Good day, ladies and gentlemen, and welcome to Pixelworks Second Quarter 2020 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, instructions will be given for the 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. Elias Nader. Please go ahead..

Thank you. Good afternoon, everyone, and thank you for joining us today. With me on today's call is Todd DeBonis, Pixelworks' President and CEO. The purpose of today's conference call is to supplement the information provided in Pixelworks' press release issued earlier today announcing the company's financial results for the second quarter of 2020.

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, Monday, August 10, 2020.

The company undertakes no obligation to update any such statements or reflect events or circumstances occurring after today.

Please refer to today's press release and our annual report on Form 10-K for the year ended December 31, 2019, 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 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.

Non-GAAP measures exclude gain on sale of patents, inventory step-up and backlog amortization, amortization of acquired intangible assets, stock-based comp expense and restructuring expense. The company uses these non-GAAP measures internally to assess our operating performance.

We believe these non-GAAP measure 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.

Also included in the company’s press release are definitions and reconciliations of GAAP to non-GAAP net loss and GAAP net loss – net income loss to adjusted EBITDA, which provide additional results – additional details. With that said, I will now turn the call over to Todd for his opening remarks. Thank you..

Thank you, Elias, and good afternoon to those joining us on today's call and webcast. As outlined in today's press release, our second quarter results reflected the anticipated headwinds associated with the broad impact from the COVID-19 pandemic on our target end markets.

Although, revenue was at the lower end of guidance range we provided, favorable product mix as well as cost-improvement initiatives resulted in better-than-expected gross margin non-GAAP EPS at the midpoint of guidance. As our results indicate, we continue to be in a challenging environment.

However, we believe it is important to clearly distinguish the ways in which Pixelworks is being impacted and the areas where we have continued to make progress. In terms of customer sell-through and end-market demand, we are seeing negative effects in all of our end markets with the projector business experiencing the largest year-over-year decline.

Given that a majority of total projector unit volume is driven by large government tenders for education and corporate tenders for enterprise applications, we've naturally observed reduced customer demand as a result of the recent shifts towards working and learning remotely.

We are confident that Pixelworks has maintained our leading market position in projector and the current revenue level of this business is purely a reflection of the projector customers' uncertainty and weak end market demand.

Similar to the projector business, our video delivery business has been in the process of working through a prolonged inventory correction when the COVID pandemic emerged.

While Japan has appeared to weather the pandemic relatively well compared to some other countries, the end products we sell into are predominantly consumer discretionary and as such demand was lower in Q2 and will continue into Q3.

We have remained engaged with our leading Japanese consumer electronics OEMs in support of new programs and development efforts, which we believe will result in Pixelworks capturing additional market share in 2021.

Our execution on new mobile programs during the first half of 2020 continued and all of the models launched were well received by the analyst community and specifically stood out with premium display performance.

But given the fact that many of the models were at the higher-priced premium and flagship category, where consumer demand has been weaker, unit volumes have been considerably lower than expected. More recently, we have seen the green shoots of the recovery in mobile demand in the current quarter.

We continue to believe there will be a high correlation between OEM's adoption of 5G technology and high-performance displays and smartphones, as video remains the most single compelling use case for 5G with consumers. We are still in the early innings of this multiyear transition to 5G and the corresponding battle by OEMs to capture market share.

In addition, we are seeing a more rapid introduction of high frame rate displays into mid-tier phones than we previously anticipated, which is positive and increases the Pixelworks value proposition in mid-tier devices.

Acknowledging the potential for a more prolonged recovery of the global economy, we began taking actions early in the second quarter to contain costs.

I provided a detailed overview of these proactive cost reduction measures in the last conference call, which collectively enabled us to immediately reduce cash operating expenses by more than 10%, while retaining 100% of our employees.

Though we are seeing increasing evidence in support of the third quarter being the bottom of the cycle for both the projector and video delivery businesses, we also believe that a more substantial recovery in these respective businesses is potentially going to be a slow process.

In response, today we implemented a restructuring plan to further reduce operating expenses, preserve cash and focus available resources on the largest growth opportunities within our mobile and TrueCut businesses.

The restructuring included a 14% reduction in Pixelworks' headcount and will produce an incremental $3.2 million in annualized cost reductions without marginalizing our ability to fully support customers for our growth initiatives or impacting our advanced technology and new product development road map.

This is a difficult, but necessary action and one that I'd hoped to avoid. I personally want to thank all of those employees affected for their past efforts and support. Turning to an update on our mobile and TrueCut growth initiatives. We've continued to gain increased interest from both existing and prospective customers for our latest technology.

