and HDR quality.

Pixelworks’ advanced decoding and transcoding SoCs are designed into do a series of both converter boxes as well as full PVR DD set top boxes. This broadcast transition is scheduled to go live in December of this year and our customers are expected to result in a meaningful upgrade cycle.

As Japanese consumers, especially those that have existing 4K TVs purchase compatible new equipment in order to view the higher quality broadcast signal.

In anticipation of this demand, our customers have announced a combination of converter boxes and full feature set top box devices utilizing one or more XCode processors that we’ll start shipping this month. The second area of focus in our video delivery business is over-the-air broadcast or OTA market, primarily here in the U.S.

As highlighted on our conference call last quarter, our transcoding SoCs continue to be designed into new OTA streaming products such as the AirTV and Nuvyyo’s Tablo family of OTA DVR solutions.

In September, AirTV launched and added local channels’ DVR functionality for both new and existing AirTV customers, which is powered by Pixelworks transcoding technology. This new feature allows users to watch live and recorded local channels both inside and outside of the home with no monthly subscription required.

In addition to enabling the DVR recording and playback functionality on the AirTV device, our proprietary transcoding technology provides a number of critical benefits, including preserving the HD picture quality of the recorded content, optimizing the bandwidth needed for wireless streaming to connected display devices and also reducing the storage capacity required to save recorded HD quality content.

More broadly, there continues to be a growing market for alternative video platforms that incorporate the ability to access, stream and record OTA broadcast content. As evidenced, both TiVo and Amazon recently launched new devices that support OTA functionality.

Although we believe that neither of these devices match the performance of Pixelworks’ transcoding technology, they each serve as further validation of the broader market opportunity, while helping to increase the awareness of OTA among consumers.

In fact, as a key enabler of OTA streaming devices with our leading transcoding technology, Pixelworks is actively pursuing innovative ways to educate and promote consumer awareness for OTA solutions.

During the quarter, we announced Pixelworks’ collaboration with a group of leading innovators in video display and delivery to launch a shared branding initiative called FlexVU.

As growing number of consumers cut the cord on traditional cable and satellite subscriptions, the seared objective of the initiative is to promote and help consumers select the most seamless and high performance cord-cutting solutions by simplifying the ecosystem enhancing the over-the-air and over-the-top video experience for consumers.

We believe Pixelworks and our FlexVU partners will collective benefit from the increased awareness and adoption of best-in-class OTA solutions. Shifting to mobile, we demonstrated notable traction during the quarter with revenue growing 33% sequentially and 400% year-over-year, driven by increased volume production orders of Iris mobile processors.

Although still building from a relatively small base, the trend is significant as we delivered our fourth consecutive quarter of revenue growth in mobile. Since our Q2 conference call, we’ve announced three wins on newly launched smartphones.

First in September, ZTE launched its Axon 9 Pro smartphone, incorporating our 3rd Generation Iris Processor, featuring Pixelworks’ industry-leading MEMC or motion estimation motion compensation process technology.

Then, in October, Nokia launched the Nokia 7.1, becoming the first smartphone to incorporate Pixelworks’ 4th Generation Iris Processor together with Qualcomm 636 Apps Processor.

In addition to fully leveraging our most advanced SDR to HDR technology, our 4th Gen Iris enabled the Nokia 7.1 to join the exclusive list of devices that are HDR certified by Amazon. Most notably, about the 7.1 is that it incorporates flagship quality display technology, while being priced and positioned as a mid-tier global smartphone.

More specifically, the Nokia 7.1 serves as a commercial validation of the Expanded SAM opportunity for Pixelworks’ mobile processing technology in mid-tier smartphones. Conservatively, this effectively doubles the previously addressable unit potential of the flagship market segment.

Most recently we announced that Xiaomi Black Shark had incorporated the Pixelworks’ 3rd Generation Iris Processor into the Black Shark Helo, their latest smartphone targeted for avid gamers.

Following the significant notoriety and demand received on their inaugural gaming phone, Black Shark’s decision to again choose Pixelworks for its newest generation smartphone is a testament to the value proposition of our advanced image and video processing technology as well as the extensive product and engineering support that we provide our mobile customers.

