PIXELWORKS, INC.
The following discussion and analysis of our financial condition and results of
operations ("MD&A") should be read in conjunction with our condensed
consolidated financial statements and related notes included elsewhere in this
document. In addition to historical information, the MD&A contains
forward-looking statements that reflect our plans, estimates, and beliefs that
involve significant risks and uncertainties. Our actual results could differ
materially from those discussed in the forward-looking statements. Factors that
could cause or contribute to those differences include those discussed below and
elsewhere in this Quarterly Report on Form 10-Q, particularly in "Risk Factors,"
and "Note Regarding Forward-Looking Statements."
COVID-19
InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak a pandemic, and the virus continues to exist in areas where we operate and sell our products and services. In response to the COVID-19 pandemic, many state governments in theU.S. and abroad issued restrictive orders, including "shelter in place" or "stay at home" orders, that have restricted their residents from leaving their homes or returning to work. SinceMarch 2022 , various cities inChina have imposed lockdowns in response toChina's "zero-COVID" policy, leading to weaker consumer demand which has had, and we anticipate may continue to have, an adverse impact onChina's economy, on our customers and on our business The spread of COVID-19 has caused us to modify our business practices, including implementing work-from-home policies and limiting travel by our employees. For more information see "Note Regarding COVID-19". The impact of the pandemic on the global economy and on our business, as well as on the business of our suppliers and customers, and the measures that may be needed in the future in response to it, will depend on many factors beyond our control and knowledge. We will continually monitor the situation to determine what actions may be necessary or appropriate to address the impact of the pandemic, which may include actions mandated or recommended by federal, state or local authorities. While we expect the impacts of COVID-19 to be temporary, the disruptions caused by the virus have negatively affected our revenue and results of operations in 2020 and 2021, and it continues to do so in 2022. 26 -------------------------------------------------------------------------------- Table of Contents OverviewPixelworks, Inc. (together with our subsidiaries, the "Company", "Pixelworks", "we", "our" or "us") is a leading provider of high-performance and power-efficient visual processing solutions that bridge the gap between video content formats and rapidly advancing display capabilities. We develop and market semiconductor and software solutions that enable consistently high-quality, authentic viewing experiences in a wide variety of applications. Our primary target markets include mobile (smartphone and tablet), projector (business, education and home entertainment), video delivery (personal video recorder ("PVR") and over-the-air) and cinema (content creation, remastering and video streaming). We were one of the first companies to commercially launch a video System on Chip ("SoC") capable of deinterlacing 1080i HDTV signals and one of the first companies with a commercial dual-channel 1080i deinterlacer integrated circuit. Our Topaz product line was one of the industry's first single-chip SoC for projection. We first introduced our motion estimation / motion compensation technology ("MEMC") for TVs and in recent years introduced a mobile-optimizedMEMC solution for smartphones, one of several unique features in the mobile-optimized Iris visual processor. In 2019, we introduced ourHollywood award-winning TrueCut® video platform, the industry's first motion grading technology that allows fine tuning of motion appearance in cinematic content for a wide range of frame rates, shutter angles and display types. Our solutions enable worldwide manufacturers to offer leading-edge consumer electronics and professional display products, as well as video delivery and streaming solutions for content service providers. Our core visual display processing technology intelligently processes digital images and video from a variety of sources and optimizes the content for a superior viewing experience. Our video coding technology reduces storage requirements, significantly reduces bandwidth constraint issues and converts content between multiple formats to enable seamless delivery of video, including OTA, or over-the-air, streaming, while also maintaining end-to-end content security. Rapid growth in video consumption, combined with the move towards high frame rate / refresh rate displays, especially in mobile, is increasing the demand for our visual processing and video delivery solutions. Our technologies can be applied to a wide range of devices from large-screen projectors to cinematic big screens, to low-power mobile tablets and smartphones, to