Starting with TrueCut. As previously communicated, we entered 2020 with significant momentum towards ecosystem adoption here in North America. Without question, work-from-home mandates and the halting of effectively all production activity in Hollywood, as well as all new theatrical releases has slowed our progress.

Against this backdrop, our team has creatively worked to overcome at least some of the hurdles brought on by the pandemic. As one example, in May we expanded Pixelworks' presence in Hollywood with an opening of an office in Burbank California.

This office is close to most of the major studios and streaming service providers, we recently installed our new TrueCut “on-prem” GPU centric processing system onsite, where we can now host studio representatives and post-production experts for collaborative demonstrations in a private screening room while complying with COVID-19 safety guidelines.

As with all market disruptions, new opportunities emerge. And in this case that is the acceleration of direct-to-consumer delivery of cinematic content. Home entertainment and streaming is now more critical than ever for both consumers and content providers.

However, one of the biggest casualties of this shift is creative intent, which today is difficult to ensure when delivering direct-to-consumers viewing at home or while traveling.

Every TV and handheld viewing device is different on how they process and display digital content, which results a wide spectrum of display quality and experiences across hundreds of millions of users.

This varied and unpredictable experience is exactly what Pixelworks' TrueCut platform was designed to eliminate by providing software-based tools leveraging Pixelworks' proprietary algorithms that enable content to be created, delivered and viewed with consistent resolution, color tone and motion across all certified devices.

So, although the pandemic has certainly extended our previous time line TrueCut's value proposition has never been more relevant. Our team remains focused on achieving a series of important milestones in the coming quarters, as we look to secure endorsement and adoption from ecosystem partners and customers.

With China's reopening in early May, we saw an increased traction with several TrueCut programs we had been pursuing. We expect some of these programs to close during the second half of this year. Looking at our Mobile business, we have continued to drive incremental adoption, despite a more challenging business landscape.

Year-to-date, our Iris visual processing technology has been incorporated into 12 announced smartphone launches across six different OEM customers. Our two most recently announced mobile wins, which launched since the first quarter conference call were the ASUS ROG Phone 3 and the Tencent Black Shark 3S.

Both devices represent the latest industry-leading gaming smartphones to be released by two recurring multiyear mobile customers. The ROG Phone 3 leverages Pixelworks' high-efficiency color calibration with every individual phone being factory tuned with our patented display calibration technology.

This gaming smartphone also features our industry-leading HDR tone mapping that provides unprecedented contrast and color depth, as well as our auto adaptive ultra-smooth brightness control for seamless viewing in all lighting environments.

The Tencent Black Shark 3S combines Pixelworks' fifth generation Iris visual processor with our software enhancement solution take full advantage of the 6.67-inch AMOLED display with optimized support for its 120 Hertz refresh rate.

In addition to this device, utilizing our always HDR mode and active dimming features the Tencent Black Shark 3S leverages Pixelworks' unique motion engine technology with dual-channel MIPI.

This advanced feature enables separation and dedicated processing of text and underlying graphics which are then recombined to deliver superior visual quality while playing Tencent games.

Additionally, I would like to emphasize the strength of our engineering team as well as our commitment to an ambitious road map and our continuous development of next-generation technology in support of new industry-leading features and products.

I'm pleased to announce that we recently completed the successful tape-out of our sixth generation Iris visual processor which we plan to formally introduce later this year.

Additionally, advanced algorithm development design and engineering work is already underway on our seventh-generation processor which is currently slated for release in the second half of 2021.

We continue to work on a solid and growing pipeline of engagements that span plans smartphones in multiple price tiers across numerous customers with some programs extending throughout next year.

Specific to our expectations for the remainder of this year, we are currently on track to have our visual processing solutions incorporated into a total of at least 20 models launched by eight different OEMs for the full year. For perspective, this compares with six models across four OEMs for the full year in 2019.

Included in these planned launches for the second half of 2020 is our second Tier-one mobile OEM engagement. In closing, I want to reiterate that despite this challenging business environment, we have maintained our market-leading or market disruptor position in each of our target end markets.

As we've done in the past, we will continue to proactively respond to changing conditions with appropriate and decisive action. [Technical Difficulty].

Yes, could you please tell me where we're dropped off?.

No, sir, your line just went on mute out of the blue..

Okay. Listen I'll tell you what, I'll start with closing -- my closing statement and then hand off to Elias. So, in closing, I want to reiterate that despite this challenging business environment, we have maintained our market-leading or market disruptive position in each of our target end markets.

