PIXELWORKS, INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 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 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 in Asia 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, 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 unless required by law. 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. 24 Table of Contents COVID-19 In March 2020, the World 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 spread of COVID-19 has caused us to modify our business practices, including implementing work-from-home policies and restricting travel by our employees. 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. For example, our revenues for fiscal year 2020 were lower than initially anticipated and we expect our revenues for 2021 to continue to be negatively impacted by COVID-19. 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 our Hollywood 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 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. As of March 31, 2021, we had an intellectual property portfolio of 336 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. 25 Table of Contents Results of Operations Revenue, net Net revenue for the three month periods ended March 31, 2021 and 2020, was as follows (dollars in thousands): Three Months Ended March 31, 2021 2020 $ Change % Change Revenue, net $ 9,270 $ 13,774 $ (4,504) (33) % Net revenue decreased $4.5 million, or 33%, in the first quarter of 2021 compared to the first quarter of 2020. Revenue recorded in the first quarter of 2021 consisted of $8.6 million in revenue from the sale of integrated circuit ("IC") products and $0.6 million in revenue related to engineering services, license revenue and other. Revenue recorded in the first quarter of 2020 consisted of $13.1 million in revenue from the sale of IC products and $0.7 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 is partially offset by increased unit sales into the mobile market. Cost of revenue and gross profit Cost of revenue and gross profit for the three month periods ended March 31, 2021 and 2020, were as follows (dollars in thousands): Three Months Ended March 31, 2021 % of revenue 2020 % of revenue Direct product costs and related overhead 1 $ 5,221 56 % $ 6,511 47 % Amortization of acquired intangible assets 245 3 298 2 Stock-based compensation 79 1 101 1 Inventory charges 2 — 0 89 1 Total cost of revenue $ 5,545 60 % $ 6,999 51 % Gross profit $ 3,725 40 % $ 6,775 49 % 1 Includes purchased materials, assembly, test, labor, employee benefits and royalties. 2 Includes charges to reduce inventory to lower of cost or market and a benefit for sales of previously written down inventory. Gross profit margin was 40% in the first quarter of 2021 compared to 49% in the first quarter of 2020. The decrease in gross profit margin was primarily due to product mix, increased product costs and absorption of fixed overhead costs 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. 26 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 month periods ended March 31, 2021 and 2020, was as follows (dollars in thousands): Three Months Ended March 31, 2021 2020 $ Change % Change Research and development $ 6,785 $ 6,267 $ 518 8 % Research and development expense increased $0.5 million, or 8% in the first quarter of 2021 compared to the first quarter of 2020 primarily due to an increase in compensation expense due to a COVID-19 relief benefit received in China in 2020 that was not received in 2021, partially offset by a reduction in headcount. The increase was also due to 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 month periods ended March 31, 2021 and 2020, was as follows (dollars in thousands): Three Months Ended March 31, 2021 2020 $ Change % Change Selling, general and administrative $ 4,854 $ 5,193 $ (339) (7) % Selling, general and administrative expense decreased $0.3 million, or 7%, in the first quarter of 2021 compared to the first quarter of 2020 primarily due to a decrease in compensation expense due to a reduction in headcount and a decrease in stock-based compensation expense due to the timing of awards granted. Restructurings In August 2020, we executed a restructuring plan to make the operation of the Company more efficient (the "August 2020 Plan"). The August 2020 Plan included an approximately 14% reduction in workforce, primarily in the areas of operations, research and development, sales and marketing. In January 2020, we executed a restructuring plan to make the operation of the Company more efficient (the "January 2020 Plan"). The January 2020 Plan included an approximately 4% reduction in workforce, primarily in the areas of research and development and sales. Restructuring expense for the three month periods ended March 31, 2021 and 2020, was as follows and was included in operating expenses (dollars in thousands): Three Months Ended March 31, 2021 2020 Employee severance and benefits $ — $ 592 Total restructuring expense $ — $ 592 During the first quarter of 2021, we did not incur any restructuring expense. During the first quarter of 2020, we recorded $0.6 million in restructuring expense related to the January 2020 Plan. The January 2020 Plan was complete in the first quarter of 2020 and we did not incur any further charges related to the January 2020 Plan after the first quarter of 2020. 