Good day, ladies and gentlemen, and welcome to Pixelworks, Inc.'s Fourth Quarter 2022 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 Brett Perry of Shelton Group, Investor Relations.

Thank you, Andrew. Good afternoon and thank you for joining today's call. With me on the call are Pixelworks' President and CEO, Todd DeBonis and Chief Financial Officer, Haley Aman. 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 fourth quarter of 2022. Before we begin, I'd like to remind you of various remarks we make on this call, including those about projected future financial results, economic and market trends and 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 different materially. All forward-looking statements are based on the company's beliefs as of today, Thursday, February 09, 2023. The company undertakes 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, 2021, 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 expense, at loss, net loss per share. Non-GAAP measures exclude amortization of acquired intangible assets and stock-based compensation expense, as well as the tax effect of the non-GAAP adjustments and the impact of non-GAAP adjustments to redeemable non-controlling interests. The company uses these non-GAAP measures internally to assess operating performance. We believe these non-GAAP measures provide a meaningful perspective into core operating results and underlying cash flow dynamics. We caution investors to consider these measures in addition to and not as a substitute for not-superior truth company's consolidated financial results as presented in accordance with GAAP. Also note throughout the company's press release and management statements during this conference call, we refer to net loss attributable to Pixelworks, Inc. as simply net loss. For additional details and a reconciliation of GAAP to non-GAAP net loss and GAAP net loss to adjusted EBITDA please refer to the company's press release issued earlier today. With that, it's now my pleasure to turn the call over to Todd for his opening remarks. Please go ahead.

Thank you, Brett, and good afternoon to those participating on the call. I'm pleased to be joining you today from a morning in Shanghai. I've recently been catching up with the team and our customers. Let me start with a few observations that I've made over the last two weeks here in China. First, with the rollback of China's strict COVID policies in mid-November, what many might not realize is that a majority of people here, including nearly all of the employees throughout China are employees, spent December at home with COVID and then recovering, making it a very weak month in terms of productivity. It wasn't until the turn of the calendar year that real normalization began and increased productivity in the return of the consumer engagement. And having personally witnessed the tailend of the recent Chinese Lunar New Year holiday, it is readily apparent that people are enthusiastic about getting back to normal, traveling locally and spending again. At a high level, these are encouraging and positive signs not only for our China-based employees and their families, but also for Pixelworks' overall business as well as the global macroeconomic environment. Turning to a recap of our financial results. For the fourth quarter, both top and bottom line were slightly lower than the midpoint of our guidance. Total revenue was up 2% year-over-year as our team continue to execute well in the face of growing macro and end markets market specific challenges. Looking at the full year, we delivered double-digit growth across each of our target end markets and total revenue growing 27% over the prior year, and this was following our annual growth of 35% in 2021. During what has been a challenging period for most of the semiconductor industry, this solid growth, combined with Pixelworks' history of…

Thank you. Todd. Revenue for the fourth quarter of 2022 was $16.9 million. Our top line results in the quarter were primarily driven by continued year over year growth in the projector market combined with an increase in revenue contribution from video delivery related to increased sales of end of life products. The breakdown of revenue in the fourth quarter was as follows, revenue from mobile was approximately $3.6 million, representing 22% of total revenue in the fourth quarter. Revenue from projector was approximately 9.2 million. Video delivery revenue in the fourth quarter increased to approximately 4 million, reflecting the last time purchase orders for specific end of life products. Following the E O L in the fourth quarter, we anticipate lower quarterly revenue contribution from sales into the video delivery market. As such, beginning with the first quarter of 2023, the revenue breakout that I just provided will group revenue contributions from projector and video delivery into a single market category called home and enterprise non gap. Gross profit margin was 53.3% in the fourth quarter of 2022 compared to 49.8% in the third quarter of 2022 and compared to 55% in the fourth quarter of 2021, non-GAAP operating expenses were 10.8 million in the fourth quarter compared to $12.2 million last quarter and $11 million in the fourth quarter of 2021. As indicated on our previous conference call during the quarter, we completed the next milestone related to our co-development agreement and as a result we recognized a $2.5 million credit to R&D, which reduced our total operating expenses for the fourth quarter on a non-GAAP basis. Fourth quarter 2022 net loss was approximately $800,000 or a loss of $0.01 per share compared to a net loss of $3.2 million or a loss of $0.06 per share in…

Certainly. [Operator instructions] And our first question comes from the line of Raji Gill Needham & Company.

