PIXELWORKS, INC. Forward-looking Statements This Quarterly Report on Form 10-Q contains "forward-looking statements" that are based on current expectations, estimates, beliefs, assumptions and projections about our business. Words such as "may," "will," "appears," "predicts," "continue," "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and the negative or other variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding: the impact of the COVID-19 pandemic (including any changes in laws or regulations in reaction to same) on Company personnel, on revenue, on Company suppliers, and on Company customers and their respective end markets; the Company's restructuring plan, its expectations and estimates regarding the workforce reduction, the objectives of the restructuring plan and the timing thereof, amounts and timing of the charges and savings to be incurred in connection with the restructuring plan, and the potential impact of the restructuring plan; the anticipated features, benefits and market opportunities for our products; our technologies and intellectual property; our international operations; our strategy, including with respect to our intellectual property portfolio, research and development efforts and acquisition and investment opportunities; our gross profit margin; our restructuring programs, including estimates, timing and impact thereof, as well as any future restructuring programs; our liquidity, capital resources and the sufficiency of our working capital and need for, or ability to secure, additional financing and the potential impact thereof; our obtaining forgiveness of our PPP loan in whole or in part; our contractual obligations, exchange rate and interest rate risks; our income taxes, including our ability to realize the benefit of net deferred tax assets, our uncertain tax position liability; accounting policies and use of estimates and potential impact of changes thereto; our revenue, the potential impact on our business of certain risks, including the concentration of our suppliers, risks of technological change, concentration of credit risk, changes in the markets in which we operate, our international operations, including inAsia and our exchange rate risks, our indemnification obligations and litigation risks. 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, including risks related to COVID-19, risks related to our business, risks related to our industry and risks related to our common stock, 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 intend 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 toPixelworks, Inc. , anOregon corporation, and its wholly-owned subsidiaries. 23 -------------------------------------------------------------------------------- Table of Contents COVID-19 InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak a pandemic, and the virus continues to spread in areas where we operate and sell our products and services. Several public health organizations have recommended, and many local governments have implemented, certain measures to slow and limit the transmission of the virus, including shelter in place and social distancing ordinances, which has resulted in a significant deterioration of economic conditions in many of the countries in which we operate. The impact of COVID-19 and the related disruptions caused to the global economy and our business did not have a material adverse impact on our business during the quarter endedMarch 31, 2020 . However, the spread of the COVID-19 virus caused us to modify our business practices, including implementing work-from-home policies and restricting travel by our employees. We also took certain actions in response to the pandemic, which are set forth above in "Note Regarding COVID-19." Looking forward, 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 additional 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 may negatively affect our revenue, results of operations, financial condition, liquidity capital investments and financing arrangements in 2020. For example, we expect that our revenues for fiscal year 2020 will be lower than initially anticipated at the beginning of the year and travel restrictions and border closures could have a material impact on our ability to achieve our business goals.
