Good day, ladies and gentlemen, and welcome to Pixelworks' Inc. Third Quarter 2019 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. Elias Nader.

Thank you. Good afternoon, everyone, and thank you for joining us today. With us 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 third quarter of 2019. 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, October 31, 2019. And we undertake no obligation to update any such statements or 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, 2018, 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 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 gain on sale of patents, deferred revenue, fair value adjustments, inventory step-up and backlog amortization, amortization of acquired intangible assets, stock-based compensation expense, restructuring expenses, discount accretion on convertible debt fair value and gain on extinguishment of convertible debt. 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. Also 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 would now turn the call over to Todd for his opening remarks. Thank you.

Thank you, Elias, and good afternoon to those joining today's call over the phone and webcast. The third quarter played out largely as expected with revenue of $18.1 million coming in above the midpoint of our guidance range. We continue to execute well across all areas of the business and Mobile revenue grew 87% sequentially, becoming a larger portion of our overall revenue mix. Gross margin was approximately 54% and operating expenses in the quarter were $10.3 million, resulting in an adjusted EPS of $0.01 loss. All of which were also at or near the midpoint of our guidance. Throughout this year, we've remained focused on meaningfully advancing our growth initiative in Mobile. This has included expanding our portfolio of visual processing solutions to now include multiple Iris visual processors with select feature sets at compelling price points as well as the introductions of our software-only solutions, Soft Iris, and also our innovative end-to-end cinematic video platform, TrueCut. We've also secured a number of key strategic partnerships that are contributing to our current co-marketing efforts and the further development of ecosystems that encourage increased adoption of Pixelworks' technology. Together with our broader portfolio of visual processing solutions, we have significantly expanded Pixelworks' total addressable market resulting in a growing number of wins at existing and multiple first-time mobile customers. Taking a closer look at our Mobile business in the third quarter. As I mentioned, revenue from Mobile grew 87% sequentially and was up over 66% year-over-year to a quarterly record. It was comprised almost entirely of revenue contribution from our Iris solutions, including the first commercial revenue from our Soft Iris solution. As further evidence of our consistent growth momentum, the third quarter represented the eighth consecutive quarter -- eighth consecutive quarter of year-over-year growth and Mobile revenue for the…

Thank you, Todd. Revenue for the third quarter of 2019 was $18.1 million compared to $18 million in the second quarter of 2019 and revenue of $21.5 million in the third quarter of 2018. Revenue for the third quarter of 2019 reflects continued sequential and year-over-year growth in both Mobile and Video Delivery businesses, partially offsets by weaker-than-normal seasonal demand in the digital projector market. The breakdown of third quarter revenue by end market was as follows. Revenue from Mobile was a record $1.6 million, predominantly from the sale of Iris solutions. Video Delivery revenue was approximately $3.7 million. Revenue from digital projector was approximately $12.8 million. Non-GAAP gross profit margin in the third quarter of 2019 was 53.9% compared to 54.1% in the second quarter and 54.7% in the third quarter of 2018. Non-GAAP operating expenses in the third quarter of 2019 were $10.3 million compared to $9.6 million in the second quarter of 2019 and $8.9 million in the third quarter of 2018. Adjusted EBITDA in the third quarter of 2019 was $452,000 compared to EBITDA of $1 million in the second quarter of 2019 and $3.8 million in the third quarter of 2018. For third quarter of 2019, the company reported a non-GAAP net loss of $518,000 or loss of $0.01 per share compared to non-GAAP net loss of $97,000 or breakeven on a per share basis in the second quarter of 2019 and non-GAAP net income of $2.7 million or $0.07 per diluted share in the third quarter of 2018. Moving to the balance sheet. We ended the third quarter with cash, cash equivalents and short-term investments of approximately $22.3 million, a decrease of approximately $1 million from the prior quarter. Other balance sheet metrics included days sales outstanding of 44 days at quarter end compared with 37 days at the end of the second quarter. Inventory turns during the third quarter of 2019 were 11x, the same level as in the prior quarter. Turning to guidance. For the fourth quarter of 2019, we expect revenue to be in the range of between $15 million and $17 million. This guidance reflects an increase in Mobile revenue, which is expected to represent up to 20% of total revenue in the fourth quarter. The increase in Mobile revenue will be offset by geopolitical and macroeconomic headwinds and weaker end market demand contributing to inventory corrections in both the digital projector and video delivery markets. Additionally, we anticipate non-GAAP gross profit margin in the fourth quarter to be in the range of 48% and 50%. We expect non-GAAP operating expenses to be in the range of between $10 million and $11 million. Finally, we expect non-GAAP EPS in the fourth quarter to be in the range of between a loss of $0.05 and a loss of $0.09 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.