Yes, thank you for taking my questions. I appreciate it. Just wondering, in terms of the commentary on the Chinese smartphone, you're indicating that it will bottom in in Q1. I'm just wondering if you could maybe elaborate a little bit further in terms of where the channel inventory is right now. You talked about kind of growth in the second quarter. Is this based on kind of feedback you're getting from customers? Are they starting to plan for that? Just any issues on the - any questions on the mobile China segment?

So, I think there’s - you're getting all kinds of feedback, Raji, from all different companies that are exposed like we are. In our particular case, we [indiscernible] lean. So then the next thing is to keep an eye on the channel inventories. Our channel inventories peaked in Q3 for mobile. And they came down reasonably well in Q4, but part of that was a down revenue quarter for mobile in Q4. We will see another down quarter in Q1. But as of today, our mobile inventories are either back to normal levels or I would suggest given the ramp we're going to see in the back half of the year, they're lean. Now, the customer inventory levels, I would say is a mixed bag. I have one customer that overbought the older processor, you'll see more phone launches from them out of the older processor as they digest that inventory, but they're sitting on that inventory, right? They're working through that inventory. They'll probably - that customer will probably get through that inventory Q2 into early Q3. But the rest of the customers I would say are at normal inventory levels today. And if they are leaning on our new processor, they don't have inventory, we're ramping those inventories. So, for example, OnePlus, you've already seen some models come out of them. You'll probably see more models come out of them. They're all X7-related. They were not sitting on inventory of X7, right? So if you put the whole thing together, our mobile inventories I would suggest are back to normal or below normal. And so the growth going forward, Q2, Q3, Q4 will purely depend on how successful we are with new phone launches and then the volume of those phone launches. And probably to give you one more layer of granularity there, in the first two weeks, so these two OnePlus launches have been well received. They have upticked their forecast from us in the first two weeks.

I appreciate all that color, Todd. Thank you. Just staying on the topic of China, if I can, what's been the feedback in terms of the customer forecast? I know you mentioned the OnePlus kind of upticking their forecast. When you kind of look at the China handset customers as they - and I appreciate somewhere kind of, it's a mixed bag. But in general, when they're looking at their forecast for 2023 and then maybe even 2024, is there a conservative kind of rebuild that's being kind of felt in their forecast or because they're going to be more cautious of what happened last year? Or how do you think about that?

So their hard forecasts and their ordering patterns are cautious. My personal expectation is too cautious. I think they're going to get bit on the upside of demand in the back half of the year.

And it’s interesting. And then you talked a little bit about anecdotally kind of what you're seeing in China. I guess how would you describe, from your vantage point, the Chinese economy and the China consumer based on your conversations with folks there and talking to the employees as well? Is there an expectation that there's going to be more of a reopening and things are going to get back to normal relatively soon? Or is there still kind of caution there?

Please standby. I see we have -- Todd having some technical difficulties. Please standby.

Okay.

Once again, ladies and gentlemen, please standby. Your conference will resume momentarily. [Operator instructions] Okay. Todd, I see you’re now connected. Please continue and Rajiv is still on.

All right. Raji is still there?

Yes, I'm.

