Pixelworks, Inc. (PXLW) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and thank you for your patience. You have joined the Second Quarter 2017 Pixelworks' Earnings Conference Call. [Operator Instructions]. As a reminder, this conference may be recorded. I would now like to turn the call over to your host, CFO, Mr. Steve Moore. Sir, you may 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 second quarter of 2017. 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 belief as of today, Tuesday, August 8, 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, 2016 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 acquisition-related costs, stock-based compensation expense and certain charges related to the company's restructuring in the first half of 2016. 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 and we caution -- 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'll now turn the call over to Todd for his opening remarks.

Thank you, Steve and good afternoon to everyone on today's call. Beginning with the news that we announced last week, I'm very pleased to have closed on our acquisition of ViXS Systems and we'll talk more about the ViXS later in my remarks. I would like to take this time to welcome the ViXS' employees to Pixelworks team as well as the entire shareholders of ViXS who are now holders of Pixelworks' shares. I'm excited to see what we were able to achieve together as a combined company. Starting with Pixelworks second quarter results. Total revenue was $20.7 million at the high end of our $20 million to $21 million guidance range which included roughly $5 million of expected contribution from End of Life products. Excluding EOL legacy products, second quarter revenue grew 15% sequentially and was up 36% year-over-year as we continue to achieve strong performance and gain incremental market share in our core Projector business. Gross margin came in above 54% and operating expenses were within the range of guidance, resulting in a net income of $0.04 on a GAAP basis and $0.10 a share on a non-GAAP basis. This is our third consecutive quarter of profitability and we generated more than $13 million in cash from operations to the end of the quarter with over $32 million in net cash. These results stand in stark contrast where the company was only 1 year ago when we reported a net loss for the quarter and cash on the balance sheet was only half of what was at this quarter-end. I applaud the entire Pixelworks team for their contributions to this significant improvement in the company's results since that time. Projectors. Shifting to the end markets and starting with our Projector business, revenue excluding EOL contribution was $15 million, representing 14% sequential growth and 35% growth year-on-year. Similar to last quarter, the growth in part reflects the return to a more normalized market environment compared to the inventory and supply channel disruptions that impacted the market in 2016. Our growth exceeded that of the overall projector market during this period of normalization, as a result of incremental market share gains and strong performance of the few key projector customers. Additionally, we continued to benefit from the restructuring actions we took last year to streamline our projector product line, including a reduction in the number of SKUs and transition of certain customers to higher-value ASP products. The best evidence of this is the over 300 basis point improvement in our reported gross margin year-over-year. As stated last quarter, we believe projector material margins were generally be in and around current levels going forward. Now we briefly touch on the general projector market. Recent order patterns have remained solid and channel inventory appears to be healthy. As a result, we expect another quarter of strong year-over-year growth in Q3 followed by a continuation of typical quarterly revenue cycles and seasonality in the fourth quarter. In our mobile business, revenue increased by over 50% on both a sequential and year-over-year basis, driven by increased unit shipments of our Iris chip in support of multiple ASUS devices. Although still relatively -- still a relatively small contributor, mobile revenue in the second quarter did include the first revenue from commercial production of our third generation processor. Our sales team is doing an excellent job of engaging prospective customers and evangelizing the benefits and value proposition of Pixelworks technology. Mobile OEMs are increasingly interested in ways to differentiate their products by offering a superior visual experience. This is especially evident in the actions taken by a number of market leaders during the first half of the year with product launches that highlighted high dynamic range or HDR, lighter color gamut and adapted displays. Further supporting the transition to more advanced mobile displays is the increasing availability and marketing of premium quality content on these devices. Streaming content providers including the Amazon and Netflix continue to roll out additional premium services that require a certified device with a high performance display in