[Operator Instructions]. Our first question comes from Sujeeva Desilva with Roth Capital.

Todd, how are you? Elias, congratulations on the Mobile progress here. So starting with the Mobile segment, it sounds like it could be up to 20% of revenues in the fourth quarter. That's a nice sequential move here. And that would exclude the Tier 1. So maybe you can give us a sense of whether the growth ex the Tier 1 is coming from the existing customers or new models? And then maybe some idea of the magnitude what the Tier 1 could do on layering on top of that.

So first, let me be clear, that does not exclude the Tier 1, that excludes the program from the Tier 1 that was targeting a fourth quarter launch. It is not done yet. There's still a chance that, that could happen. We -- what we've done is we signed into a risk-sharing agreement, we have booked and built over the last 4 months and continuing for the next two months, enough with to accommodate multiple product launches, including the fourth quarter product launch. The fourth quarter product launch was on an accelerated schedule that given this race to 5G in China, most of the OEMs are accelerating their launch plans to try to catch it. And integration of our product and making sure that what we do to a display in combination of what they're trying to do with these new 5G phones is not an insignificant development. And so to hit the criteria that the customer wanted, we were on a very short schedule. We are coming to the end of that schedule. If -- right now, I'm assuming that we will not make the cut on that program, but we have bookings for follow on programs. Some of the revenue in Q4 are basically any revenue that's in -- currently in our guidance for the Tier 1 as well as other customers would be for the follow-on programs.

Okay. And just to be clear, you're building up ship inventory for those programs, the models may go into the market in early '20. Is that the way to think about it?

Not only am I building up, I have backlog. The problem is the backlog could shift out into 2020, right? Today, it was shorter term backlog.

Okay. Okay. And that's helpful. This sounds very exciting. And just to be clear, this Tier 1 is not one you've talked about in the past. It is a new customer to Pixelworks' Mobile, is that correct?

We have not had a Tier 1 by my definition.

Yes.

So as such, this is a new customer.

Outstanding. Okay, good. Shifting over to Soft Iris. I don't know how we should think about the magnitude of the opportunity relative to your revenue run rate? Clearly, ASUS is doing it. Is there a pipeline beyond ASUS? And how should we think about the revenue margin opportunity being material or not to you guys?

Actually, one of the multiple opportunities with Tier 1, and I'm not going to say how many there are. There are multiple. And it's more than -- multiple means more than 2. I'll give you that, okay? One of them is a Soft Iris. And then we have some follow-on Soft Iris opportunities with the existing customers. It could start to -- first of all, it's pure profit. And it could start to actually -- it will definitely contribute to the gross margin line as it accelerates, which right now, we're thinking back half of 2020 when it actually impacts the gross margin line.

Okay. And then a couple of more questions. On the Japan weakness is a driver type from where you sit, macro, consumer sort of caution in the current environment? Or are there other factors to the Japan process?