Unique to Black Shark Helo is a recently expanded capability we now offer with our 3rd Generation processor which enables always HDR mode, previously only available on our 4th Generation. This capability adds Pixelworks’ proprietary real time SDR to HDR conversion technology to the features offered in the 3rd Generation Iris.

Our growing number of announced wins is driving increased customer interest in Pixelworks industry-leading display processing technology, which is materializing in the expansion and quality of our pipeline.

As part of our targeted sales approach, we are increasingly pursuing targeted opportunities on more mid-tier smartphones with the Nokia 7.1 serving as the first proof point of our initial success. Additionally, subsequent to quarter end, we announced the appointment of Peter Carson as the new Vice President of Marketing for Mobile.

Peter is a true industry veteran, most recently holding multiple intellectual product marketing roles at Qualcomm. He brings an extensive track record of wireless and mobile semiconductor experience to our existing team.

I look forward to Peter spearheading our efforts to further increase prominence of Pixelworks brand and technology in the mobile market. As a final note, we are continuously advancing our mobile product roadmap and we are currently scheduled to take out our 5th Iris Mobile Processor before the end of the year.

I look forward to more formally introducing this product in early 2019. To close out my prepared remarks, our strong third quarter financials were complemented by increased market traction in mobile and video delivery, including a series of wins on newly launched customer products and features.

We continue to expand both the number and more importantly the quality of our customer engagements in support of a sustainable long-term growth.

As our leading image and video centric processing and delivery solutions are incorporated into a larger number of consumer products, the prominence associated with Pixelworks technology will continue to grow, leading to further adoption and increased momentum.

In the fourth quarter we expect to deliver continued year-over-year revenue growth with strength in our mobile and video delivery business being offset by seasonality in the projector market. With that, I’ll turn the call over to Steve for a more detailed review of our third quarter financials and our guidance for the fourth quarter.

Steve?.

Thank you, Todd. Revenue for the third quarter of 2018 was $21.5 million, which reflected a combination of seasonal growth in our digital projector business, expanded shipments of Iris mobile processors in support of new smartphone launches and a ramp in shipments of XCode transcoding chips to OEM customers in Japan.

For comparison, revenue in the second quarter of 2018 was $19.3 million and in the third quarter of 2017 was $18.8 million. The breakdown of revenue during the third quarter was as follows.

Revenue from digital projector was approximately $17 million, mobile revenue was approximately $1 million and revenue from video delivery was approximately $3.5 million. Non-GAAP gross profit margin was 54.7% in the third quarter of 2018 compared to 52.7% in the second quarter of 2018 and 54.9% in the third quarter of 2017.

Non-GAAP operating expenses were $8.9 million in the third quarter of 2018 compared to $10 million in the second quarter of 2018 and $8.9 million in the third quarter of 2017.

Note that lower operating expenses in both the third quarter of 2018 and the third quarter of 2017 reflected the recognition of approximately $1.8 million and $1.3 million respectively, offsets to R&D associated with our co-development projects with a large projector customer.

Adjusted EBITDA was $3.8 million for the third quarter of 2018 compared to $1.1 million in the second quarter of 2018 and $2.3 million in the third quarter of 2017. Reconciliation of adjusted EBITDA to GAAP net income loss may be found in today's press release.

We reported non-GAAP net income of $2.5 million or $0.07 per diluted share in the third quarter of 2018, compared to non-GAAP net loss of $140,000 or breakeven on a per share basis in the prior quarter. And non-GAAP net income of $976,000 or $0.03 per diluted share in the third quarter of 2017.

Moving to the balance sheet, we ended the third quarter with cash, cash equivalents and short-term investments of approximately $24.1 million, an increase of nearly $4 million from the prior quarter, largely driven by cash from operations.

Other balance sheet metrics include day sales outstanding of 24 days at quarter end, compared with 31 days at the end of the second quarter 2018. Inventory turns during the third quarter of 2018 were 12.9 times compared to 13.7 times in the prior quarter. Our guidance for the fourth quarter of 2018 is as follows.

We expect revenue to be in the range of between $20 million and $21 million, reflecting typical seasonality in the digital projection market, partially offset by continued year-over-year growth in mobile and video delivery. Q4 revenue includes approximately $1.5 million of planned end of life projected revenue.