high-quality video infrastructure equipment and streaming devices. Our products are architected and optimized for power, cost, bandwidth, and overall system performance, according to the requirements of the specific application. On occasion, we have also licensed our technology. During the third quarter of 2021, we engaged in a strategic plan to re-align our mobile, projector, and video delivery businesses to improve their focus on theAsia -centered customers and employee stakeholders of those businesses. The global center of the mobile, projector, and video delivery businesses continues to be inAsia , and the steps taken by us to date and going forward are intended to improve our ability to access capital, customers, and talent. We have operated our primary R&D center inAsia for over 15 years and feel that the time is right to take advantage of that existing footprint and develop PWSH as a full profit-and-loss center underneathPixelworks, Inc. , for the mobile, projector, and video delivery businesses. Most of these steps were completed before the end of 2021. This plan will further enable PWSH to seek qualification to file an application for an initial public offering on theShanghai Stock Exchange's Science and Technology Innovation Board, known as the STAR Market (the "Listing"). We believe that the Listing will have many benefits, including improved access to new capital markets and the funding of our growth worldwide. We presently intend to qualify PWSH to apply for the Listing so that the Listing is consummated in 2023. The process of going public on the STAR Market includes several periods of review and, therefore, is a lengthy process. There is no guarantee that PWSH will be approved for a Listing at any point in the future. As ofSeptember 30, 2022 , we had an intellectual property portfolio of 297 patents related to the visual display of digital image data. We focus our research and development efforts on developing video algorithms that improve quality and architectures that reduce system power, cost, bandwidth and increase overall system performance and device functionality. We seek to expand our technology portfolio through internal development and co-development with business partners, and we continually evaluate acquisition opportunities and other ways to leverage our technology into other high-value markets. 27 --------------------------------------------------------------------------------
Table of Contents Results of Operations Revenue, net
Net revenue for the three and nine months ended
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 % Change 2022 2021 % Change
Revenue, net $ 17,552 $ 15,196 16 % $ 53,258 $ 38,516 38 %
Net revenue increased
Revenue recorded in the third quarter of 2022 consisted of$17.2 million in revenue from the sale of integrated circuit ("IC") products and$0.4 million in revenue related to engineering services, license revenue and other. Revenue recorded in the third quarter of 2021 consisted of$14.3 million in revenue from the sale of IC products and$0.8 million in revenue related to engineering services, license revenue and other. Revenue recorded in the first nine months of 2022 consisted of$52.3 million in revenue from the sale of IC products and$0.9 million in revenue related to engineering services, license revenue and other. Revenue recorded in the first nine months of 2021 consisted of$36.0 million in revenue from the sale of IC products and$2.5 million in revenue related to engineering services, license revenue and other.
The increase in IC revenue in the third quarter of 2022 compared to the third quarter of 2021 is due to the following factors:
•Sales into the mobile market increased
•Sales into the projector market increased
•Sales into the video delivery market increased
The increase in IC revenue in the first nine months of 2022 compared to the first nine months of 2021 is due to the following factors:
•Sales into the mobile market increased
•Sales into the projector market increased
•Sales into the video delivery market increased
These increases were due to increased demand compared to the prior periods.
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Cost of revenue and gross profit
Cost of revenue and gross profit for the three and nine months ended
Three Months Ended September 30, Nine Months Ended September 30,
% of % of % of % of
2022 revenue 2021 revenue 2022 revenue 2021 revenue
Direct product costs and related
overhead 1 $ 8,760 50 % $ 7,131 47 % $ 26,207 49 % $ 18,998 49 %
Stock-based compensation (47) 0 (138) (1) 20 0 17 0
Amortization of acquired intangible
assets - 0 218 1 72 0 681 2
Inventory charges 2 43 0 - 0 52 0 - 0
Total cost of revenue $ 8,756 50 % $ 7,211 47 % $ 26,351 49 % $ 19,696 51 %
Gross profit $ 8,796 50 % $ 7,985 53 % $ 26,907 51 % $ 18,820 49 %
1Includes purchased materials, assembly, test, labor, employee benefits and royalties.
2Includes charges to reduce inventory to lower of cost or market and a benefit for sales of previously written down inventory.
