Pixelworks, Inc. (PXLW) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to Pixelworks, Incorporated Fourth Quarter 2017 Earnings Conference Call. I will be your operator for today’s call. [Operator Instructions]. This conference call is being recorded for replay purposes. I would now like to turn the call over to Pixelworks' CFO, Mr. Steve Moore.

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 fourth quarter and fiscal year 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, Thursday, February 15, 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, 2016 and subsequent SEC filings for 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 deferred revenue share value adjustment, inventory step-up and backlog amortization, amortization of acquired intangible assets, acquisition and integration related costs, stock-based compensation expense, restructuring expenses, fair value adjustment on convertible debt conversion option, discount accretion on convertible debt fair value, extinguishment of convertible debt and a tax benefit related to tax reform. With the exception of stock-based compensation and the tax benefit related to tax reform, 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 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 everyone joining us on today's call. Beginning with an overview of our results, fourth quarter revenue was $18.4 million which present a high end of our $17.5 million to $18.5 million guidance. For the full year, we achieved consolidated revenue growth of 35%, which doesn’t include over $15 million in revenue contribution from End of Life products. And on a pure organic basis and also excluding any contribution from the EOL we delivered year-on-year growth of over 25% marking a transformational year of growth for Pixelworks. Fourth quarter gross margins of 56.9% was also on the top end of our guidance as we benefited from a richer product mix resulting from our previous streamlining of Pixelworks product portfolio as well as the increased contribution from high margin video delivery products. Operating expenses were in line with the expectation and fourth quarter EPS was above the midpoint of our guidance. Although the impact from the ViXS acquisition weighed on EPS in the back half of 2017, we achieved solid profitability for the full year on a non-GAAP basis. Importantly, we have now fully completed the integration of the video delivery business positioning us to deliver on our commitment of the acquisition being accretive in 2018. Also notable, I want to highlight that we generated $1.4 million in cash flow from operations in Q4 and over $12 million for the full year. Turning to commentary and highlights on our three end markets of projector, mobile and video delivery. First, in our projector business. Fourth quarter revenue reflected better than typical seasonality on a sequential basis, and grew approximately 5% over the prior year fourth quarter. When excluding the contribution from EOL our projector business grew over 38% year-on-year. As of yearend, we now believe the market has more or less normalized following the inventory and supply channel disruptions in 2016. During the quarter, we continue to execute on our core development activity with a large customer for a next-generation SOC and we are on track to complete the project on schedule in late 2018. More broadly, Pixelworks is well positioned in the market and we remain closely engaged with customer on both their current and future product roadmaps. Booking levels for the current quarter are solid and consistent with traditional seasonal patterns and based upon current visibility, channel inventories the supply chain and overall market dynamics appear healthy. Looking forward, we feel comfortable that the step up in our gross margin over the last year can largely be sustainable through 2018, however, as mentioned last quarter year-over-year growth rate in our projected business will moderate as we compare to increasingly higher comps. Now taking a look at mobile. As anticipated revenue grew sequentially in our mobile business and was driven by increased shipments of our Iris video processor in support of the latest generation of tablets at ASUS. Mobile revenue for the full year grew 37% over 2016 even though the contribution from mobile remained relatively small. Looking back at 2017 a number of key developments took place across the mobile market that serve to further support Pixelworks review and escalate the relevance of our display processing technology. First, the two largest mobile OEMs introduced flagship phones with over displays and their associated display pipeline including wired color gamut and HDR playback. Not only did this increase awareness of ACR quality among consumers but it helped reinforce the video streaming ecosystems investment in available mobile HDR content. All of this has given credence to our marketing effort and added real pressure on other OEMs to adopt similar display features and functionality. Moreover, we continue to believe there are few OEMs outside of the top two or three leaders that have the internal capability and know how to incorporate true, advance display processing into the next-generation platforms. As such, our focus remains on capitalizing on these current market dynamics and partnering with target OEMs in Asia where we are making good progress. Specifically related to our recent progress in mobile, early last quarter we began sampling our fourth generation Iris display processor. We’ve since actively engaged in ongoing evaluations with