Overview
Pixelworks 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 from cinema to smartphones. Our primary target markets include Mobile (smartphone, gaming and tablet),Home Entertainment (TV, personal video recorder ("PVR"), over-the-air ("OTA") and projector), Content (creation, remastering and delivery), and Business & Education (projector). 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 digital projection. We first introduced our motion estimation / motion compensation technology ("MEMC") for TVs and in recent years introduced a mobile-optimized MEMC 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 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, smartphones, 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. As ofJune 30, 2020 , we had an intellectual property portfolio of 345 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 and 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. 24 -------------------------------------------------------------------------------- Table of Contents Results of Operations Revenue, net Net revenue for the three and six month periods endedJune 30, 2020 and 2019, was as follows (dollars in thousands): Three Months Ended Six Months Ended June 30, June 30, 2020 2019 % Change 2020 2019 % Change Revenue, net$ 9,253 $ 18,027 (49) %$ 23,027 $ 34,675 (34) % Net revenue decreased$8.8 million , or 49%, in the second quarter of 2020 compared to the second quarter of 2019 and decreased$11.6 million , or 34% in the first half of 2020 compared to the first half of 2019. Revenue recorded in the second quarter of 2020 consisted of$8.8 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 second quarter of 2019 consisted of$17.6 million in revenue from the sale of IC products and$0.4 million in revenue related to engineering services, license revenue and other. Revenue recorded in the first half of 2020 consisted of$21.9 million in revenue from the sale of IC products and$1.1 million in revenue related to engineering services, license revenue and other. Revenue recorded in the first half of 2019 consisted of$32.7 million in revenue from the sale of IC products and$2.0 million in revenue related to engineering services, license revenue and other. The decrease in IC revenue in both periods presented is primarily due to decreased unit sales into the digital projector and video delivery markets as a result of customers continuing to correct their inventory levels and the disruptions caused by COVID-19 to our revenue. The decrease in revenue related to engineering services, license revenue and other is primarily due to the recognition of license revenue during the first quarter of 2019. We expect that the disruptions caused by COVID-19 to our revenue will continue into the second half of 2020. Cost of revenue and gross profit Cost of revenue and gross profit for the three and six month periods endedJune 30, 2020 and 2019, were as follows (dollars in thousands): Three Months Ended June 30, Six Months Ended June 30, % of % of % of % of 2020 revenue 2019 revenue 2020 revenue 2019 revenue Direct product costs and related overhead 1$ 3,783 41 %$ 8,151 45 %$ 10,294 45 %$ 15,945 46 % Amortization of acquired intangible assets 298 3 298 2 596 3 596 2 Stock-based compensation 127 1 83 0 228 1 178 1 Inventory charges 2 (4) 0 119 1 85 0 96 0 Inventory step-up and backlog amortization - 0 - 0 - 0 12 0 Total cost of revenue$ 4,204 45 %$ 8,651 48 %$ 11,203 49 %$ 16,827 49 % Gross profit$ 5,049 55 %$ 9,376 52 %$ 11,824 51 %$ 17,848 51 % 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 55% in the second quarter of 2020 compared to 52% in the second quarter of 2019 and was 51% in the first half of 2020 compared to 51% in the first half of 2019. The increase in gross profit margin in the second quarter of 2020 compared to the second quarter of 2019 was primarily due to a more favorable mix of sales into the digital projector market. The consistent gross profit margin in the first half of 2020 compared to the first half of 2019 is primarily due to a more favorable mix of sales into the digital projector market offset by high margin license revenue recorded in the first half of 2019.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, inventory step-up and backlog, and the timing and execution of manufacturing ramps as well as other factors. 25 -------------------------------------------------------------------------------- Table of Contents 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. Research and development expense for the three and six month periods endedJune 30, 2020 and 2019, was as follows (dollars in thousands): Three Months Ended Six Months Ended June 30, June 30, 2020 2019 % Change 2020 2019 % Change Research and development$ 6,314 $ 6,364 (1) %$ 12,581 $ 12,836 (2) % Research and development expense decreased$0.1 million , or 1% in the second quarter of 2020 compared to the second quarter of 2019 and decreased$0.3 million , or 2% in the first half of 2020 compared to the first half of 2019. The decreases in the 2020 periods compared to the 2019 periods were primarily due to a general decrease across multiple expense categories