order to view the highest quality content. My point here is really twofold, first, there continues to be evidence and the market is moving in a direction of Pixelworks technology; and two, many of these trends are still in the relatively early stages. Since previewing it at our Analyst Day in May, we successfully tapped out our fourth generation Iris mobile processor. We're currently on track to sample the fourth generation device with customers in the fourth quarter. This device was specifically designed to lower the hurdles for OEM adoption, including significant improvement in power, size and cost. The fourth generation device will offer new advanced features and functionality that have the potential to broaden the statement of the mobile market we're targeting today. Our focus remains on what we can control at Pixelworks, namely positioning our technology and product roadmap in an effective way to lower the hurdles and encourage broader adoption by leading global manufacturers of handsets and mobile devices. Driving the adoption of any new technology is always difficult. However, we continue to be very encouraged by the progress we're making and are comfortable with our positioning relative to the emerging trends in the broader mobile market. Turning now to ViXS. I had recently -- I recently had my first meetings with a number of current and prospective ViXS customers. And following those meetings, I'm encouraged about both the market opportunities for the current offerings as well as the expanded opportunities created by the complementary technologies of the 2 companies. Additionally, the customers and prospective customers were excited about the acquisition given its positive impact on the financial strength of the combined company. They indicated it gives them even more of a reason to commit to new business. Together, Pixelworks and ViXS create an impressive and complementary portfolio of image, video and streaming intellectual property. More importantly, this transaction meaningful increases the scale of our R&D resources to further support current and future technology development. Overtime, we believe the combination of Pixelworks visual display processing and ViXS comprehensive end-to-end delivery technologies will enable us to offer new and innovative visual display and video-streaming solutions. ViXS has existing products that address multiple emerging market trends that we believe represent compelling opportunities. Collectively, these products have the potential to drive substantial revenue growth through 2018. Following the divestiture of their legacy MoCA business earlier this year, ViXS' remaining products and solutions can be grouped into two general categories, one group includes professional video and video delivery for enterprise and infrastructure. These solutions primarily consists of IP-based media gateways and professional decoders and leverage encoding/transcoding and best-in-class HEVC or High Efficiency Video Coding, decoding technology, including the world's only HEVC capable of 12-bit HDR. The other category is consumer. For ViXS has a numerous solutions for UHD, HDR and over-the-air or OTA streaming which includes the ability to optimize streaming video based upon the device capability and available bandwidth, also known as adapted bit rate streaming. Many of these solutions are increasingly relevant as the ecosystem tries to satisfy growing consumer demand to view content, any time, any where and on any device. Given these trends, one area we're particularly excited about is the over-the-air or OTA solution. This plays directly into the growing trend known as cord cutting, where consumers abandon expensive pay-TV subscriptions in favor of a combination of free over-the-air HDTV and services like Sling TV, DirecTV Now and Hulu Live. In fact, the trend is gaining momentum with recent third-party estimates suggesting that over 1 million subscribers cut the cord during the second quarter alone. With many of them switching to OTA and OTT solutions. Together with the fact that ViXS began shipping initial production volume of both single and dual band OTA streaming products in the first half of the year, we believe this opportunity is still in the early innings and could prove to be a meaningful driver of incremental growth for Pixelworks. After we've made further progress on the integration during the quarter, I will plan to address additional ViXS products and market opportunities in more detail of future -- as part of future quarterly calls. Finally and most importantly, I do want to emphasize that we remain committed to the acquisition being accretive in 2018. To conclude my remarks, I am very pleased with our financial results for the first half of 2017 which appropriately reflect the dedicated effort and work of the entire team. In addition to the year-over-year growth, we have strengthened the fundamentals and effectively every area of the business, customer facing, technology products, operations and finance. With that, I'll turn the call over to Steve to review our second quarter financials and consolidated guidance for the third quarter in more detail. Steve?