target customers and we released our fourth generation device for production in January. Additionally, we continue to be engaged with multiple customers on design and activity for our third generation Iris chip and in addition our Iris HDR reference design has now been approved by a leading streaming service provider. This reference design enables a quicker path for OEMs that want to become wait-listed by this particular provider. Customer engagements for Iris grew in Q4 and we exited the year with 10 active programs at eight different OEMs. I would like to caution that given the volatility of the smartphone business it is never certain that all of these programs will result in design wins or make its production. However, we are very encouraged by the interest in our Iris processors and we are working hard to expand our mobile engagements. Based upon the current design activity we expect to begin ramping meaningful volume production in mid-2018. Turning to video delivery. As previously mentioned, we successfully completed our integration and restructuring of this business during the fourth quarter, which has enabled us to begin realizing approximately $4 million in annualized cost synergies. As is typical with some acquisitions, after rationalizing order patterns with future customer demand in legacy and de-legacy areas of the business we now believe that a normalized annual revenue run rate for the acquired business was approximately $10 million in 2017. Although this is a lower base line to start from, we continue to believe that this business is capable of growing 30% to 40% in 2018. Going forward, our video delivery team is exclusively focussed on two meaningful opportunities. The first of these opportunities is in the consumer electronics market in Japan, where today, our Xcode family of advanced decoding and transcoding SoCs are used in HD and UHD Blu-ray playback and recording products. Both the broadcasting standards and the way the consumer receive and manage broadcast content is significantly different in Japan as compared to in the U.S. Most importantly, Pixelworks video technology provides the Japanese OEMs with the ability to meaningfully differentiate their products to consumers end markets where dedicated set top box equipment isn’t issued by a service provider. We have staffed our Japan sales office and engineering support team with the intention of expanding our share and have enabled to show early success. Early in the quarter, we finalized our multimillion dollar development agreement with the consumer electronics OEM in Japan to work on a next-generation family of products targeted for production release at the end of this year. The other opportunity we are focused on is OTA or over-the-air streaming. Here in the U.S. consumers are increasingly demanding more control over their video content, including when and where they can access it and only paying for the content they want to watch. This is driving the decline of traditional pay TV subscribers as an increasing number of consumers choose to cut the cord in favour of new alternatives for content such as such as OTT and OTA. Pixelworks OTA transcoders enable consumers to stream live HD broadcast television to effectively any wireless device or streaming media players such as Roku or Apple TV. Two recently launched products incorporating Pixelworks' OTA solutions were, the [Indiscernible] quarter TV device with a dual tuner that allows consumers to simultaneously watch two live channels or free local HD broadcast on two different devices, which was announced in conjunction with CES. Second, Air TV’s soft launched its newest OTA device which is also compactible with sling TV enabling users to not watch the free local HD channel at home, but effectively anywhere with Internet access. For Sling subscribers they get the added benefit of an integrated OTA channels within their sling user guide. These are just two examples of the many single, dual and quad channel solutions based upon our SOCs. Today, the market for OTA devices largely consists of early adopters and consumers that are anxious to cut the cord. As awareness of cord cutting alternatives increases, the market for OTA devices has the potential to become a significant opportunity for Pixelworks. To conclude my prepared remarks, I want to emphasize again that 2017 was a transformational year for Pixelworks with reasonably good fundamentals in place at the beginning of 2017 we successfully executed on a number of key objectives throughout the year to deliver significant top line growth and over 450 basis point improvement gross margin and non-GAAP profitability for the year. Additionally we added approximately $10 million of non-dilutive capital to the balance sheet from End of Life products and also generated over $12 million in cash flow from operations. This and a large part enabled us to opportunistically acquire ViXS highly synergistic group of video centric engineers and products, not to mention a complimentary portfolio of over 450 patents. Also during the year we secured two development agreements with two of our leading customers in the projector and video delivery markets. And finally we successfully completed and begin sampling our fourth generation Iris mobile display processor. With respect to 2018, I believe we are well positioned to execute on and capture the size growth opportunities ahead of us in both our mobile and video delivery markets, while maintaining our leadership position in the 3 LCD projector market. 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 ?

