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PXLW > SEC Filings for PXLW > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for PIXELWORKS, INC

Form 10-Q for PIXELWORKS, INC


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.

Forward-looking Statements
This Management's Discussion and Analysis of Financial Condition and Results of Operations contains "forward-looking statements" that are based on current expectations, estimates, beliefs, assumptions and projections about our business. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict and which may cause actual outcomes and results to differ materially from what is expressed or forecasted in such forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in Part II, Item 1A of this Quarterly Report on Form 10-Q. These forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q. If we do update or correct one or more forward-looking statements, you should not conclude that we will make additional updates or corrections with respect thereto or with respect to other forward-looking statements. Except where the context otherwise requires, in this Quarterly Report on Form 10-Q, the "Company," "Pixelworks," "we," "us" and "our" refer to Pixelworks, Inc., an Oregon corporation, and its wholly-owned subsidiaries.

Overview
We are an innovative designer, developer and marketer of video and pixel processing semiconductors and software for high-end digital video applications and hold 117 patents related to the visual display of digital image data. Our solutions enable manufacturers of digital display and projection devices, such as large-screen flat panel televisions and digital front projectors, to manufacture their products with a consistently high level of video quality, regardless of the content's source or format. Our core technology leverages unique proprietary techniques for intelligently processing video signals from a variety of sources to ensure that all resulting images are optimized. Additionally, our products help our customers reduce costs and differentiate their display and projection devices, an important factor in industries that experience rapid innovation.
Our business also includes the license of technologies developed for our integrated circuit ("IC") semiconductor products to non-competitive customers and partners, as well as co-development arrangements with current or prospective IC customers. Pixelworks was founded in 1997 and is incorporated under the laws of the state of Oregon.

Results of Operations

Revenue, net
Net revenue for the three and nine month periods ended September 30, 2012 and 2011, was as follows (dollars in thousands):
Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 % Change 2012 2011 % Change Revenue, net $ 16,285 $ 17,391 (6 )% $ 46,139 $ 47,781 (3 )%

Net revenue decreased $1.1 million, or 6%, from the third quarter of 2011 to the third quarter of 2012, and decreased $1.6 million, or 3%, from the first nine months of 2011 to the first nine months of 2012. Revenue related to IC product sales was $15.7 million and $17.3 million for the third quarter of 2012 and 2011, respectively and was $41.1 million and $47.8 million for the first nine months of 2012 and 2011, respectively. Revenue related to licensing agreements was $0.6 million and $5.0 million for the third quarter and first nine months of 2012, respectively. The 2011 periods did not include any revenue associated with licensing agreements.
The decrease in revenue related to IC product sales was primarily attributable to a 15% decrease in average selling price ("ASP"), during the 2012 periods compared to the 2011 periods. This decrease in ASP was partially offset by a 7% increase in units sold during the third quarter of 2012 compared to the third quarter of 2011. Total units sold during the first nine months of 2011 compared to the first nine months of 2012 were relatively unchanged.
The decreases in ASP were primarily due to a greater proportion of unit sales of our latest generation MotionEngine® co-processor ICs, which have lower price points than our other product lines. The decrease was also attributable to reduced pricing on our earlier generation digital projector products.


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The increase in units sold during the third quarter of 2012 compared to the third quarter of 2011 was primarily due to increased sales of our MotionEngine® co-processor IC products into the advanced television market, partially offset by a decrease in sales of our earlier generation digital projector products due to competitive factors affecting customer transition to next generation digital projector solutions.
We anticipate that macro-economic weaknesses and seasonality will contribute to reduced revenue for the fourth quarter of 2012, compared to the third quarter of 2012. We have historically experienced higher revenue from the digital projector market during the third quarter of the year and lower revenue during the first quarter of the year, as our Japanese customers reduce inventories in anticipation of their March 31 fiscal year end. Cost of revenue and gross profit
Cost of revenue and gross profit for the three month periods ended September 30, 2012 and 2011, was as follows (dollars in thousands):

                                                        Three Months Ended September 30,
                                                               % of                         % of
                                                2012         revenue         2011          revenue
Direct product costs and related overhead 1 $    8,016           49 %     $   8,800           51  %
Licensing costs 2                                  297            2               -            0
Inventory charges 3                                  -            0              (2 )          0
Other cost of revenue 4                            184            1             137            1
Total cost of revenue                       $    8,497           52 %     $   8,935           51  %
Gross profit                                $    7,788           48 %     $   8,456           49  %

1 Includes purchased materials, assembly, test, labor, employee benefits, warranty expense and royalties, all of which are related to sales of IC products.