As we've done in the past, we'll continue to proactively respond to changing conditions with appropriate and decisive actions, while simultaneously remaining focused on the successful execution of our mobile and TrueCut growth initiatives.

I'm extremely confident we have a winning strategy and team in place today and that Pixelworks' longer term growth prospects are still fully intact.

As previously mentioned, in mobile, we have a solid pipeline of new engagements and are well-positioned to generate momentum in the second half of the year as customers incorporate more advanced displays and premium viewing devices including HCR, higher frame rate, variable frame rate, and auto adapted visual enhancements in conjunction with their introductions of new 5G-enabled smartphones.

With that, I'll hand the call over to Elias one more time to review the second quarter financials and provide our guidance for the third quarter.

Elias?.

Thank you, Todd. Revenue for the second quarter of 2020 was $9.3 million compared to $13.8 million for the first quarter of 2020 and compared to revenue of $18 million in the second quarter of 2019.

As Todd indicated in his opening remarks, second quarter 2020 revenue, primarily reflected the ongoing inventory corrections in a digital projector and video delivery markets compounded by lower end market demand resulting from the global pandemic across all of our target markets.

The breakdown of revenue in the second quarter was as follows; revenue from digital projector was approximately $6.5 million. Video delivery revenue was approximately $2.3 million. Revenue from mobile was approximately $419,000 comprised largely of sales of our Iris visual processes and Soft Iris solutions.

Non-GAAP gross profit margin expanded to 59.2% in the second quarter of 2020 from 52.1% in the first quarter of 2020 and 54.1% in the second quarter of 2019.

The increase in gross margin reflects a combination of particularly favorable product mix in the quarter as well as our ongoing initiatives to drive product cost improvements, especially on newer products.

Non-GAAP operating expenses decreased to $9.3 million in the second quarter of 2020, compared to $9.7 million last quarter and $9.6 million in the same period last year. The reduction in operating expenses reflects our continued focus on cost containment across our business.

Adjusted EBITDA for the second quarter of 2020 was a negative $2.9 million compared to a negative $1.5 million in the first quarter of 2020 and a positive $1 million in the second quarter of 2019.

On a non-GAAP basis, second quarter 2020 net loss was $3.9 million or a loss of $0.10 per share compared to a net loss of $2.6 million or a loss of $0.07 per share in the prior quarter and a net loss of $97,000 or breakeven on a per share basis in the second quarter of 2019. Moving to the balance sheet.

We ended the second quarter of 2020 with cash, cash equivalents, and short-term investments of approximately $21.4 million, compared to approximately $20.4 million at the end of the first quarter of 2020.

The sequential increase of approximately $1 million reflected an approximately $2.5 million in net proceeds generated from the sale of stock through our ATM vehicle and $800,000 in cash proceeds from the paycheck protection program loan, partially offset by approximately $700,000 useful operating activities, repayments of approximately $800,000 on the outstanding balance of our line of credit and approximately $700,000 in capital expenditures.

As discussed on our conference call last quarter, we have taken a series of additional actions to meaningfully reduce operating expenses since the beginning of the year.

In addition to the benefits of our participation pay check protection program other steps taken have included relief from the Chinese government in the form of lower employee benefit payments through June 2020 amounted to approximately $400,000.

We offered an RSG compensation program to our employees providing the option to receive RSGs in lieu of a salary cut of 5% or 10% resulting in an unexpected cash savings to the company of approximately $300,000 per quarter.

Additionally, as Todd outlined previously, we implemented a restructuring plan to further reduce operating expenses and preserve cash. As a result, we expect to record a onetime restructuring charge of approximately $1.5 million in the third quarter.

Whilst fully implemented these actions are anticipated to generate an incremental $3.2 million in annualized cost savings. In terms of other balance sheet metrics for the second quarter, day sales outstanding were 58 days at the quarter end which was consistent to the 58 days at the end of the first quarter.

Inventory turns was 3.1 times in the second quarter, compared to 5.2 times in the prior quarter. Now, turning to our guidance for the third quarter of 2020. As previously indicated, we expect the near-term environment to remain challenging, especially for large portions of the projector and digital delivery markets.

While the magnitude of the impact of our customers in this market varies, we expect many customers to remain more conservative in their order patters due to heightened uncertainty related to end market demand.

That said, we do anticipate meaningful growth and the mobile business for the third quarter as we continue to support previously announced smartphones and ramp shipments associated with customers' planned launches of new devices in the second half of the year.

Based on recent order trends and our current backlog, we expect total revenue in the third quarter to range between $7.5 million and $10 million. We expect non-GAAP gross profit margin in the third quarter of between 52% and 56%. We anticipate operating expenses in the third quarter to range between $8 million and $9 million on a non-GAAP basis.