We expect non-GAAP gross profit margin of between 53% and 55%. For operating expenses, we expect the fourth quarter to range between $9.5 million and $10.5 million on a non-GAAP basis.

Our expectations for operating expenses in the fourth quarter of 2018 included the anticipated recognition of approximately $200,000 of offsets to R&D related to our co-development project with a large digital projector customer.

We expect the offset to R&D in the fourth quarter to be the last offset associated with the current co-development agreement. And finally, we expect fourth quarter non-GAAP earnings per share to be in the range of between breakeven and $0.04 per diluted share. With that, we'll now open the call for questions. .

[Operator Instructions] Our first question comes from the line of Richard Shannon of Craig-Hallum. Your line is now open..

Hey, guys. Thanks for taking my questions. I jumped on a little bit late. So I'm not sure if I caught all your beginning remarks. Todd, so apologize if I'm repeating things here. Maybe I'll ask about your XCode business particularly in Japan.

One, if you can give us a sense of forecast you're hearing from your customers, I know, you talked about that transition happening later this quarter in Japan, whether you expect acceleration or is there an inventory build and sort of a wait through there? Or if can give us a sense of kind of forecasts and inventory build that might help us understand forward volatility?.

Yes. So, good question, Richard. We did see both in Q3, I think I mentioned it on the last call. But in Q3, and in Q4, they were building up the pipeline of both the converter boxes and set top box for launch this -- I mean the formal available, they've already announced the formal availability is in November.

And so we already we’re seen forecasts and follow through orders, actually, for Q1 already. I would say it’s at a conservative rate until they really see what the sell through is, when they go live. And as far as the forecast for next year, forecast for next year is strong.

Just because it's, I guess, the basis of us not shipping really much into this market. I think we'll probably have a better handle on it by the next call. Depending on what the sell through is, we’ll be a month into post-Christmas selling season, we'll see what the sell-through was..

Okay, fair enough. That sounds very promising so far. We look forward to hearing about that next quarter. Maybe a question on mobile, had some nice wins to put up on the board here recently. I think volumes increasing.

Obviously, we'd love to see some sense of both breadth and continuing breadth of that customer base as well as when it could be more sizeable, it could be many millions per year.

Todd, maybe if you can just comment on how the pipeline is building both in breadths and depths here? And when we might see -- potentially see a much larger customer coming to the fold?.

Yes, another good question.

So, the quality and the quantity of our pipeline once again has extended, but certainly the larger customers, the level of engagement has ticked up significantly since not really the first announcement of these design wins, but when these phones hit the market, most of the larger competitors went out and acquired the phones, almost everybody is looking at the gaming space.

So, from a gaming perspective, like that Black Shark phone, I have been to a half a dozen large customer meetings where the customer pulled out the phone and told me what their analysis said, which was very positive.

And so, right now, I’m feeling confident about continued momentum and that’s why we’re working seriously to take out a 5th Generation device..

Okay. We look forward to hearing about that, as well. One more last question for me. I’m probably making assumption on this question, but since I have the opportunity to ask it, I’ll ask it directly.

What is the inventory situation on the projector side, I know you’re talking about a seasonal decline, normal seasonal decline in fourth quarter, but how would you characterize what you’re seeing out there?.

Well, the inventory didn’t really change. Our inventories I would say in general our customers both our large customer, which we get access to their manufacturing inventory let’s say and then the rest of the customers, which all go through one channel partner.

They hold anywhere between some customers two to four weeks of inventory of quarterly inventory, some maybe five to six weeks. But in general, probably you see about a month of forward looking forecast inventory. So, we saw no change from that. Now customers do anticipate their seasonality.

So, when they pull their orders in or expand their orders, they try to maintain that level of inventory. We saw no change in that..

Okay, perfect. That’s all the questions for me. Thank you..

Thank you. Our next question comes from the line of Charlie Anderson of Dougherty & Company. Your line is now open..

Yes, thanks for taking my questions. Sorry, I’m bouncing between calls here, so I apologize if anything has been asked. But Todd, it looks like you guys are sort of averting some challenges that others are seeing right now in terms of trade war impact, tariffs, et cetera.