2 Includes direct labor costs and allocated overhead associated with license revenue arrangements.

3 Includes a benefit for sales of previously written down inventory.

4 Includes stock based compensation and additional amortization of a non-cancelable prepaid royalty.

Gross profit margin decreased to 48% of revenue during the third quarter of 2012, down from 49% of revenue in the third quarter of 2011. Excluding the impact of license revenue, direct product costs and related overhead as a percentage of revenue were approximately 51% during the third quarter of 2011 and the third quarter of 2012, reflecting reduced ASPs and product costs as well as offsetting fluctuations in product mix. Gross profit margin on our license revenue during the third quarter of 2012 was consistent with our overall gross profit margin during the third quarter of 2012 and 2011.


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Cost of revenue and gross profit for the nine month periods ended September 30, 2012 and 2011, was as follows (dollars in thousands):

                                                          Nine Months Ended September 30,
                                                                  % of                          % of
                                                 2012            revenue         2011         revenue
Direct product costs and related overhead 1 $    21,544             47  %     $  24,620           52 %
Licensing costs 2                                   802              2                -            0
Inventory charges 3                                 (11 )            0              300            1
Other cost of revenue 4                             548              1              414            1
Total cost of revenue                       $    22,883             50  %     $  25,334           53 %
Gross profit                                $    23,256             50  %     $  22,447           47 %

1 Includes purchased materials, assembly, test, labor, employee benefits, warranty expense and royalties, all of which are related to sales of IC products.

2 Includes direct labor costs and allocated overhead associated with license revenue arrangements.

3 Includes charges to reduce inventory to lower of cost or market less a benefit for sales of previously written down inventory.

4 Includes stock based compensation and additional amortization of a non-cancelable prepaid royalty.

Gross profit margin increased to 50% of revenue in the first nine months of 2012, up from 47% of revenue in the first nine months of 2011. This increase was due primarily to the recognition of higher margin license revenue during the first nine months of 2012. The favorable impact of licensing revenue on gross margin was partially offset by non-recurring charges related to a discontinued product and increased warranty returns during the first nine months of 2012. Additionally, direct product costs and related overhead as a percentage of revenue during the first nine months of 2012 compared to the first nine months of 2011 reflected reduced ASPs and product costs as well as offsetting fluctuations in product mix.
Pixelworks' gross margin is subject to variability based on changes in revenue levels, recognition of license revenue, product mix, ASPs, startup costs, and the timing and execution of manufacturing ramps as well as other factors. Research and development
Research and development expense includes compensation and related costs for personnel, development-related expenses, including non-recurring engineering and fees for outside services, depreciation and amortization, expensed equipment, facilities and information technology expense allocations and travel and related expenses.
Co-development agreement
During the second quarter of 2012, we entered into a best efforts co-development agreement (the "Co-development Agreement") with a customer to defray a portion of the research and development expenses we expect to incur in connection with our development of an IC product to be sold exclusively to the customer. We expect our development costs to exceed the amounts received from the customer under the Co-development Agreement, and although we expect to sell units of the product to the customer, there is no commitment or agreement from the customer for such sales at this time. Additionally, we retain ownership of any modifications or improvements to our pre-existing intellectual property and may use such improvements in products sold to other customers.

The initial $3.5 million due under the Co-development Agreement was received within sixty days of contract signing and two additional payments of $1.75 million are each payable upon completion of certain development milestones. As amounts become due and payable without recourse, they are offset against research and development expense up to the amount of related costs incurred. We recognized an offset to research and development expense of $3.1 million and $0.4 million during the third and second quarters of 2012, respectively.