Please note third quarter operating expenses will include only a partial quarter benefit from today's announced restructuring plan. Lastly, we expect third quarter non-GAAP EPS to be in the range of between a loss of $0.06 and a non-GAAP loss of $0.13 per share. That concludes our prepared remarks, and we will now open the call for questions.

Operator, please proceed with managing the Q&A session. Thank you..

Certainly. [Operator Instructions] Your first question comes from the line of Charlie Anderson from Collier Securities. Your line is open..

Yeah. Thanks for taking my questions. I just want to start out on the Q3 guide. I wonder if you'd be willing to talk a little bit about each of the segments.

It did sound like projector and video delivery have their challenges mobile growing so maybe just relative to what we're seeing in Q2, and any additional comment there? And then also on gross margin, you did hit this very high gross margin in Q2 but it looks like it's coming back to the low to mid-50s in Q3, maybe you could talk about just the trajectory gross margin as well and some of the factors there.

And then I've got a follow-up..

Thanks Charlie. So we don't usually and we probably are not going to now break down our businesses when we give forward guidance. I mean, as you know we're giving a pretty wide range and there's still several companies not giving guidance.

But I will say that – yeah, I mean we expect mobile to sequentially grow and we expect projector and video delivery to not sequentially grow. And I probably won't talk about the magnitude.

But with that said, we do expect Q4 with what we know today, we expect Q4 for both projector and video delivery to start coming back and we expect continued sequential growth in mobile. But that's with what we know today. And there's still a lot of uncertainty with how each of the economies is going to be affected as we move forward on this pandemic.

Regarding the margins, it's partly due to mix that we come back down in Q3. Software is still helping us there. But some of the product mix the SoC product mix that we had benefit for in Q2 changes a little bit in Q3. Also, still have an absorption issue especially at those revenue levels.

On a go-forward basis, we do expect corporate gross margins to continue to make progress..

Perfect. And then, you did mention the second Tier 1 mobile OEM, so that's great news and congratulations on that. I wonder, maybe if you want to maybe just reset our expectations of what this means big picture. I know, there was a view earlier in the year potentially getting mobile to half the revenue at some point.

So, maybe taking that into account and taking previous thoughts on where this could all go just maybe update us on your views there Todd?.

So, one of the things that we're dealing with in the mobile arena is – especially, if you look we've had a pretty targeted focus in China. And even within China, as I define Tier 1s there are four in China, and we're focused on three of them.

And for the most part those three and some of the Tier 2s, especially ones that have large exposure to the Chinese market have been impacted by Huawei coming back and being very aggressive at trying to get rid of inventory in the Chinese market. Now whether that is a short-term impact or a longer-term impact, I think it remains to be seen.

We believe and it's just our belief that longer term these three companies that we're focused on will maintain a reasonable market share in China, and also will grow their international business as soon as the economies that they're focused on start to emerge out of this pandemic.

And all three of these companies have big exposures in India, and they are starting to put a footprint into Western Europe and elsewhere. So gaining ground at a second Tier 1 that we've been working with for a long time and then finally convincing them to take a leap on a program is a big deal for us.

So far any place that we've had at least one program over time, we've been able to secure multiple. So it's no guarantee of future success, but it certainly is an indicator that one in many cases leads to multiple. So it's very encouraging for us. And then secondly, we're working on – we'll be sampling Iris 3 to customers this quarter.

We taped out in Q2. We got it through the fab tool suite and so far it looks good. We are scheduled to sample early customers, I think next week even. And we're engaged on some very innovative ecosystem and architectural changes for Iris 7 that would enable capabilities that currently none of our visual processors enable.

And so I think many of these engagements we have especially with the two Tier 1s, they see – their current engagements as a predecessor of what could be. And so they will continue to stay engaged with us. And if we execute, I'm convinced they'll expand their footprint with us.

So at some point one would say, projector and video delivery will come back next year that we do expect growth next year, because it's going to be over the reduction induced by the pandemic this year. But overall, they're not high-growth markets. Mobile is. And so at least for us.

And so we -- at some point unless we fail, mobile will be more than 50% of our revenue. It will become the predominant part of our revenue at some point. Previously anticipated that to be -- and this was all pre-COVID anticipated to leave the year at that.

It's probably unlikely that it will happen this year, but we still predict it in our near future..

Great. Thank you so much..

Thank you. And our next question comes from the line of Suji Desilva from ROTH Capital. Your line is open..

Hi, gentlemen.