as we focused on cost management in response to the effects of COVID-19. These decreases were partially offset by an increase in non-recurring engineering expense due to the timing of development activities. Selling, general and administrative Selling, general and administrative expense includes compensation and related costs for personnel, sales commissions, facilities and information technology expense allocations, travel, outside services and other general expenses incurred in our sales, marketing, customer support, management, legal and other professional and administrative support functions. Selling, general and administrative expense for the three and six month periods endedJune 30, 2020 and 2019, was as follows (dollars in thousands): Three Months Ended Six Months Ended June 30, June 30, 2020 2019 % Change 2020 2019 % Change Selling, general and administrative$ 5,156 $ 4,935 4 %$ 10,349 $ 10,395
0 %
Selling, general and administrative expense increased$0.2 million , or 4%, in the second quarter of 2020 compared to the second quarter of 2019 and decreased$0.1 million , or 0% in the first half of 2020 compared to the first half of 2019. There were no individually significant increases or decreases contributing to the overall changes in the 2020 periods compared to the 2019 periods. 26 -------------------------------------------------------------------------------- Table of Contents Restructurings InJanuary 2020 , we executed a restructuring plan to make the operation of the Company more efficient (the "2020 Plan"). The 2020 Plan included an approximately 4% reduction in workforce, primarily in the areas of research and development and sales. InJune 2019 , we executed a restructuring plan to make the operation of the Company more efficient (the "2019 Plan"). The 2019 Plan included an approximately 2% reduction in workforce, primarily in the areas of sales and operations. Restructuring expense for the three and six month periods endedJune 30, 2020 and 2019, was as follows and was included in operating expenses (dollars in thousands): Three Months Ended Six Months Ended June 30, June 30, 2020 2019 2020 2019 Employee severance and benefits $ -$ 398 $ 592 $ 398 Total restructuring expense $ -$ 398 $ 592 $ 398 During the three months endedJune 30, 2020 , we did not record any restructuring expense. During the six months endedJune 30, 2020 we recorded$0.6 million in restructuring expense related to the 2020 Plan. The 2020 Plan was complete in the first quarter of 2020 and we do not expect to incur any further expenses related to the 2020 Plan. During the three and six months endedJune 30, 2019 , we recorded$0.4 million in restructuring expense related to the 2019 Plan. The 2019 Plan was complete as of the second quarter of 2019. OnAugust 6, 2020 , the Board approved an additional restructuring plan which would result in an approximately 14% reduction in workforce. For additional information, see "Note 13: Subsequent Events". Provision for income taxes The provision for income taxes during the 2020 and 2019 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 negligible benefit for the reversal of previously recorded foreign tax contingencies during the first half of 2020 and during the first half of 2019. 27 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Cash, cash equivalents and short-term marketable securities Total cash and cash equivalents increased$13.1 million to$20.4 million atJune 30, 2020 from$7.3 million atDecember 31, 2019 . Short-term marketable securities decreased$6.0 million to$1.0 million atJune 30, 2020 from$7.0 million atDecember 31, 2019 . The net increase in cash, cash equivalents and short-term marketable securities of$7.1 million during the first half of 2020 was the result of$4.3 million in proceeds from our short-term line of credit,$2.5 million in net proceeds from our "at the market" equity offering,$0.8 million in proceeds from a Paycheck Protection Program loan,$0.3 million in proceeds from the issuances of common stock under our employee equity incentive plans and$0.2 million provided by operating activities. These increases were partially offset by$0.6 million used for purchases of property and equipment and$0.3 million used for payments on other asset financings. As ofJune 30, 2020 , our cash, cash equivalents and short-term marketable securities balance consisted of$13.9 million in cash equivalents held inU.S. dollar denominated money market funds,$6.5 million in cash,$0.7 million in corporate debt securities and$0.3 million in commercial paper. 