Okay. So I don't know where I dropped off. I think I dropped off somewhere I was talking about that they -- phone OEM customers had to do abnormal behavior, which is digest older technology inventory. And I think their end markets were soft. So this caused them to be cautious. Their hard forecasts and their ordering pattern is still cautious, right? I mean, in my particular case, these phones, they're upticking, but I would say in general, they're still cautious. The dialogue though, I can see them warming up, and it really has been they're trying to gauge it collectively all four tier one OEMs. So I would suggest some are more exposed to the international markets than others, but collectively, 70% of their volume comes to China. And so it's the main driver for them, and it's the main driver for their sentiment. And, if you just walk around, it is busy. People are not, I would - I figured they would be shell shot from what they went through for the last 12 months. They are not, they're just -- they're ready to get out and they're ready to resume their lives. And I think you'll start to see some the consumer come back. I think they'll be cautious. And I think that the sup, the phone OEMs are sort of warming up to that. I've talked to three of the four tier ones already in the first two weeks I've been here they, two of them are bullish. One of them is sanguine, right? It's mixed color. I think it's going to change what, I think what they're worried about is that they're seeing a near term uptick in business. They don't know if it's sustainable, but they don't know.

In terms of the, the inventory of components that the Chinese handset customers are holding, do you think we're at bare bone levels? Is there any way to kind of quantify that relative to history?

Well, like I said, different vendors, different situation, right? I've also met with, I have many friends in the industry over here that, that represent other suppliers into the, the supply chain for mobile phones. And, I had dinner with a gentleman two nights ago and, and he, he represents a large supplier into the market and their channel inventories are still at six to eight months and their customer inventories are at another six months. And so in that particular, in that particular supplier's situation, I would call normal four months of customer inventory, maybe three months of customer inventory, depending if you're ramping or not and 45 days of channel inventory. So, they're a long ways from normal. Appreciate all the color using those same -- using those same numbers. I would say our channel inventory is normal in aggregate, our customer inventory is still a little bloated, which is why we have the Q1 forecast. But, the question for us is, is how much does it bounce back in Q2? If I look at the long term program, so there's the short term, what is the market telling us? It, it's cautiously optimistic. And then in Pixelworks is, okay, is your strategic initiative to be adopted by more customers and then have those customers widen the exposure of the use of your visual processor and reinforce that use of your visual processor by having the ecosystem come in and support your features. If I look at the back half of the year, our strategy is absolutely intact. We will expand our customers and expand the models within the customers, and we will announce ecosystem partners that previously had not supported our solution. So in our case, I'm, I'm bullish for the back half of the year if the market comes back to normalize, I'm really bullish.

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

Hi Todd. So maybe this question's a little hard, but Todd, do you have any idea how far out the unit crossover is for X7 just to get an idea of how that would ramp up or are there too many moving parts in that question to be able to answer that?

Me meaning that we ship more to X7 than X5. Well today we're shipping more X7 than X5.

But you already are.

Yes. Now, you got to remember, I think collectively we shipped last year all processors, which we're predominantly X5, X6, and in the ramp up of X7, between nine and 10 million units, something like this. We had customers telling, at the beginning of last year, telling us they were going to consume way more than that. That was capacity limited. Okay. Of course coming into the back half of the year, some of those customers were not so bullish and they were -- they overbought, we held them accountable for their aggressive purchases. So those are the customer, there's some of those customers, one of them in particular that's sitting on some, they're burning through X5, right. But as far as, and we still have some customers putting X5 in new programs, it's not like it's debt, it's just because it's at a different cost point than X7. And, but I would say on an ongoing basis, we've already crossed that point and there's some people talking if as we expand the models within the customers, we've already announced they usually start at flagship premium with us. And so there's only so many flagship premium models. So that means to expand, sometimes you have to push down into mid-market to lower premium. And in those models they're very price sensitive. Right. So you could see an uptick if we're very successful there, you see an uptick in X5 volume. I don't think it will cross back, but it could.

Okay. Sounds like a lot of X5s already shipped in and the customer's going to absorb it. And is the pricing on X7 Todd still abruptly two X5? Is that what do you think about it?

I wouldn't say quite 2X. I would say, I would say we've been aggressive, but it's significantly higher it's between, 50% and 80% higher than okay X5.

Great. And my last question's on licensing, you talked about in the prepared marks licensing opportunity, you weren't specific there. I'm wondering if that was reference to TrueCut or whether there other core video licensing opportunities or projector somehow. And if TrueCut, I'm sorry, go ahead.

Go ahead. No, go ahead. Finish.