Gross profit margin was 50% in the third quarter of 2022 compared to 53% in the third quarter of 2021. The decrease in gross profit margin was primarily due to product mix, partially offset by absorption of fixed overhead costs and decreased amortization of acquired intangible assets as an amount and as a percentage of revenue when comparing the third quarter of 2022 to the third quarter of 2021. Gross profit margin was 51% in the first nine months of 2022 compared to 49% in the first nine months of 2021. The increase in gross profit margin was primarily due to decreased amortization of acquired intangible assets as an amount and as a percentage of revenue when comparing the first nine months of 2022 to the first nine months of 2021.Pixelworks' gross profit margin is subject to variability based on changes in revenue levels, product mix, average selling prices, startup costs, restructuring charges, amortization related to acquired intangible assets, and the timing and execution of manufacturing ramps as well as other factors. 29
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Research and development
Research and development expense includes compensation and related costs for personnel, development-related expenses, including non-recurring engineering expenses 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 third quarter of 2021, we entered into a best efforts 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 integrated circuit product. We expect our development costs to exceed the amounts received from the customer, 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. Under the co-development agreement,$5.8 million was payable by the customer within 60 days of the date of the agreement and three additional payments of$2.2 million ,$1.3 million and$1.3 million are each payable upon completion of certain development milestones. As amounts become due and payable, they are offset against research and development expense on a pro rata basis. During the first nine months of 2022, we recognized an offset to research and development expense of approximately$1.8 million .
During the remainder of 2022, we expect to record an offset to research and
development expense of approximately
Research and development expense for the three and nine months ended
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 % Change 2022 2021 % Change
Research and development $ 8,445 $ 6,792 24 % $ 24,126 $ 20,248 19 %
Research and development expense increased
•A
•Compensation expense increased
Research and development expense increased
•Compensation expense increased
•Non-recurring engineering expense and depreciation and amortization expense
increased
•These increases were partially offset by a
•Remaining
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Selling, general and administrative
Selling, general and administrative expense includes compensation and related costs for personnel, sales commissions, facilities and information technology expense allocations, 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 months ended
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 % Change 2022 2021 % Change
Selling, general and administrative $ 5,082 $ 5,097 0 % $ 16,590 $ 14,847 12 %
Selling, general and administrative expense was $5.1 million in the third
quarter of 2022 consistent with $5.1 million in the third quarter of 2021 and
increased $1.7 million , or 12%, in the first nine months of 2022 compared to the
first nine months of 2021.
The increase in the first nine months of 2022 compared to the first nine months of 2021 was due to the following factors:
•Compensation expense increased
•Accounting and other professional fees increased
•Marketing expenses increased
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Provision for income taxes
The provision for income taxes during the 2022 and 2021 periods is primarily comprised of current and deferred tax expense in profitable cost-plus foreign jurisdictions, accruals for tax contingencies in foreign jurisdictions and benefits for the reversal of previously recorded foreign tax contingencies due to the expiration of the applicable statutes of limitation. We recorded a benefit of$0.1 million for the reversal of previously recorded foreign tax contingencies during the first nine months of 2022 and a negligible benefit for the reversal of previously recorded foreign tax contingencies during the first nine months of 2021.
Liquidity and Capital Resources
Cash and cash equivalents
Total cash and cash equivalents decreased$4.0 million to$57.6 million atSeptember 30, 2022 from$61.6 million atDecember 31, 2021 . The net decrease during the first nine months of 2022 was the result of$11.5 million used in operating activities,$1.4 million used for purchases of licensed technology,$1.3 million used for purchases of property and equipment and$0.9 million used for payments on other asset financings. These decreases were partially offset by$10.7 million received in net proceeds from our non-controlling interest and$0.4 million in proceeds from the issuances of common stock under our employee equity incentive plans. As ofSeptember 30, 2022 , our cash and cash equivalents balance consisted of$19.0 million in cash equivalents held inU.S. dollar denominated money market funds and$38.6 million in cash. Although we did not hold short- or long-term investments as ofSeptember 30, 2022 , our investment policy requires that our portfolio maintain a weighted average maturity of less than 12 months. Additionally, no maturities can extend beyond 24 months and concentrations with individual securities are limited. At the time of purchase, the short-term credit rating must be rated at least A-2 / P-2 / F-2 by at least two Nationally Recognized Statistical Rating Organizations ("NRSRO") and securities of issuers with a long-term credit rating must be rated at least A or A3 by at least two NRSRO. Our investment policy is reviewed at least annually by our Audit Committee.