Thank you, Todd. Revenue for the second quarter of 2017 was $20.7 million which included $5.1 million of EOL product revenue. This is compared with $22.7 million in the first quarter of 2017 which included $9.2 million of EOL revenue and revenue of $12.6 million in the second quarter of 2016. Excluding EOL contribution, revenue in the second quarter of 2017 reflected a 35% year-on-year growth in our digital projection business. The breakdown of revenue during the second quarter was as follows, revenue from ongoing digital projection products was approximately $15.1 million; mobile revenue was approximately $560,000; and revenue from legacy chips sold as part of the EOL was approximately $5.1 million. Non-GAAP gross profit margin was 54.4% in the second quarter of 2017 compared to 54.8% in the first quarter of 2017 and 51.6% in the second quarter of 2016. Non-GAAP operating expenses were $7.6 million in the second quarter of 2017 compared to $8.3 million in the previous quarter and $7 million in the second quarter of 2016. As part of our co-development agreement with the customer, R&D expenses in Q2 included a net benefit of approximately $268,000. Adjusted EBITDA was $4.7 million for the second quarter of 2017 compared to $5 million in the first quarter of 2017 and $300,000 in the year-ago quarter. 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 $3.2 million or $0.10 per diluted share in the second quarter of 2017 as compared to a net profit of $3.8 million or $0.12 per diluted share in the prior quarter and a non-GAAP net loss of $756,000 or $0.03 loss per share in the second quarter of 2016. Moving to the balance sheet. Cash and cash equivalents increased sequentially to -- by $12.6 million to approximately $32.2 million at the end of the second quarter as a result of the strong cash flow from operations. Other balance sheet metrics include days sales outstanding of 25 days at quarter-end compared to 38 days at the end of the first quarter. The decrease is primarily due to a large portion of our EOL orders from the prior quarter shipping in the month of March. On an annualized basis, inventory turns increased to 17.2x in the second quarter compared to 15.6x in the prior quarter. Now turning to guidance which does include a partial quarter of contributions from ViXS Systems which closed on August 2. For the second quarter of 2017, we expect -- excuse me, for the third quarter of 2017, we expect revenue to be in the range of between $18 million and $19 million which includes approximately $2 million in revenue contribution from ViXS. Additionally, we currently do not expect any additional or any meaningful revenue contribution from EOL in the third quarter. Excluding the anticipated contributions from ViXS and previously recognized EOL revenue, the midpoint of our third quarter revenue guidance would imply organic growth in our core business of 9% sequentially and 37% year-over-year. We expect non-GAAP gross margin of between 54% and 55%. Operating expenses on a non-GAAP basis are expected to be between $10 million and $11.3 million. These amounts include between $2.5 million and $2.8 million in non-GAAP expenses related to ViXS in Q3 2017. We expect non-GAAP EPS to be in the range of between loss of $0.06 per basic share and income of $0.01 per diluted share. Pixelworks base business without ViXS contribution would expect Q3 non-GAAP EPS to range between breakeven and $0.05 per diluted share. We do not expect to break out these 2 business categories in the future. We continue to expect that the ViXS acquisition will be accretive to earnings in 2018. We believe that there are significant synergies between the 2 companies that we intend to act quickly to secure. We also expect the continuing ViXS revenues, especially in the consumer category, to grow in 2018 from 2017 at between 30% and 40%. With that, we will now open the call for questions.

[Operator Instructions]. Our first question comes from the line of Charlie Anderson of Dougherty & Company.

Todd, I want to start with some of your comments around meeting the ViXS customer base and how financial strength was some of the way appreciated. I wonder kind of where you are in the design cycle for a lot of those customers. Does that feel like something that can convert fairly quickly? Or do you have to wait for another design cycle? Just any extra commentary around this and the opportunities that are going to confront you there would be interesting. And then I have got follow-up for Steve.