I imagine to some degree some of the markets you’re in there are some production in China. I wonder if there is maybe any challenges that you’re seeing there or maybe opportunities if they’re not produced in China where maybe your customers could take some market share. And then I’ve got a follow up..

Yes. We haven’t really seen it yet. For us, we manufacture in Taiwan and we ship predominantly into Taiwan and China for mobile and then into Japan for both video delivery and projector. So, very few of our products come -- manufactured there and come back here. So, from a tariff perspective, we aren’t really directly impacted.

And I don’t think the projector market has seen an impact from the tariff, I don’t think they’re on the tariff list, I haven’t heard that. And so, even the projectors that come back into this market, they’re from Japan, they’re not from China. Everything we ship into China is pretty much consumed in China. So for us, I don’t see the impact.

Where the impact would come is in general, this tariff tiff I’ll call it is just starting to slow the economy down a bit, especially overseas, probably not as much here, I think eventually it will hit here, we’ll just see the general effects of a slowing economy. But we’ll see that in the projector space because we’re exposed.

It’s a mature market and in the 3LCD we’re 95%, 90% market share, we’re high market share. So, if economy slowed it down in its mature market, we’re going to feel that. For mobile, I mean, I think everything we show is going to be based upon our execution even if the market slows down a little bit.

We’re coming from such a small base, I just don’t see it we could use that as an excuse for lack of execution. .

Yes, got it. Okay, and on then OTA I think we're seeing some pretty good momentum there in that market. I think you mentioned in your script about anonymously Amazon and another company on TiVo. And then, it looks like AirTV, there has been a lot of promotional activity they seem to really be pushing it.

I wonder in terms of maybe broadening that customer base are there a fair amount of other people considering this technology at this point, what it was for the design pipeline look like these days on OTA. Thanks..

It still as much as I've seen swing up the promotion since they announced the product, we expect them to hit it much harder over the next three months.

We are -- we do have an active program a collaboration to broaden -- we have two initiatives one is with a large customer and then one is this FlexVU initiative, which you can go online and see it flexivu.com it’s more of an awareness to the consumer of what OTA is transcoding based OTA.

And the other with a large customer is to bring more integrated OTA compliant hardware vendors to their OTT expanded video service program, right? So they'll give incentives to the hardware partners to expand the offering. But it's slow going.

I still believe that just this is the math the math is I believe that you see today for the OTT offerings that have signed agreements to include retransmission of free over-the-air signals have a 40 plus percent cost disadvantage if somebody that doesn't like swing. And I believe that that's going to increase.

T-Mobile has just come back and said that this announcement for the video service that they're going to -- streaming video service that they previously announcement were going to launch in 2018.

The mobile offering, the ability to take that same service outside the home and stream it to your mobile devices is not going to be offered until 2019 and the reason they quoted was because they can't get the deals.

From the content providers and that they would have a severe cost disadvantage and in their case larger players that had volume discounts. I think cost of offering a service matters.

I think those that are going to go out and not charge for what is really free channels that are already available to the consumer just make the hardware available to integrate those free channels and make it seamless for the consumer after installation.

It's a significant enough cost advantage that I think we will have a market, but I think we're still in the early stages, Charlie. .

Got it. Great. Thanks so much, guys. .

[Operator instructions]. Our next question comes from Jason Smith of Lake Street Capital. Your line is now open. .

Hey, guys. Thanks for taking my questions most have been answered.

But just wanted to touch on the OpEx line, when we think about OpEx in 2019 with your design win pipelines across your segments should we expect any ramps out of the ordinary?.

None out of the ordinary related to those sales we are continuing development of chips, we will not get the benefit of credits from the credit development agreement that we have now finished. So you want to make sure that if you're looking backwards that you take that into account that we had significant credits in 2018..

$4 million. We have $4 million of credit -- we have a little under -- I think it was like $3.6 million. And so, that's the major headwind, Jason is that we just don't have those credits and if we sign another deal you never know, but right now that's not on the table..

Okay, that makes sense. Thanks a lot..

Thank you. [Operator instructions]. I am showing no further questions at this time, I’d like to hand the call back over to management for any closing remarks..

All right, well thanks. It was a very robust quarter for us, we’re pretty proud of it and we’re excited going into next year. Thanks for listening in..

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may all disconnect. Everyone have a great day..