You got it. That's a long answer to a short question. I'll just separate the 2. Projector, I think it's a combination of twofold, I think, one pricing of flat panel displays has dropped -- large flat panel displays has dropped dramatically in the last 12 months. This has corresponded at the same time when we've seen -- I mean, we will finish the year off at probably below a 20% decline in our projector business. Now, we had forecasted a slight decline. We did not forecast that large of a decline. I do not think the majority of it is contributed from the large flat panel pricing. I think the majority is contributed from the global economic environment, specifically in China, China infrastructure. If you think about it, most of the projectors that we are in today, get put around globally, in new offices, most people don't upgrade their projectors in existing offices. They move to a new office, they build out a new office, that's when these systems go in or if it's large venue, et cetera. If that type of construction and build out slows down dramatically, projector acquisition slows down dramatically. And so I think that's the #1 contributor, right? But I also do think that this -- I mean, probably a year ago, a 75-inch flat panel display or a 65-inch, let's say that's even more aggressive, was probably to the tune of $1,200 to $1,500 on an average ASP. I would say that it's almost half that right now. And so I think that is providing some headwinds. And I'd love to be optimistic. There are some new markets that projector -- our projector customers are going after that will show growth. They're pivoting. But you add it all together, and I'm believing that over a 5- year trend projector is a flat market.

Our next question comes from Charlie Anderson with Dougherty & Company.

Kind of a two parter on Mobile, one that's sort of precise and one's big picture. You're sort of on the precise aspect, you mentioned the 20% in Q4. I wonder, Todd, if you have any early thoughts on 2020 in terms of Mobile as a percent of revenue? And then as you've gotten a lot more clarity on these programs in China. I wonder if maybe you have sort of any updated views on the size of the TAM for you guys over the next few years in terms of what's out there? And then I've got a follow-up.

Okay. So first, I said up to 20%, okay? So there's still a variability. And because of the way I articulated this engagement with the customer. There's still uncertainty on all this, right? This is a new engagement. It's a very intense engagement, and it's during a very chaotic time as this acceleration to 5G and high frame rate displays happens. So because of that uncertainty, we have a wide revenue guidance range. And I'm saying, up to 20%. As far as next year, let me tell you what the -- I'm not going to make any comments, I'm not going to give 2020 guidance. But what I will say is the goal of all 220 people at Pixelworks today is to exit 2020 with Mobile being the majority revenue business from this company.

Great. And then sort of a follow-on to that, the gross margin guidance for Q4, you're going to step down from the level you're at. Mobile is a larger portion of the mix. I wonder if that's a -- how much of that is the factor versus maybe just a lower overall business from everything else? And then maybe big picture view on where you see the trend of gross margin as you go through this transition?

Yes, that's a really good question, Charlie. So first of all, I don't know the exact numbers, but my guess is at least 100 basis points is probably due to absorption, low revenue number, et cetera. But that would still say that there is a significant downtick in our overall product mix, gross margin, that's an attribute of 2 things. One, our projector video delivery business have a higher gross margin than our mobile product line. We are ramping our mobile product line, we're ramping a new product hard you usually go through a learning curve and yield. I mean, when you're ramping this hard, you will throw away some wafers, right? And you will improve your yields. And so we're going through that. And then even within our light projector portion of our guidance, it is weighted heavily towards our co-development customer, which is a lower margin profile than the other customers. So a combination of all of the above is why you see the margins guided where we are. To the second part of your question, I've said that even though we have the headwinds with this co-development customer with this new product. It's a lower ASP, but it's a higher margin. If you really look out in time, if we are successful with the mix of mobile that we're pursuing, we're able to maintain the ASPs, we think we can maintain in the mobile market. We shift this projector customer to the -- this large projector customer to the new chip and it's the predominant shift that they would buy in the back half of the year. And then we get the headwind of not a lot, but some Soft Iris and TrueCut revenue, which is pure software. If we exit where we want to exit, we're going to exit 2020 at a higher corporate gross margin than we exited 2019.

Our next question comes from Richard Shannon with Craig-Hallum.

Maybe a follow-up quickly on the Mobile commentary on the fourth quarter being up to 20%. Todd, do you wish to provide a floor for that number?

Zero. I mean, no. I'm being flippant. I'm sorry, Richard, I'll put it this way. We are currently over 100% booked for the quarter on the guidance we gave you. So the uncertainty is not bookings. The uncertainty is how many of those bookings will ship in Q4 and not.

Okay. And it's all related to that one engagement, which just trying to rush out to market in China?

For Q4, yes.