Okay. Well, let me see, I have visited, I think 5, what I would call sizable customers with sizable forward opportunities. Four of the 5 current revenue levels are either low or nonexistent. One of the 5 was Sharp which ViXS previously announced a series of the design wins with, or they are a -- I call them a set-top box, when effectively they are as a ultra-high definition Blu-ray player, recorder and HDR that also become -- you can receive cable or direct broadcast signals. And this is how many consumers instead of getting your box from your pay-TV subscriber, this is how consumers in Japan get their TV and manage their TV. All the 4K products that Sharp is going forward with currently include ViXS, they were just launched 3 months ago. The reason I bring that up is because directly to your question of where the Atman design cycle, this is a platform design win that took over 18 months to bring to production and a collaborative software development between 3 parties and Sharp. Once it's in production, all derivative products are going to try to leverage that, so effectively, as long as we maintain a solid relationship and I'm just going to use Sharp as an example and I'm going to talk about the other 4 in a minute. As they continue down the introduction of 4K products over their 2K products and there would be a transition where 4K starts to outstrip the shipments at 2K over the next couple of years, ViXS will be our product line, Pixelworks now will be the main provider of both the SOC and transcoding solutions for those boxes. So there is several new designs that are either in the works or in discussions. Sharp in particular felt much more comfortable, given they were exposed with ViXS, given the amount of commitment they made to this company over the last 18 months and they feel much more comfortable now, given that technology, those R&D resources and that product line are under the fold of Pixelworks and our current financial systems. So I would say they are a particular customer that feels very comfortable with us. And the reason I used them is because they were an announced customer and I don't think they're going to have any issue with what I just talked about, I don't -- there is any real disclosure issues there. The other customers, I'm not going to tell you who they are. But I will say a couple of them are in the category of the OTA and a couple in the category of consumer, yes, just call it consumer, I don't want to give you any more clarity with that. In all 4 of those cases, the development work is either several months in or almost complete to launch new products. And so now we're talking about the timing of those products launching and securing additional revenue. It could be as soon as 3 months, it could be as soon as midyear next year. Is their risk that in some cases they may not launch the product? There is some small risk in probably one of the cases that's tied to a whole new service that isn't currently on the market. But if they all hit, it will be a significant revenue contribution. And we're working not only to make sure all of them hit, but to see if we can't expand with new opportunities. Long-winded answer, Charlie, but I -- you usually get that from me.

Fair enough. Now that's perfect, Todd. So then Steve follow-up for you, how should we think about the balance sheet kind of on a pro forma basis post the close year in terms of some of the line end that was -- that are going to change? And then also want to think about expenses, you are on a run rate here that you've given us for Q3, but it's 2 out of the 3 months and certainly, you're trying to get some synergies, so any commentary around where we go from here on expenses, it will be helpful too.

Okay. Well, yes, certainly the balance sheet is going to change. We're taking on some of ViXS debt and some of it we're paying off, payed off their line of credit already, but their convertible debt debentures largely are going to stay. So that number isn't entirely decided. Some of the debentures holders actually have the opportunity to get cashed out and is not determined how many of them will choose to do so. We obviously believe that the converters are a good investment for them in the midterm to longer term. Cash will be lower than our Q2 balance, but I think it will for Pixelworks remain at a higher -- historically highest levels or how we were to catch it. From expense standpoint, clearly there will be synergies. I'm not able or willing to talk in any real detail about what those are going to be. The company will get to small fabulous semiconductor companies with public company reporting requirements, so clearly there is some things that can be brought together. So do expect some changes.

[Operator Instructions]. The next question comes from the line of Richard Shannon of Craig-Hallum.

I guess, Todd, maybe I'll ask you a question here may be kind of a two-pronged approach into the mobile party of markets. You talked about the slowdown in last quarter's conference call regarding high-quality video service system guys like Amazon and Netflix and I think you mentioned in your prepared remarks here about the requirement is certified devices. Can you help us how your conversations have gone with OEMs that are working with video delivery companies like those 2 to create certified devices? And maybe more broadly just talk about how the pipeline is building here either for the gen 3 that sounds like you're just ramping up here or gen 4 is stepping out?