Sorry. Cut you off. If it's okay if it's true. Cut. If it's the pipeline there is coming in with the, the movie success and so forth to formalize sort of revenue opportunity there. Yep.

Okay. So, to make sure we clear that up for everybody on the call that was not a reference to TrueCut. Our business model is to it's a service support and licensing model for the content creators so that they can use our technology to create 4K HDR high frame rate cinematic content. With that engagement, they have the rights to distribute that content for theatrical releases. So there's no further licensing for theatrical releases beyond the initial engagement. But they don't have the right to distribute for home entertainment, that high frame rate content that they use TrueCut motion with. So the business model is the distributors, whether they be streaming companies, etcetera, have to support the TrueCut motion ecosystem and have the rights to distribute high frame rate, TrueCut motion, high frame rate content, and the device manufacturers would have to have the rights to display TrueCut motion content. What I was referring there from the previous statement was it had nothing to do with TrueCut, but I wanted to take the opportunity to make sure everybody understood the business model with TrueCut. Because I think I've seen a lot of questioning on people where people don't understand the business model. Well, that's the business model I just explained. I've asked all the analysts to not model revenue from TrueCut right now. Now we clearly are getting some revenue, I just don't want to model it because until we really gain major support from a large distributors streaming companies you're just looking at theatrical releases, which is not a big revenue. If it gets to the point where it's material, then I'll have you guys start to model it. Once we have a signed on distributor, the device OEMs are very excited about adding TrueCut motion to their…

Thank you. And our next question comes from the line of Richard Shannon with Craig-Hallum.

Hi Todd, Haley. Thanks for taking my questions and good morning to you Todd. Let's see here. I want to make sure I heard some of your language here specifically on how to think about the second half of the year. I think you said the first quarter is the bottom of growing in the second quarter, and did I hear you correctly that you're expecting year and year growth in the second half of the year? And is, and so does that mean each quarter or just collectively in the second half?

So we expect for sure year over year growth for the mobile business. I'm still, projector. I think you'll see a dip in q1, but it'll come back in the back half. Does it come back to the point where it shows strong year over year growth? I think that's yet to be seen. And then, with video delivery, because we did this big end of life in the second half of this year, you won't see year over year growth and video delivery. Okay. Now, if the mobile year over year growth is strong enough, you'll see corporate year over year growth in the second half. Okay. So that comment wasn't across the entire company, it's across specific segments. I just want to be clear. Yes, I think I made the growth comment specifically. I Hay Haley mentioned that we expect growth in the back half of the year, which is I think the mobile gonna be strong enough exiting the year that you'll see corporate year-over-year growth.

Okay, that's helpful. So how do we how do you think the distribution of mobile revenues as we get through the, into the second half of the year, how do, how do you think this progresses? You've talked specifically and hopefully I collect your comments correctly about, sorry, I'm scrolling up on my notes. Expect to yield a series of top mobile games in the next tier supporting our rendering accelerator in next seven. How do we think is this, is this entirely driven by gaming and how broad are we expecting the uptake here by all the tier one targets you have in China?

I would say it's not entirely driven by gaming. So, one of the things right now that we're doing is many, many of the models we win, some of the OEMs will go out and market that model globally, but they will have a different skew for China than they do internationally. We are gaming, mobile gaming is, if you really go look at how these guys are marketing their premium and flagship phones, they're trying to market the, the new utility that their new phones will give you and why you should spend money and upgrade your phone. And in China, mobile gaming is either the key utilities that they're trying to bring you, depending on the model and the demographic targeting or the second biggest feature they're targeting, which the first would be camera and internationally. And then, consuming social and video content, which we also improve is further down on the list as far as what you utility they bring you. What we're trying to get these China mobile OEMs to do is take this expertise and differentiation that they've built into their China models, which is unique and market it internationally because that's what differentiates them in many of these international markets because, who they butt up against in the international markets, and I'm talking about Android, they butt up against Samsung. So this gives all of those four tier ones a significant differentiation advantage, and not just because of us, but because this is where mobile gaming content is king. And so if they have optimized content and our visual processor in their models, many of those studios that I just, that I'm mentioning, so with Genson impact, Tencent with many of their games, net East by Dance has multiple studios developing games. Many of…

Okay. So would it be fair to conclude from what you just said here that you think the biggest single factor and upside potential for your mobile business second happen going forward? Is international introduction of your X7 naval phones or is it some other single factor that you think is more important?