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2012 v. 2011
Research and development expense for the three month periods ended September 30, 2012 and 2011, was as follows (dollars in thousands):

Three Months Ended
September 30, 2012 v. 2011
2012 2011 $ Change % Change
Research and development $ 4,702 $ 5,982 $ (1,280 ) (21 )%

Research and development expense decreased $1.3 million, or 21%, from the third quarter of 2011 to the third quarter of 2012. The decrease was primarily attributable to a benefit of $3.1 million recognized in the third quarter of 2012 offset by an increase in non-recurring engineering expense of $1.6 million. The benefit recognized and the increase in non-recurring engineering expense are both related to the Co-development Agreement. The decrease was also partially offset by an increase to compensation expense due to an increase in headcount and variable compensation expense.
Research and development expense for the nine month periods ended September 30, 2012 and 2011, was as follows (dollars in thousands):

Nine Months Ended
September 30, 2012 v. 2011
2012 2011 $ Change % Change
Research and development $ 14,510 $ 17,531 $ (3,021 ) (17 )%

Research and development expense decreased $3.0 million, or 17%, from the first nine months of 2011 to the first nine months of 2012. The decrease was primarily attributable to a benefit of $3.5 million recognized in the first nine months of 2012 offset by an increase in non-recurring engineering expense of $1.0 million. The benefit recognized and the increase in non-recurring engineering expense are both related to the Co-development Agreement. The decrease was also attributable to a $0.5 million reduction in direct labor costs and allocated overhead associated with the utilization of research and development engineers on license revenue agreements; these costs were recorded in cost of revenue. These decreases were partially offset by an increase to compensation expense due to an increase in headcount and variable compensation expense.

We anticipate an increase in research and development expense for the fourth quarter of 2012 compared to the third quarter of 2012 as we continue to incur expenses related to the Co-development Agreement and do not expect to recognize additional offsets to research and development expense until the completion of certain development milestones in 2013.
Selling, general and administrative
Selling, general and administrative expense includes compensation and related costs for personnel, sales commissions, allocations for facilities and information technology expenses, travel, outside services and other general expenses incurred in our sales, marketing, customer support, management, legal and other professional and administrative support functions.
Selling, general and administrative expense for the three and nine month periods ended September 30, 2012 and 2011, was as follows (dollars in thousands):

Three Months Ended Nine Months Ended
September 30, 2012 v. 2011 September 30, 2012 v. 2011
2012 2011 % Change 2012 2011 % Change
Selling, general and administrative $ 3,557 $ 3,641 (2 )% $ 11,368 $ 11,132 2 %

Selling, general and administrative expense decreased $0.1 million, or 2%, from the third quarter of 2011 to the third quarter of 2012, and increased $0.2 million, or 2%, from the first nine months of 2011 to the first nine months of 2012. The decrease from the third quarter of 2011 to the third quarter of 2012 was primarily due to a decrease in compensation expense resulting from reduced headcount. The increase from the first nine months of 2011 to the first nine months of 2012 was primarily due to increased non-recurring legal expenses and variable compensation expense, partially offset by reduced headcount.


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Other income (expense), net
Net other income (expense) for the three and nine month periods ended September 30, 2012 and 2011, was as follows (dollars in thousands):

                                          Three Months Ended                       Nine Months Ended
                                            September 30,                            September 30,
                                          2012           2011       $ Change       2012         2011       $ Change
Interest expense and other, net 1     $    (105 )     $    (89 )   $    (16 )   $   (304 )    $  (395 )   $     91
Gain on sale of patents 2                     -              -            -            -        1,600       (1,600 )
Gain on sale of marketable securities         -              -            -            -          264         (264 )
Total other income (expense), net     $    (105 )     $    (89 )   $    (16 )   $   (304 )    $ 1,469     $ (1,773 )

1 Interest expense and other, net consists of interest expense, interest income and amortization of debt issuance costs. The decrease from the first nine months of 2011 to the first nine months of 2012 was primarily due to a decrease in interest expense and amortization of debt issuance costs attributable to the repayment of our convertible subordinated debentures in the second quarter of 2011.

2 In the first quarter of 2011, we sold certain patents and related rights and materials for proceeds and a net gain of $1.6 million. All of the patents were originally obtained by us during our June 2005 acquisition of Equator Technologies, Inc., and the underlying technologies pertain to markets that we no longer pursue.

