What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-08 compared with 2022-03-09 · 84 added, 91 removed, 182 unchanged (49% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operation.

In March 2020, the World 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.

Several public health organizations have recommended, and many local governments have implemented, certain measures to slow and limit the transmission of the virus, including various 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 our revenues for 2021 continued to be negatively impacted by COVID-19.

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).

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Pixelworks is a leading provider of high-performance and power-efficient visual processing semiconductor and software solutions that enable consistently high-quality and authentic viewing experiences in a wide variety of applications.

We define our primary target markets as Mobile (smartphone and tablet), Home & Enterprise (projectors, personal video recorders ("PVR"), and over-the-air ("OTA") streaming devices), and Cinema (creation, remastering, and delivery of digital video content).

Previously we classified our primary target markets as Mobile, Projector, Video Delivery and Cinema, but have since aggregated the Projector and Video Delivery categories into one called "Home & Enterprise".

Pixelworks has been a pioneer in visual processing technology for over 20 years.

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.

We launched one of the industry’s first single-chip SoCs for digital projection.

We were the first company to integrate motion estimation / motion compensation technology ("MEMC") as a mobile-optimized solution for smartphones.

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.

Our core visual processing technology intelligently processes digital images and video from a variety of sources and optimizes the content for a superior viewing experience.

Rapid growth in video and gaming consumption, combined with the move towards bright, high resolution, high frame rate and high refresh rate displays, especially in mobile, is increasing the demand for our solutions.

Our technologies can be applied across a wide range of applications:

cinema theaters, low-power mobile tablets, smartphones, streaming devices, and digital projectors for the home, school, or the workplace.

Our products are designed and optimized for power, cost, bandwidth, viewer experience, 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 the Asia-centered customers and employee stakeholders of those businesses.

The global center of the mobile, projector, and video delivery businesses continues to be in Asia, 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 in Asia 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 underneath Pixelworks, 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 the Shanghai 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.

During the third quarter of 2021, we engaged in a strategic plan to re-align our Mobile and Home & Enterprise businesses to improve their focus on their Asia-centered customers and employee stakeholders.

Our subsidiary, Pixelworks Semiconductor Technology (Shanghai) Co., Ltd.

(or "PWSH"), now operates these businesses as a full profit-and-loss center underneath Pixelworks.

In connection with this strategic plan, the Company and PWSH closed three separate financing transactions in 2021 and 2022, which are further described in "Note 14:

Redeemable Non-Controlling Interest and Equity Interest of PWSH Sold to Employees", "Note 15:

Non-Controlling Interest" and "Note 17:

Subsequent Events", which are incorporated by reference into this section.

PWSH is in the process of preparing to file an application for an initial public offering of PWSH shares on the Shanghai Stock Exchange’s Science 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 PWSH’s growth worldwide.

We presently intend to qualify PWSH to apply for the Listing in 2023.

The process of going public on the STAR Market is lengthy and includes several periods of review by various government agencies of the People’s Republic of China (“PRC”), such as the Shanghai Stock Exchange and the China Securities Regulatory Commission (“CSRC”).

There is no guarantee that PWSH will be approved for a Listing at any point in the future.

The listing of PWSH on the STAR Market will not change the status of PXLW as a U.S.

public company.

We are neither a PRC operating company nor do we conduct our operations in China through the use of variable interest entities.

As of December 31, 2022, we had an intellectual property portfolio of 291 patents related to the visual display of digital image data.

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We sell our products worldwide through a direct sales force, distributors and manufacturers’ representatives.

We sell to distributors in China, Europe, Japan, Korea, Southeast Asia, Taiwan and the U.S.

We sell to distributors in China, Europe, Japan and Taiwan.

Our distributors often provide engineering support to our end customers and often have valuable and established relationships with our end customers.

In certain countries in which we operate, it is customary to sell to distributors.

In certain countries in which we operate, it is

customary to sell to distributors.

While distributor payment to us is not dependent upon the distributor’s ability to resell the product or to collect from the end customer, the distributors may provide longer payment terms to end customers than those we would offer.

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The majority of our revenue to date has been denominated in U.S.

For additional information regarding how the COVID-19 pandemic has affected us, please see “NOTE REGARDING COVID-19” above.

Our business is subject to seasonality related to the markets we serve and the location of our customers.

For example, we have historically experienced higher revenue from the digital projector market in the third quarter of the year, and lower revenue in the first quarter of the year, as our Japanese customers reduce inventories in anticipation of their March 31 fiscal year end.