Okay, interesting. Maybe step back here and take a look at the Tier 1 OEM that you're talking about here. Maybe if you can kind of talk a little bit about the history of this customer here, how long you've been engaged with them at any length? How long has it been serious? What's kind of pushed them over the edge? And maybe you can describe the breadth of their engagement? What are they looking at? Any -- we can characterize type of phone, it's probably not gaming or anything, but any way you can characterize the phone would be helpful.

Richard, you are bold today. That was bold. As you know, I'm not going to answer that question. But I appreciate you asking that level of detail. I'll give you a very broad stroke. We've been engaged with this, first of all, if you consider the sales and marketing process, we've engaged with this customer for probably 2 years. If you consider when they thought they needed visual processing technology to be included in their product portfolio, I would say, less than 6 months. Beyond that, I just don't want to talk about the scope. I mean, there's still some uncertainty in this. We're still having to prove ourselves. There's nothing guaranteed in this world. And every one of these Tier 1s that still exist are fighting for their own survival, even if they're a large company. And so given that level of uncertainty. And until they roll out products with our visual processor, I just don't want to give a lot of insight. Sorry.

Okay. That's fair. Certainly understand but just wanted to go to the edge of what you're willing to. That's helpful.

I appreciate it. I appreciate it you asking.

Some very interesting topics here. I'm sure if you can talk about a more level probe even deeper. So with that said, let me jump into to TrueCut. You obviously introduced this in April, gave an update last quarter. Maybe if you can just kind of discuss the engagements since the last quarterly updates, where you're seeing some pick up here from streaming guys or content guys or studios or wherever you're seeing and maybe give us a thought process? And when can we see a kind of a major milestone about announcement relative to one of those leaders in those categories?

Ladies and gentlemen, please stand by. Your conference will resume momentarily. Speakers, you may resume.

Richard, sorry, about that pause. Looks like we dropped.

I'm sorry. Can you hear me now?

I can. So you were just starting your next question, and we dropped so.

Sure. So I asked a question on TrueCut. Wanted to get a sense or an update over the last three months since your last conference call and what's going on there? If you can discuss any -- characterize any engagements or in discussions with the major players that you wish to engage with like streaming guys, content guys, studios? And what kind of time frame could we see a, kind of, a major milestone public announcement that kind of confirms traction with TrueCut?

Well, I consider the YOUKU announcement and then the fact that they've converted 10,000 hours of content and reached the majority of their mobile customer base, and then now they are out marketing heavily, this advanced format. I consider that already validation. So if you're talking about further validation.

Well, how about say it from western or U.S. companies. How is that?

Okay. So you're talking about North America. I mean, listen, we are -- we're very focused as a reflection from the awards I've announced. Words don't pay bills. But what those awards do is they create a very -- first of all, you don't get an award like that unless -- these are -- you go through a technology review process, right? And it's -- this technology is reviewed by a peer group of people that are deep in the creative process of Hollywood. And we won a couple of awards. And so what that does is that helps influence the people that need tools that we have. I mean, let's just make sure we scope the problem. Today or up to today, most of the content produced was originally target -- I'm talking about cinematic content was originally produced to be displayed first in cinema and then either sent out in the old days on DVDs or VHS to consumers or played on premium networks or today, streamed -- via the streaming services. As we move forward, I don't know what the actual number is, but we're getting close to the crossing point that most cinematic video is either prepared to be delivered directly to streaming customers or quickly thereafter after a cinematic release. And when you do that. When you deliver via streaming, you're delivering to devices, whether they're mobile devices, whether they're tablets or whether they're TVs. And all of these devices are at higher frame rate and a brighter environment and with ambient light around them than a movie theater. And a movie theater is a controlled environment. And so as more content is being delivered to this uncontrolled environment and to these high frame rate displays, the content creators are now very conscious of how…

To a great extent, you did talk in a lot more detail, and I appreciate that.

I'm not showing any further questions at this time. I would now like to turn the call back over to Todd DeBonis for any closing remarks.

Well, thanks for joining us today. Obviously, we are disappointed by these corrections, the inventory corrections that we're anticipating in the short term, but at the same time, we're extremely excited about our Mobile and TrueCut initiatives. This has been our focus for a long time, and we're starting to see some real traction on it, and it's a lot of hard work, but we're having fun. Thank you.

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