Good day, ladies and gentlemen, and welcome to Pixelworks, Inc.'s First Quarter 2023 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'd now like to turn the call over to Brett Perry with Shelton Group, Investor Relations.

Thank you, Liz. Good afternoon and thank you for joining us on 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 first 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, Tuesday, May 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, annual reports on Form 10-K for the year ended December 31, 2022, 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, net loss and net loss per share. Non-GAAP measures exclude amortization of acquired intangible assets and stock-based compensation expense, as well as the tax effects of the non-GAAP adjustments. 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, 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 Pixelworks' CEO, Todd DeBonis. Please go ahead.

Thank you, Brett, and good afternoon and welcome to those participating on today's call. Coming off our 27% revenue growth in '22, we acknowledge that revenue will be down significantly in the first quarter due to a combination of the inventory correction in the broader smartphone market as well as anticipated seasonality in the projector market. As outlined in today's press release, our first quarter financial results were consistent with our prior guidance. Today we are confident that Q1 was the bottom of the correction for our mobile business. As of the end of March, all previous inventory of our mobile ICs, both within the channel and held by customers, was well below normal, clearing the way for renewed growth and momentum in the second quarter. Taking a closer look at the mobile market, there's recently been ample market commentary from many of the prominent suppliers that sell into the smartphone segment. Rather than reiterating general comments on the market, we will focus on how Pixelworks and our current position is different than some of these other companies. Clearly an inventory correction has been taking place as many suppliers overbuilt and both the distribution channel and smartphone OEMs amassed excess inventory due to the weaker than anticipated demand in '22, which continued into Q1 of 2023. As a result, multiple component suppliers indicated that digesting that inventory could potentially extend out to the end of this year. Specific to Pixelworks, we were capacity constrained for effectively all of 2022 and with that, we managed inventory conservatively. As a result, unlike many others today, we are shipping to fulfil current customer demand and refill depleted channel partners' buffer inventory. Regarding China's smartphone OEM demand, although there are differing views on the pace of the China recovery, most industry commentary suggests that…

Thank you. Todd. Revenue for the first quarter of 2023 was $10 million in line with the midpoint of our guidance. The sequential and year-over-year decline was driven by lower demand in mobile related to the industry-wide inventory correction in smartphone, combined with historical first quarter seasonality in the projector market. Additionally, as anticipated, video delivery revenue declined sequentially following higher sales of certain end-of-life products during the fourth quarter. The resulting breakdown of revenue in the first quarter was as followed. Revenue from mobile was approximately $3.3 million, home and enterprise revenue was approximately $6.7 million. As a reminder, home and enterprise now reflects the combination of revenue from projector and video delivery end markets. Projector accounted for approximately 90% of home and enterprise revenue in the first quarter, and we expect it to continue to represent a majority of home and enterprise revenue in future quarters. Non-GAAP gross profit margin was 44.1% in the first quarter of 2023, compared to 53.3% in the fourth quarter of 2022, and compared to 53.2% in the first quarter of 2022. Gross margin for the quarter reflected a combination of product mix and reduced absorption rate associated with lower revenue. Non-GAAP operating expenses were $13.6 million in the first quarter compared to $10.8 million last quarter and $11.6 million in the first quarter of 2022. As a reminder, operating expenses in the fourth quarter benefited from a $2.5 million credit to R&D related to our co-development project. Excluding this credit, first quarter operating expenses were largely consistent with the OpEx level in the fourth quarter of 2022. On a non-GAAP basis, first quarter 2023 net loss was $8.2 million or a loss of $0.15 per share compared to a net loss of approximately $800,000 or a loss of $0.01 per share in…

[Operator instructions] first question comes from the line of Rajiv Gill with Needham.

Yes, thanks for taking my questions and congrats on really good momentum in your business. In the mobile phone market for the second quarter and kind of what you're saying throughout the year, Todd, you're bucking a lot of the trends that you're seeing in the China handset market and what a lot of suppliers have been indicating that the correction is steeper and the recovery in the China handset market's going to take longer than expected. You guys are really bucking that trend. So, I guess my first question is one, you had managed your channel inventory pretty effectively last couple of quarters. Maybe you could talk a little about that in terms of way your channel inventory is, and then in terms of the rebound that you're seeing in in your -- with your customers, can you talk about, where the inventory levels are that the customers are sitting on and just clarity on kind of how you're able to kind of diverge from both trends.