Thank you, Todd. Revenues for the fourth quarter of 2017 was $18.4 million compared to $18.8 million in the third quarter and revenue of $16 million in the fourth quarter of 2016. The year-on-year increase in fourth quarter revenue reflects the combination of continued growth in our core digital projection business as well as the first full quarter of revenue contribution from the acquired ViXS business. The breakdown of revenue during the fourth quarter was as follows; revenue from digital projector was approximately $15.1 million, mobile revenue was approximately $420,000 and revenue from video delivery was $2.5 million. Additionally, we recorded approximately 400,000 of legacy TV monitor products sold. Non-GAAP gross profit margin was 56.9% in the fourth quarter of 2017, compared to 54.9% in the third quarter of 2017 and 53.6% in the fourth quarter of 2016, the sequential and year-over-year expansion in gross profit margin during the quarter was due to a favorable mix of revenue including increased revenue contribution from our high margin video delivery solutions. Non-GAAP operating expenses were $10.6 million in the fourth quarter 2017 compared to $8.9 million in the third quarter 2017 and $7.3 million in the year ago fourth quarter. This expected sequential increase in operating expenses reflected that we did not recognize an offset to R&D during the fourth quarter associated with our co-development project with a large projector customer. While in the third quarter we benefited from approximately $1.3 million in credits related to this project. Additionally, we incurred a full quarter of expenses related to the acquired video delivery business. Adjusted EBITDA was $778,000 for the fourth quarter 2017 compared to $2.3 million in the third quarter 2017 and $2.1 million in the fourth quarter 2016. Reconciliation of adjusted EBITDA to GAAP net income loss may be found in today's press release. On an non-GAAP basis the company reported a net loss of $379,000 or one penny per share in the fourth quarter of 2017 as to a non-GAAP net income of $976,000 or $0.03 per diluted share in the prior quarter and non-GAAP net income of $1.2 million or $0.04 per diluted share in the fourth quarter – in the year ago fourth quarter. Moving to the balance sheet, we ended the fourth quarter with cash and cash equivalents of approximately $27.5 million, an increase of $1.2 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 days sales outstanding of 23 days at quarter end compared to 24 days at the end of the third quarter. Inventory returns during the fourth quarter of 2017 were 10.6 times compared to 12.2 times in the prior quarter. Turning now to guidance, for the first quarter of 2018 we expect revenue to be in the range of between $14.5 million and $15.5 million, this range is consistent with projector market seasonality. We expect non-GAAP gross profit margin of between 52% and 54%. For operating expenses we expect the first quarter to range between $8 million and $9 million on an non-GAAP basis. Note, our expectation for operating expenses in the first quarter include the anticipated recognition of approximately $2 million of offset to R&D related to the ongoing co-development project with a large digital projector customer. And finally we expect first quarter non-EPS to be in a range of between a loss of $0.06 per share and breakeven. With that, we will now open the call for questions.

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

Yes. Thanks for taking my questions. I think Todd you referenced in your script, the video delivery business you’re looking at 10 million run rate I think it was little bit higher previously. So wonder if you can just talk about what change happened there, and then also I wondered if you could revisit last quarter I think you talk about accelerating growth in 2019 and beyond. Is that still your view given some of the pickup you’ve seen mobile? I think you still expect the video delivery business to grow pretty good, so just an update on that? Then I’ve got a follow-up. Thanks.