So perhaps you can talk about the dynamic in China with the flagship high end phones and the midrange phones crossing that with 5G ramp? And how that's affecting you guys constructively or whether it's a challenge?.

Well, I’m trying to -- so the question is 4G versus 5G, Suji?.

No. In 5G, the -- I think the customers are maybe leaning toward more of the midrange versus the flagships perhaps..

Well, I mean, I would say -- I understand now where you're coming from the question. I would say, going into late 2019, it was premium and flagship that were 5G. They are now pushing to bring 5G to a much lower price point. In fact, some of the phones that were launched by some of our customers have pushed 5G below $400.

You will see -- in fact I'm trying to search right now of any forward-looking program that we're either targeting launch in 2020 or 2021. I don't think there's any 4G programs left. So everything we're working on is 5G.

And I think that's a natural reaction given the economic slowdown, particular OEMs we call on are a very nimble reactive group of customers. And they're reacting to the environment they're in.

And so -- and they do -- if you really look at these customers, they have launches throughout the year, but there's a big wave at the front part of the year, and there's a big wave at the latter part of the year. And so they almost have a six-month rhythm.

And the launches that happened, people were focused on, because they made decisions in the back half of 2019. They were focused on higher ASP, higher-margin products. In the back half of 2020, they're clearly focused on skinner margin, lower ASP products..

Yes. And Todd, if you could just kind of follow-up on that with the impact to you guys in terms of your content and market position..

Well, we have a family of solutions. And with the introduction of Iris 6, we haven't formally announced it yet, so I'm not going to talk about the features in the price point. But what I will say is that, it falls between our previous low-cost Iris 3 solution and our high-end Iris 5. And we have done a very good job.

The ops team has done a very good job of pushing the cost down of Iris 3. And so we have been very aggressive at positioning Iris 3 at low-cost mid-tier devices. So we have a family of products that can fit the gap across the board and follow our customers' reaction..

Okay. That's very helpful color, Todd. And then just one quick question on the TrueCut. I think you mentioned new programs in China.

Is that some new customers or those existing customers? And is there sort of, a kind of, revenue model that you'd be able to talk about now coming out of these efforts? Or is it still early days for that?.

The TrueCut programs I'm talking about would be new customers. And it's a licensing business. And like I said in the past depends on how the engagements go. They can be onetime license, they can be over multiple years. It depends who the customer and the program is. But that's probably as far as I'm going to go until we actually announce the program..

Okay. Fair enough. Thanks, guys..

Thank you, Suji..

Thank you. [Operator Instructions] And your next question comes from the line of Jaeson Schmidt from Lake Street. Your line is open..

Hey, guys. Thanks for taking my questions. I know you said you believe the projector and video delivery businesses come back in Q4.

Is that confidence really being driven by expected new launches or just the inventory having been fully digested in Q3?.

I'd say a combination of both. There are customers that have -- I mean, one thing I'll say is across the board the Japanese OEMs had stayed fairly focused. We haven't seen mass layoffs even though their business was way off. It's not their typical approach. And so what they usually do is hunker down and they start working on new program development.

They'd already been working on some new programs and transitioning to newer products from us. And so I think the main thing will be their customers. It's not like we expect these tenders to go away, the education tenders and the enterprise tenders. We just expected them to get delayed.

And the question is when do they start to come back? And we anticipate -- we've seen some green shoots of it already in Q3. We anticipate more of it in Q4..

Okay. That's helpful. And I know you mentioned 20 models this year for the mobile business.

But have you seen the size of orders, the POs get downwardly adjusted at all going into the second half just given the macro environment?.

Well all of our mobile business goes through our channel. And so how they adjust is they just let the channel sit on the inventory until they're ready to digest it. So the way we see it, is we see inventories at the end of the quarter not being depleted. And then we have to wait for those inventories to deplete to convince the distributors to refill.

And they're not going to do it until the demand from the customers. So there are some new programs that are coming on for the second half of the year and then we're seeing inventory start to deplete in Q3. So that's why we're feeling more comfortable with mobile..

Okay. That’s helpful. Thanks a lot guys..

Thank you, Jaeson..

Thank you. And I'm showing no further questions at this time. I would now like to turn the conference back to the management for any closing remarks..

Thank you. So obviously, challenging times and a little bit of a somber day at Pixelworks. Some very good people that worked very hard over the last several years at Pixelworks, we were forced to part ways with today. And we look forward to trying to dig our way out of this and grow quickly and see where that takes us. Thank you for your time..

Ladies and gentlemen, this concludes today's conference. Thank you all for joining. You may now all disconnect..