Yeah, sure. Thanks Rajiv. So overall channel inventory, we went into the start of Q1 when we guided down significantly. We went in probably all of Q1 and some of Q2 in the channel for whatever we were projecting for mobile. By February I was in -- for the month of February was in there, it became clear to me that the new programs that we were included in were ramping much harder than I anticipated, and so it became clear that we would burn through that inventory sometime in probably April. So we started while I was there in February ramping up new orders to our supply chain through both our foundry and assembly and test. The good news is because we're bucking the trend, getting access in short term to capacity was not a challenge, this particular time, right, but even with that, going into March, those programs were doing better than forecasted customers were trying to expedite what we had in WIP [ph]. They had ran through inventory and then needed to expedite what we had in Wip, and so we have multiple tier ones for multiple programs simultaneously for both X5 and X7 that were expedited -- paying expedite fees for us to get that product through our foundry quicker than anticipated. So today, the channel is lean to say the least. With the guidance we gave you, we could probably beat the midpoint if we get expedited wafers quicker than we anticipate, which will be a challenge. So that demand pool is exceeding through into Q3. It's probably too early. We have new models being launched in the second half of the year that'll add to these models. So we're optimistic, but I want to see if that sticks through with the consumers and how China comes back, but right now we're pretty optimistic.

Great. Appreciate it. And for my follow up, the gross margins you kind of talked a little bit about some of the puts and takes in the near term. Now that you're seeing a pickup in X7, which have higher ASPs I'm just curious how you're thinking about the pricing environment over the next couple quarters. Thanks.

Yeah, good question. So we -- X7 seven does have a higher ASP, but it has a bunch of new features and definitely is a larger dye than X5. And where we priced it, even though it's a higher ASP, it has a lower margin profile than X5, when we kept it that way on purpose to try to increase adoption of it. When we originally priced it we expected the price increases from the supply chain to abate. I think it's well known out there that they have not fully abated and there was some new price increases that got extended into '23 through the supply chain. We are no longer absorbing those. So we are now passing through price increases to all of our customers in all of our markets for the starting in the second half of this year.

[Operator instructions] Our next question comes from Suji DeSilva with Roth Capital.

Hi Todd. Hi Haley. These new smartphone programs, some of these -- were these paused Todd during the lockdowns, and are they resuming now? And I presume some of the newer programs, if they are coming back, they sound like from what you said, they're coming back fairly aggressively. Are they more for the X7 seven or is it a mix of the two?

It was a mix of the two. So when we went out of '22 with inventory there was some X7 inventory in the channel, but it was -- if you look at the channel and the customers, it was predominantly X5. I thought for sure it would take us six months to eight months to burn through the X5 inventory. Some of the expedites are on X5 devices. So some of the phones that I just mentioned and I mentioned to which ones that included X5, they had such strong demand for those models, they went through our excess inventory of X5 and our expediting new wafer starts, and then same with X7. Some of the models were X7, the demand was high and they went through our inventory and now are expediting wafers through the line. They're all Suji, to be clear, all of this demand is based upon models that have been released. I want to make sure pretty much all the demand, it's got to be well over 95% are models that were released from either later part of December or early January on. So this is not like a rejuvenation of older models that burnt through inventory. These are all new models and you got to understand the customers I think, went into these new models being conservative because they had not been conservative the year prior and in our particular case, we had four or five different models that all blew through the initial forecast and when they realized they were blowing through the forecast, we quote 26 weed, like these guys came in and were expediting within eight weeks to when they needed the parts. And the closer you're in to that cycle time, the harder it is for us to expedite the further out it easier it is to expedite.

Okay, great. Todd, and then switching over to the projector market, just understand what kind of -- what's your updated view on end demand for '23 versus the typical year? I know it's obviously had a headwind starting the year. I'm curious what you're expecting in terms of where that demand starts to come back into normal or not this year?