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 decreased to$5.9 million as ofJune 30, 2020 from$10.9 million as ofDecember 31, 2019 . The average number of days sales outstanding decreased to 58 days as ofJune 30, 2020 from 61 days as ofDecember 31, 2019 . The decrease in accounts receivable and days sales outstanding was due to normal fluctuations in the timing of sales and customer receipts within the second quarter of 2020, and the fourth quarter of 2019. Inventories Inventories were$4.8 million as ofJune 30, 2020 and$5.4 million atDecember 31, 2019 . Inventory turnover decreased to 3.1 as ofJune 30, 2020 from 7.9 as ofDecember 31, 2019 primarily due to lower cost of goods sold during the second quarter of 2020 compared to the fourth quarter of 2019. Inventory turnover is calculated based on annualized quarterly operating results and average inventory balances during the quarter. Capital resources Short-term line of credit OnDecember 21, 2010 , we entered into a Loan and Security Agreement withSilicon Valley Bank (the "Bank"), which was amended onDecember 14, 2012 ,December 4, 2013 ,December 18, 2015 ,December 15, 2016 ,July 21, 2017 ,December 21, 2017 ,December 18, 2018 ,December 18, 2019 andApril 17, 2020 (as amended, the "Revolving Loan Agreement"). The Revolving Loan Agreement provides 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)$2.5 million plus 80% of eligible domestic accounts receivable and certain foreign accounts receivable of bothPixelworks andViXS Systems, Inc. , subject to certain limitations on the amount of accounts receivables attributable to ViXS. The Revolving Line has a maturity date ofDecember 27, 2020 . 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 us 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 us 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 our 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 ofJune 30, 2020 , we were in compliance with all of the terms of the Revolving Loan Agreement. As ofJune 30, 2020 , short-term borrowings outstanding under the Revolving Line consisted of$4.3 million . The weighted-average interest rate on short-term borrowings outstanding as ofJune 30, 2020 was 3.5%. As ofDecember 31, 2019 , we had no outstanding borrowings under the Revolving Line. 28
-------------------------------------------------------------------------------- Table of Contents Paycheck Protection Program Loan OnApril 25, 2020 , we entered into a loan withSilicon Valley Bank as the lender in an aggregate principal amount of$0.8 million (the "Loan") pursuant to the Paycheck Protection Program (the "PPP") under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). The Loan is evidenced by a promissory note (the "Note") datedApril 25, 2020 , and matures 2 years from the disbursement date. The Note bears interest at a rate of 1.000% per annum, with the first six months of interest deferred. Principal and interest are payable monthly commencing 6 months after the disbursement date and may be prepaid by the Company at any time prior to maturity with no prepayment penalties. The Note contains customary events of default relating to, among other things, payment defaults or breaches of the terms of the Note. Upon the occurrence of an event of default, the Lender may require immediate repayment of all amounts outstanding under the Note. Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of loans granted under the PPP. The Loan is subject to forgiveness to the extent proceeds are used for payroll costs, including payments required to continue group health care benefits, and certain rent, utility, and mortgage interest expenses (collectively, "Qualifying Expenses"), pursuant to the terms and limitations of the PPP. The Company intends to use the Loan amount for Qualifying Expenses and we intend to apply for forgiveness, however, no assurance is provided that the Company will obtain forgiveness of the Loan in whole or in part. 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 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 the Company. 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. As ofJune 30, 2020 and during the three months endedJune 30, 2020 , we sold an aggregate of 803,528 shares of our common stock under this at the market offering, resulting in aggregate net proceeds to us of approximately$2.5 million , and gross proceeds of approximately$2.8 million and paid Cowen commissions and fees of approximately$0.1 million , and other expenses of$0.2 million . As ofJune 30, 2020 , the remaining availability under the at the market offering is$22.2 million . Liquidity As ofJune 30, 2020 , our cash, cash equivalents and short-term marketable securities balance of$21.4 million was highly liquid. We anticipate that our existing working capital will be adequate to fund our operating, investing and financing needs for at least the next twelve months. 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. In addition, the impact of COVID-19 has affected our ability to pursue such financing arrangements and we are uncertain about when that will change. 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. 29 -------------------------------------------------------------------------------- Table of Contents Contractual Payment Obligations Our contractual obligations for 2020 and beyond are included in our Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2020 , filed with theSecurities and Exchange Commission onMay 8, 2020 . Our obligations for 2020 and beyond have not changed materially as ofJune 30, 2020 . 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. Item 3. Quantitative and Qualitative Disclosure About Market Risk. Not applicable. 30
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