27 Table of Contents Provision for income taxes The provision for income taxes during the 2021 and 2020 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 quarter of 2021 and during the first quarter of 2020. Liquidity and Capital Resources Cash, cash equivalents and short-term marketable securities Total cash and cash equivalents decreased $5.8 million to $25.4 million at March 31, 2021 from $31.3 million at December 31, 2020. Short-term marketable securities decreased $0.3 million to zero at March 31, 2021 from $0.3 million at December 31, 2020. The net decrease in cash, cash equivalents and short-term marketable securities of $6.1 million during the first three months of 2021 was the result of $6.7 million used in operating activities, $0.2 million used for purchases of property and equipment and $0.2 million used for payments on other asset financings. These decreases were partially offset by $1.1 million in proceeds from the issuances of common stock under our employee equity incentive plans. As of March 31, 2021, our cash and cash equivalents balance consisted of $18.1 million in cash equivalents held in U.S. dollar denominated money market funds and $7.3 million in cash. 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 $5.5 million as of March 31, 2021 from $4.7 million as of December 31, 2020. The average number of days sales outstanding increased to 54 days as of March 31, 2021 from 44 days as of December 31, 2020. The increase in accounts receivable and days sales outstanding was due to normal fluctuations in the timing of sales and customer receipts within the first quarter of 2021, and the fourth quarter of 2020. Inventories Inventories were $1.7 million as of March 31, 2021 compared to $2.4 million at December 31, 2020. Inventory turnover increased to 10.1 as of March 31, 2021 from 6.0 as of December 31, 2020 primarily due to lower average inventory balances during the first quarter of 2021 compared to the fourth quarter of 2020. Inventory turnover is calculated based on annualized quarterly operating results and average inventory balances during the quarter. Capital resources Short-term line of credit On December 21, 2010, we entered into a Loan and Security Agreement with Silicon Valley Bank (the "Bank"), which was amended on December 14, 2012, December 4, 2013, December 18, 2015, December 15, 2016, July 21, 2017, December 21, 2017, December 18, 2018, December 18, 2019, April 17, 2020 and December 14, 2020 (as amended, the "Revolving Loan Agreement"). The Revolving Loan Agreement provided 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 both Pixelworks and ViXS Systems, Inc., subject to certain limitations on the amount of accounts receivables attributable to ViXS. In addition, the Revolving Loan Agreement provided for non-formula advances of up to $10.0 million which may have been made solely during the last five business days of any fiscal month or quarter and which were required to 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 did not provide us with usable liquidity. The Revolving Loan Agreement contained customary affirmative and negative covenants as well as customary events of default. The occurrence of an event of default could have resulted in the acceleration of our obligations under the Revolving Loan Agreement, and an increase to the applicable interest rate, and would have permitted the Bank to exercise remedies with respect to its security interest. The Revolving Line had a maturity date of March 26, 2021. We did not renew the Revolving Loan Agreement upon its maturity. As of March 31, 2021 and December 31, 2020, we had no outstanding borrowings under the Revolving Line. 28 Table of Contents Paycheck Protection Program Loan On April 25, 2020, we entered into a loan with Silicon 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 was evidenced by a promissory note (the “Note”) dated April 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. We used the Loan amount for Qualifying Expenses. During the fourth quarter of 2020, we applied for and received full forgiveness and recorded a gain of $0.8 million within other income in our consolidated statements of operations. Equity Offering On December 14, 2020, we completed the sale of 4,900,000 shares of common stock in an underwritten registered offering. On December 16, 2020, an additional 735,000 shares were issued pursuant to the 30-day over-allotment option exercised by the underwriter. With the over-allotment shares, a total of 5,635,000 shares of common stock were sold in the offering at a price to the public of $2.45 per share. Net proceeds to the Company, after deducting underwriting discounts, commissions, and other expenses, were approximately $12.7 million. Private Placement Investment On December 7, 2020, we completed a private placement of 724,288 shares of common stock to a certain accredited investor at a purchase price of $2.071 per share. On December 15, 2020, we completed a private placement of 2,475,712 shares of common stock to a certain accredited investor at a purchase price of $2.071. Net proceeds to the Company, after deducting commissions and other expenses, were approximately $6.2 million. At the Market Offering On June 5, 2020, we entered into a sales agreement (the "Sales Agreement") with Cowen 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 $25,000, 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. During the year ended December 31, 2020, we sold an aggregate of 1,747,466 shares of our common stock under this at the market offering, resulting in aggregate net proceeds to us of approximately $4.4 million, and gross proceeds of approximately $4.9 million and paid Cowen commissions and fees of approximately $0.2 million, and other expenses of $0.3 million. Liquidity As of March 31, 2021, our cash and cash equivalents balance of $25.4 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. 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 29 Table of Contents 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. Contractual Payment Obligations Our contractual obligations for 2021 and beyond are included in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission on March 10, 2021. Our obligations for 2021 and beyond have not changed materially as of March 31, 2021. 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 Table of Contents