Benefit for income taxes
The benefit for income taxes during the 2012 and 2011 periods is primarily due to the reversal of previously recorded foreign tax contingencies due to the expiration of the applicable statutes of limitation, partially offset by current and deferred tax expense in profitable cost-plus foreign jurisdictions and accruals for tax contingencies in foreign jurisdictions. Due to the full valuation allowance on our U.S. net deferred tax assets, including our U.S. net operating losses, we do not incur significant U.S. income tax expense or benefit. We recorded a benefit for the reversal of previously recorded tax contingencies of $1.4 million and $1.0 million during the first nine months of 2012 and the first nine months of 2011, respectively. Liquidity and Capital Resources

Cash and cash equivalents
Total cash and cash equivalents increased from $15.1 million at December 31, 2011 to $15.6 million at September 30, 2012. The net increase during the first nine months of 2012 resulted from $2.8 million provided by operating activities and $0.4 million in proceeds from the issuance of common stock, partially offset by $2.7 million used for payments on property and equipment and other asset financing.

As of September 30, 2012, our cash and cash equivalents balance of $15.6 million consisted of $0.6 million in cash and $15.0 million in cash equivalents held in U.S. denominated money market funds. Although we did not hold short- or long-term investments as of September 30, 2012, our investment policy requires that our portfolio maintains a weighted average maturity of less than 12 months. Additionally, no maturities can extend beyond 24 months and concentrations with individual securities are limited. Investments must be rated at least A-1 / P-1 / F-1 by at least two Nationally Recognized Statistical Rating Organizations, and our investment policy is reviewed at least annually by our Audit Committee. Although cash balances held at our foreign subsidiaries would be subject to U.S. taxes if repatriated, we have sufficient U.S. net operating losses to offset the liability associated with any such repatriation and foreign taxes due upon repatriation would not be significant.
Accounts receivable, net
Accounts receivable, net decreased to $3.8 million as of September 30, 2012 from $4.6 million as of December 31, 2011. The average number of days sales outstanding decreased to 21 days as of September 30, 2012 from 24 days as of December 31, 2011. The decrease in days sales outstanding was primarily due to an increase in customer payments received in advance of payment terms.


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Inventories
Inventories increased to $4.7 million as of September 30, 2012 from $4.1 million as of December 31, 2011. Inventory turnover decreased to 7.6 as of September 30, 2012 from 8.0 as of December 31, 2011, primarily due to decreased material costs. Inventory turnover is calculated based on annualized operating results and average inventory balances for the respective quarters. Capital resources
Short-term line of credit
On December 21, 2010, we entered into a Loan and Security Agreement (the "Revolving Loan Agreement") with Silicon Valley Bank (the "Bank"). The Revolving Loan Agreement provides for a secured working capital-based revolving line of credit (the "Revolving Line") in an aggregate amount of up to the lesser of
(i) $10.0 million, or (ii) 80% of eligible domestic accounts receivable and certain foreign accounts receivable. In addition, the Revolving Loan Agreement provides for non-formula advances of up to $10.0 million which may be made solely during the last five business days of any fiscal month or quarter and which must be repaid by the Company on or before the fifth business day after the applicable fiscal month or quarter end. Due to their repayment terms, non-formula advances do not provide the Company with usable liquidity. The Revolving Loan Agreement contains customary affirmative and negative covenants as well as customary events of default. The occurrence of an event of default could result in the acceleration of the Company's obligations under the Revolving Loan Agreement and an increase to the applicable interest rate, and would permit the Bank to exercise remedies with respect to its security interest. As of September 30, 2012, we were in compliance with all of the terms of the Revolving Loan Agreement. As of September 30, 2012 and December 31, 2011, we had no outstanding borrowings under the Revolving Line.

Liquidity
As of September 30, 2012, we have no short- or long-term debt and our cash and cash equivalents balance of $15.6 million is highly liquid. We anticipate that our existing working capital, as well as funds available under our Revolving Line, will be adequate to fund our operating, investing and financing needs for the next twelve months. If necessary, management will pursue financing arrangements including the issuance of debt or equity securities or will reduce expenditures, in order to meet the Company's cash requirements. There is no assurance that, if required, we will be able to raise additional capital or reduce discretionary spending to provide the required liquidity which, in turn, may have an adverse effect on our results of operations and financial position. From time to time, we may evaluate acquisitions of businesses, products or technologies that complement our business. Any further transactions, if consummated, may consume a material portion of our working capital or require additional financing activities, including the issuance of equity securities that may result in dilution to existing shareholders. Contractual Payment Obligations
Our contractual obligations for 2012 and beyond are included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission on March 8, 2012. Our obligations for 2012 and beyond have not changed materially as of September 30, 2012.

Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.


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