Accounts receivable, net
Accounts receivable, net increased to$10.8 million as ofSeptember 30, 2022 from$8.7 million as ofDecember 31, 2021 . The average number of days sales outstanding increased to 55 days as ofSeptember 30, 2022 from 47 days as ofDecember 31, 2021 . The increase in accounts receivable and days sales outstanding was due to normal fluctuations in the timing of sales and customer receipts within the third quarter of 2022, and the fourth quarter of 2021.
Inventories
Inventories were$2.7 million as ofSeptember 30, 2022 compared to$1.5 million atDecember 31, 2021 . Inventory turnover decreased to 14.2 as ofSeptember 30, 2022 from to 19.5 as ofDecember 31, 2021 primarily due to higher average inventory balances during the third quarter of 2022 compared to the fourth quarter of 2021. Inventory turnover is calculated based on annualized quarterly operating results and average inventory balances during the quarter. Capital resources At the Market Offering OnJune 5, 2020 , we entered into a sales agreement (the "Sales Agreement") withCowen and Company, LLC ("Cowen"), pursuant to which we may issue and sell shares of the Company's common stock, par value$0.001 per share, having an aggregate offering price of up to$25.0 million , from time to time, through an "at the market" equity offering program under which Cowen will act as sales agent. Under the Sales Agreement, Cowen may sell the shares by methods deemed to be an "at the market offering" as defined in Rule 415(a)(4) promulgated under the Securities Act of 1933, as amended, including sales made by means of ordinary brokers' transactions on the Nasdaq Global Market or on any other existing trading market for the common stock or otherwise at market prices prevailing at the time of sale, in block transactions, or as otherwise directed by us. We pay Cowen a commission equal to three percent (3.0%) of the gross sales proceeds of any common stock sold through Cowen under the Sales Agreement. The Sales Agreement may be terminated by us upon prior notice to Cowen or by Cowen upon prior notice to us, or at any time under certain circumstances, including but not limited to the occurrence of a material adverse change in the Company. We are not obligated to sell any shares under the Sales Agreement. During the year endedDecember 31, 2021 , we sold an aggregate of 61,018 shares of our common stock under this at the market offering, resulting in aggregate net proceeds to us of approximately$0.3 million , and gross proceeds of approximately$0.4 million , and paid Cowen commissions and fees and other expenses of approximately$0.1 million . There was no activity under this at the market offering during the nine months endedSeptember 30, 2022 . 32
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Capital Increase Agreement
We have entered into a Capital Increase Agreement pursuant to which our subsidiary PWSH, received net proceeds from the sale of its securities pursuant thereto in an amount ofRMB 279.7 million ($42.3 million USD ). Additional information is provided in "Note 13: Redeemable Non-Controlling Interest and Equity Interest of PWSH Sold to Employees", which is incorporated by reference into this section. Equity Transfer Agreement We have entered into an Equity Transfer Agreement pursuant to which we received net proceeds of$10.7 million in exchange for a 2.73% equity interest in PWSH. Additional information is provided in "Note 14: Non-Controlling Interest ", which is incorporated by reference into this section.
Liquidity
As ofSeptember 30, 2022 , our cash and cash equivalents balance of$57.6 million was highly liquid. We anticipate that our existing working capital will be adequate to fund our operating, investing and financing needs for the next twelve months and beyond. We may pursue financing arrangements including the issuance of debt or equity securities or reduce expenditures, or both, to meet our cash requirements, including in the longer term. 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 financial position, results of operations and cash flows. From time to time, we evaluate acquisitions of businesses, products or technologies that complement our business. Any transactions, if consummated, may consume a material portion of our working capital or require the issuance of equity securities that may result in dilution to existing shareholders. Our ability to generate cash from operations is also subject to substantial risks described in Part II, Item 1A., "Risk Factors". If any of these risks occur, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash and cash equivalents to support our working capital and other cash requirements. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through debt financing, equity financing or from other sources. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our shareholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing shareholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility and would also require us to incur interest expense. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us. Other than as set forth above, there were no material changes to our liquidity and capital resources during the nine month period endedSeptember 30, 2022 from those set forth in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , filed with theSecurities and Exchange Commission onMarch 9, 2022 . 33
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