Well, there's, there's two. There's two. So if we gain a fourth tier one, that's an uptick in market for us. So if you see us announce with the one tier one we haven't announced yet, then that's an uptick. Second, if we can expand all the customers from just targeting their, what they call their domestic models, their China specific models to expanding to their international model, you get to leverage the R&D work that's already done on that model, and you just get higher, higher volume from the same r and d work. And then three, we are talking with customers to expand to higher volume, lower priced models, the gaming functionality and features, their customers are pushing them and demanding it. We've had customers come to us and say, we get a great deal of feedback and they want to know why we don't have the display processor technology on this particular model, which is usually a lower end model. And so there are companies that are exploring whether they can put it on these, these higher volume models, but of course their first approach is to come in and want me to sell it for cost and our answer is no. So those are the three ways, right? Expand the customers, one, expand the international models with the same target targets we're doing two, and then expand the, the model line-up within the existing customers. Three.

Okay. And to that last point there, Todd would this, these lower price models, would you expect any of them be doing it with X7 or would that be mostly X5 or even older opportunity,

Different discussions with different OEMs, they're going to lean on the cost. They're very cost driven. So I would, if I was a betting person, I would say that some of these higher volumes, they're gonna try to go to the lowest cost technology we have. But at the same time we make such, the actual visual improvement that you can see between X5 and X7 is palatable. It's noticeable. And if you look at our roadmap, which we haven't announced yet, but the, some of the tier one customers have seen it, going to see another fundamental leap forward by 2024 ASPs will go up, not because we're just trying to extract more value, but to make these fundamental leaps in performance, we have to be more aggressive on how we do the technology, which twofold, one, we're putting more transistors down, and two, we're moving to lower process nodes, which are more expensive.

Fair enough. That's great perspective, Todd. The last quick question for me I haven't heard anything, any direct statement here about how you feel like the engagement with TrueCut is going with potential streaming partners here. But I guess, and we're not close enough to have any sort of big announcement, maybe you just characterize the, the progress in the last quarter any feedback you've gotten from Avatar two and potential other releases, and then how do we think about these other theatrical releases you're looking for this year?

So, we've had discussions with major distributors about high frame rate technology. We continue to have those discussions. They are bullish by the way, but they want to kick it off. They want more content. Now they're actually even helping us by making introductions to, to studios that they rely on for content. So they're I would say that our streaming discussions are a positive thing, but to get it to the point where they're ready to go out and really, so once they announce it, what do they have to do? They have to market it and they have to go communicate to all their streaming customers the value proposition of TrueCut Motion. And so they want to be sure that when they go spend all that energy and money, that they got enough content to follow through with the value proposition. So with that said anytime they extend help to us, we take it. We were already spending a lot of time trying to cultivate more theatrical content because more theatrical content becomes a pool of content for distribution to home entertainment and I would say that the release of Way of the Water put all of our technology put high frame rate 3D out in thousands of theaters globally with there's some people that review it and don't like it, but they're minor. They're very small group of people. The grand majority of the people love the immersive effects that high frame rate 3D brought with that movie. They love the technology, they love the movie, which is a story and how it was delivered. And James Cameron did a great job, but they also love the technology used to help deliver that story. And that clearly has helped us be credible in trying to expand the use of that technology and get more people to bring out high frame rate theatrical content. But that's all a work in progress. So no announcements to be made. A lot of work to be done. Okay. Well as always, Todd, I appreciate all the detail. I am all done. Thank you. Thank you, Richard.

Thank you. I would now like to turn the call back over to management for any closing remarks.

Well it was a longer call today than I expected. I'm here for another couple of weeks. It's interesting times over here. And then we get to see how the rest of the year unfolds. But I would say in general, I am more positive today than I was two weeks ago when I arrived. So, but that said everybody enjoy the evening. Thank you.

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