So, first question regarding sort of level setting around the video delivery business. There’s sort of two variance. I mean, our view gone into this was probably closer to – we require a business that was at $12 million run rate that was going to grow, right. So you’re talking about a couple of million over the year. Where did that – where we seeing the weakness out of that $12 million at the starting point and there’s two areas, one is the legacy business which there are a lot of smaller customers, it was fairly high margin customers and they still are. And they are somewhat unpredictable but it was clear there was one large one in that group of customers that was sitting on quite a bit inventory that I did not know going into the deal. That was one of it. And then the second piece of it was the take rate on the 4K set-top boxes is starting to pick up, but it wasn't at the run rate that I had anticipated with the first product that we saw in Japan. So I think we’re seeing a little bit of weakness in both those areas at the starting point if you look at the main vectors that we were focused under an acquisition this still in place. I mean, its OTA streaming and then an expansion of these consumer products in Japan. And I stick with it at the very front end of that. The large customers that we acquired in the consumer space in Japan when we acquired the business was sharp, it still is sharp. The first project announced with the vicious the product line was started shipping I think in – I want to say mid 2017, so it was a fairly new product. And the thought process was that it was going to ramp quickly. It is ramp but it just not ramping as quickly as they thought. So that’s the area's office there. And then as far as your second question, do I still expect – if I still think were positioned for accelerated growth rate in 2019, I do.

Great. And then housekeeping question for Steve, I wonder if you could maybe just update on the status of the converts you guys acquired from Texas?

Sure. When we acquired the company, they had about approximately $5 million worth of U.S. convertible bonds. We had a small conversion in the fourth quarter, not worth mentioning but in January we have seen conversions of about $2.7 million out of that $5 million, and would expect that the remainder of about $2.3 million would either convert or be purchased back before the end of the quarter.

Got it. Okay. Thanks so much.

Thank you. And our next question comes from the line of Suji Desilva with Roth Capital.

Hi, Todd, hi, Steve. Congrats on the progress of 2017. Steve, just the housekeeping question first, the inventory went up in 3Q and 4Q is that the projector business as well as balance sheet there?

The gross inventories actually came down and lot of that decline had to do with the step up of the inventory that we acquired from ViXS. So yes, it was automatic decrease. From a turn standpoint, that has more to do with the changes in revenue relative to that base.

Okay. And then one housekeeping question where there revenues in the fourth quarter that with 400,000 of legacy TV product?

Yes. It was the OLED. We knew – we had this orders before we gave guidance so that was in our guidance. It was in a very high ASP which is also part of our higher margin guidance that we gave and in fact we had a number of things contributing to our good margin performance this quarter that was one of them.

Okay. Great. And then couple of questions for Todd, on the business. Todd, you talking about timing of mobile revenues being mid 2018, does that presume the launches of the phones will be in a more second half holiday type launches or with some of the launches be a possibility for some of our customers to get going?

Telephones are out, I don’t like to talk too much about them, Suji, but I will say that with all those -- I mentioned 10 programs. Some of those programs are front half of the year. Some of them back of the year, some of them are launched in 2019 programs. So they’re all at various different stages of where they are in their cycle of development.

Okay. That’s helpful. Lastly what metric should we watch for Pixelworks ViXS OTA growth? What would you suggest to be keeping an eye on to, note that is tacking in 2018 as an inflection trend?

Today it’s definitely an early adopter. I called it the hobbyist market. I mean, there’s a intent group of people that really do not want to pay for their either cable satellite and they still want their free broadcast TVs or television stations. And so there off and they are the ones driving the sales, but I think what incrementally or with the inflection will come is when you have a large OTT streaming service provider that has chose not to pay the retrans fees and bundle the regional broadcast, but instead offers their OTT streaming in conjunction with OTA free channels. And I think that’s when you’ll see a broader user base, when you see integrated software so that we have an EPG and a user guide, you will get the seamless look of both you’re free over the air channels and you pay channels that you choose to pay for. And I think once those types of solutions hit the market then there’ll be -- it will go beyond the hobbyist. It will start to hit more of a general populace. And I think then that’s when you see the growth rates.