Yes. So I mean we have had 1 particular company that I'm not going to name, streaming services company. They -- I think multiple -- both companies I mentioned certify devices and you can talk to them. But they are the company we were working with that actually provides guidance to their customers on how to certify to be qualified for mobile HDR content. And we have worked with both their customers and with the service provider to make sure that a Pixelworks-enabled phone with the right display will meet those criteria. And not that you can't meet it without Pixelworks, but we're trying to position it that the easiest way to do it is with Pixelworks. And I would suggest that unless there is intimate knowledge in the display pipeline itself, they might not be able to do it on their own accord, right? So I think there are some very large OEMs that certainly have the capability in house to do it, right? But there is a lot of customers that don't have this expertise in house. At Pixelworks, we're trying to position ourselves is who you go to, if you want to add this capability and you want to have this know-how as part of your design team, you engage with Pixelworks. That answer your question?

Yes, quote that I might follow up here in a couple of other ways. So you mentioned larger company -- larger OEMs may be able to do it, but the smaller ones not so much. Can you give us a sense of how did you might approach larger OEMs that might have that capability anyway?

Well, I think I've been pretty clear in the past that there are a couple of very large OEMs that I believe have the know-how in house. And as a small company, we have to use our resources wisely. I don't pursue them. I focus elsewhere. I do want to be clear though, those couple of people that I called out, I think even specifically in the past that have -- that I believe have very good capability internally. They're market makers. I want them to be successful. I want their display technology teams internally to achieve what we're achieving and drive it into the market, because I think it will be very helpful with our business strategy.

Makes perfect sense. I may follow up on that later, but thanks for that detail, Todd. My last question is regarding your comments about ViXS growth and I may have missed some of the details here, but I think you've talked about between 30% and 40% growth for next year. I was wondering if you can help us bridge between your guidance for the third quarter which clearly is 2/3 of the month into next year. Can you give us a sense of how to bridge that numerically?

No is the clear -- is the short answer. And the reason is it was a partial quarter, I wouldn't just linearize it. Their revenue is with a broad customer base. There is good and bad with that and we don't want to get in front and start giving guidance for Q4 of 2018. But I'll just be honest with you, we were even debating internally whether we put any kind of growth target on that ViXS portion of the business and the reason I wanted to is because they were -- we're a public company and they had historical financials, you can all go get them. And so people probably are asking why did you acquire this company, right? I want to be clear. This is a company that has very good R&D. Very good technology, proven technology that I think in some cases, their past business strategy was a very high-risk business strategy and a very difficult one, maybe one that they weren't prepared to engage with. I mean if some luck on their side, they might have succeeded with it, but luck wasn't on their side. But that doesn't take away from the technology that was developed. And as we move forward with our longer term business strategies, especially on the mobile side, resource limitation becomes a problem. And so I was looking how do I scale up the organization with the right type of people, right R&D resource. And hopefully with a growth revenue that pays for it. And that's what I believe ViXS to be. So if you look at past financials, you don't see the growth. I believe the growth will be there, or else we would not have done this deal, okay? I want to basically articulate that in order for us to make our commitment to be accretive, it will take a combination of growth and synergies. Not just synergies and not just growth. And so I think I wanted to articulate it in that way, but to give any specifics and any clarity, it's going to be hard for you guys to model the combined company going in the next year. We put a number out there for you, so you can model, but beyond that I don't want to give any more clarity.

Thank you. At this time, I'd like to turn the call back to management for any closing remarks.

Well, this continues to be a journey for us. Team's executing well on the core business. The past strategic decisions we made to streamline our product line and focus on lowering the barriers as entry mobile are starting to pay off. They are evident in our numbers. And the new journey we're taking with combining ViXS, there is a lot of work ahead of us, but I'm very excited about the work that's going to be done over the next 6 months and we'll report on the progress on a quarterly basis.

Thank you, sir. Ladies and gentlemen, that does conclude your program. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful day.