We don't really want to give annual guidance, but, I will say that right now we expect mobile to finish the year as a growth business year-over-year compared to '22, even with the trough we had in Q1. We still expect projector to probably be down low double digits, just 10% to 15% for the year right as the correction takes through. We don't give guidance on TrueCut. I do expect us to be through any inventory correction by the end of this year on projector, but we're expecting this back half of the year to be for mobile, the growth year-over-year growth business.

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

Well, hi Todd and Haley, thanks for taking my questions. Can you hear me?

We can, thanks Richard.

I got on a little late and I may have missed some comments here, so apologies for redoing some of this, but just want to make sure I understand on the guidance for the second quarter about the moving pieces here wasn't clear to me whether you expected any growth within the home and enterprise bucket. Whether that includes any last time buys or is it all of it coming from mobile?

No, no. Last time buys. The last time buys we had on the transcoding products finished up in the fourth quarter of '22. And we expect overall home and enterprise, which is projector and transcoding to be slightly, slightly up from Q1. So sequentially up and then we expect mobile to be significantly up.

Okay. And if I'm running my model here, Todd almost in real time here, it seems like that's getting close to kind of doubling substantially then. Is that about right?

That is about right.

Okay. I might come back to that in a second here. One hit a couple other topics here, fiscal on gross margins. We had your number from the year, which I think makes sense here without passing through the cost, but as we think about your passing those through I'm not sure what kind of pace you're thinking of, but what kind of number could we think if you were trying to adjust this quarter for price increases, what could we see? Is this a couple points or few points or…

Well, the Q2 we guided and the reason we're guiding to a low margin is we give plenty of lead time to our price increases to our customers, so that there are no price increases loaded into the Q2 numbers. So that growth is all unit growth. Q3 and Q4 we're passing on price increases across the board to all markets, all customers, various different levels. Depending on the mix, we're trying to get back -- there's two things happening. One, our mix is more mobile centric. Okay. And it probably will be on a go-forward basis for the foreseeable future. It's going to be just a much faster growing business than projector in home and entertainment. But we didn't pass through all the price increases that we absorbed or continue to absorb and we are now doing that. Now with the goal that we get back at a -- if we get back to a reasonable mix, it's still going to be more mobile centric that we get back above a 50% corporate level gross margin, with the higher mobile mix. We are still not modeling in any of this significant TrueCut revenue. Once TrueCut, the licensing business, once this kicks in, we will re-advice to all the analysts what the corporate goals for our margin are, but they're significantly higher than low fifties.

Okay. Well that is helpful. One last question for me, I'll jump outta the line, Todd. Obviously you had a lot of nice milestones and events in your TrueCut business last year and you've been clear this is a long process developing an ecosystem. So assuming you sign up a streaming customer at any point in time, I'm not trying to apply timeframe to this, but assuming you'd do that, what kind of milestones would you expect to be able to announce not only with the streaming customer, maybe before that with other ecosystem partners to make this a reality?

So, that's a good question. I think that's good for any investors that are listening on the call to see, how do you keep an eye and see if we're hitting our milestones, given that we're not putting financial milestones in there. I would suggest that we are getting interest and strong interest in helping other studios deliver high frame rate to premium large format theaters around the world with new releases. So, you probably will hear some of that activity sooner than later. I think if people monitor us and see more content partners using our technology to deliver a better experience. I think that that's a telling tale. Upon announcing our first distribution partners streaming company to then want to deliver this premium format content to the home and entertainment world, you will quickly see us announce partnerships with device manufacturers that are on the other end of that home entertainment delivery. I think once you see that, that's zero to one. Then the next question is, does it expand beyond that first major distributor and those device partners and multiply to multiple streaming companies and multiple device partners? So that's how you that see it roll out, I think.

Okay. I'm sure we'll follow up on that in the future, but I think that's all the questions for me. Thanks a lot, Todd.

That concludes today's question-and-answer session. I'd like to turn the call back to management for closing remarks.

For those of you attending today's call, thank you for your time. I hope it was helpful. Look forward to giving you updates as the year progresses.

This concludes today's conference call. Thank you for participating. You may now disconnect.