Okay, great. Thanks for the color, Todd. Thanks guys.

Thank you. [Operator Instructions] Our next question comes from the line of Richard Shannon with Craig-Hallum.

Hi, guys. Thanks for taking my questions as well. I guess, some of the question on the quarterly guide, any sense if you give us of the split up between the buckets there, if you maybe describe kind of sequentially and how would you describe those sequential changes in the first quarter relative to seasonality?

We don’t – we’re not going to break out the components of revenue in our guidance, but we certainly, we already discussed starting from a lower base on the video delivery products. The decline in projector its consistent with our traditional declines, I think perhaps at the higher end over a number of years, but still within the range that we seen in the past, and that mostly as I think you understand driven by most of our projector customers are Japanese and Japan this is the year end so their inventories at the end of the year are depressed, leading into Q2 where their re-inventory or rebuilding inventories to a more normal run rate.

Okay. Fair enough. Question for you, Todd, I wonder to one of the earlier questions regarding OTA, you said you think the market is going to become less of the hobbyist to more mainstream once OTT providers integrate OTA in there. Are you seeing any real work being done development and potentially market and market development to make that a reality anytime in the foreseeable future? And if so can you maybe suggest exactly what’s going on and what kind timeframe to look further?

Yes. We’re actively engaged in programs today and no, I can't comment on it.

Okay. But I guess not a surprising, but I’ll forward to more comment there in future. Let’s see, I guess one last question from me and I’ll jump out of line. You mentioned in your press release and remarks win with a reference design related to streaming service for HDR. Can you just describe to what extent you think this reference design will help drive design towards that and get some sort of enhanced reputation or preferred marketing access by using that reference design versus going at traditional fashion?

Well, it’s definitely healthy. And it’s helping today on some of the programs that I mentioned earlier that we’re engaged in. And it’s a large stream service provider, somebody that spent the great deal of money on their own content or acquiring content, and has an initiative to get a high quality version of that content to mobile users. And the way that they can ensure that a mobile user sees their high-quality content as it was meant to be seen, is to actually qualify each phone model and then they whitelisted. And so, when that phone if it’s been whitelisted when it goes on to that video stream website, it will have access to mobile HDR content that non-whitelisted phones would not get access to, right. And that’s basically they just don’t make the content available if your phone is not going to display it in the manner it should be. And that’s how they control the experience of their consumer, right. And what we’re able to do we convince this streaming provider through a diligent effort and many demonstrations of with both LCD technology and OLED technology that we could as long this screen itself either LCD or OLED met certain criteria in conjunction with our display processing capability we would meet their what they viewed was a minimum criteria to be whitelisted. And so we went through several exercises. We proved our point. They agreed with us. And effectively they will support us as we go market, our offering to the phone manufacturers. So if the phone manufacturers care about either bundling that particular video streaming service provider’s path or they just think its compelling in the aftermarket, it helps us with our marketing effort, definitely.

Okay. That’s helpful. I think it’s all the questions from me. I’ll jump out the line guys. Thank you.

Thank you. And that concludes the question and answer session for today. I’d like to turn the floor back over to management for any closing remarks.

So, I’d actually prepared remark today, usually, I'd wing it. But so going into 2018, we believe that Pixelworks is well-positioned to participate in the rapidly developing highly disruptive markets of high-quality content delivery and multi-device consumption. We believe that these markets are in their infancy and will rapidly expand over the next three to five years. This management will continue to balance the best interest of all our stakeholders while investing an opportunity that position Pixelworks to achieve sustainable long-term growth. Our leveraged resource model is working well and we are focused on executing the strategy we put in place last year. On a final note someone asked me the other day if I was still having fun pixel works. I think I speak for the entire team when saying that we are having a blast. Thank you.

Ladies and gentlemen, thank you for your participation in today conference. This does concludes the program and you may now disconnect. Everyone have a great day.