For example, we have historically experienced higher revenue from the digital projector component of the Home & Enterprise market in the third quarter of the year, and lower revenue in the first quarter of the year, as our Japanese customers reduce inventories in anticipation of their March 31 fiscal year end.

Results of Operations

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Revenue recorded in 2021 consisted of $50.8 million in revenue from the sale of IC products and $4.3 million in revenue related to engineering services, license revenue and other.

The increase in IC revenue is due to a significant increase in unit sales into the mobile market and an increase in unit sales into the digital projector market as we experienced increased demand in the mobile market and sustained recovery in the digital projector market.

The increase in revenue related to engineering services, license revenue and other is primarily due to the recognition of license revenue during 2021.

The increase in IC revenue from 2021 compared to 2022 is due to the following factors:

• Sales into the Mobile market increased $5.0 million or 31%, primarily due to a change in product mix as customers transitioned to newer generation product offerings.

• Sales into the Home & Enterprise market (previously referred to as the projector and video delivery market) increased $12.4 million or 35%, primarily due to an increase in units sold driven by increased customer demand as well as implementing an end-of-life on some of our legacy products sold into the video delivery market.

The increase in revenue was also due to a change in product mix, resulting in higher overall average selling prices.

Average selling prices also increased partially due to passing on increased supplier costs to our customers.

Revenue related to engineering services, license revenue and other decreased $2.4 million or 54% primarily due to a decrease in licensing revenue in the Mobile market.

Revenue related to the Cinema market was not material in 2022 or 2021 and was therefore included in the engineering services, license revenue and other category within the Mobile market.

Cost of revenue and gross profit

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Stock-based compensation 41 0 43 0

Restructuring — 0 173 0

Total cost of revenue $ 34,265 49 % $ 27,409 50 %

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2 Includes charges to reduce inventory to lower of cost or net realizable value and a benefit for sales of previously written down inventory.

Gross profit margin increased to 50% in 2021 compared to 49% in 2020, primarily due to high margin license revenue recorded, more absorption of fixed overhead costs due to increased revenue and decreased amortization of acquired developed technology.

These favorable increases to gross profit margin were partially offset by an unfavorable impact to gross profit margin due to a significant increase in sales into the mobile market compared to the comparable period.

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 developed technology and the timing and execution of manufacturing ramps as well as other factors.

Gross profit margin increased to 51% in 2022 compared to 50% in 2021, primarily due to product mix.

The increase in sales into the Home & Enterprise market favorably impacted gross profit margin, while the increase in sales into the Mobile market unfavorably impacted gross profit margin.

The increase was also due to decreased amortization of acquired developed technology, largely offset by a decrease in high margin license revenue.

Pixelworks’ gross profit margin is subject to variability based on changes in revenue levels, product mix, average selling prices, startup costs, amortization related to acquired developed technology and the timing and execution of manufacturing ramps as well as other factors.

Research and development

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As amounts become due and payable, they are offset against research and development expense on a pro rata basis.

During the year ended December 31, 2021, we recognized an offset to research and development expense of approximately $4.0 million.

We recognized offsets to research and development expense of approximately $4.3 and $4.0 million during the years ended December 31, 2022 and 2021, respectively.

Research and development expense was as follows (in thousands):

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Research and development $ 30,521 $ 27,250 $ 3,271 12 %

Research and development expense increased $2.2 million, or 9%, from 2020 to 2021.

The increase was 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, as well as annual merit salary increases and an increased management bonus accrual.

2021 also included an increase in non-recurring engineering expense due to the timing of development activities.

This increase was largely offset by a benefit related to the co-development agreement.

Research and development expense increased $3.3 million, or 12%, from 2021 to 2022 due to the following factors:

• Compensation expense increased $2.8 million due to an increase in headcount and annual merit salary increases.

• Depreciation and amortization increased $0.9 million due to the timing of development activities.

• These increases were partially offset by a $0.4 million increase in the credit recognized related to the co-development agreement in 2022, compared to the credit recognized in 2021.

Selling, general and administrative

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Selling, general and administrative $ 22,177 $ 20,445 $ 1,732 8 %

Selling, general and administrative expense increased $0.6 million, or 3%, from 2020 to 2021.

The increase was primarily due to increases in accounting and legal fees incurred related to our strategic plan with our PWSH subsidiary as well as an increase in compensation expense due to annual merit salary increases and an increased management bonus accrual.

These increases were partially offset by 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 was as follows (in thousands):

Year ended December 31,

Employee severance and benefits

Total restructuring expense

Included in cost of revenue

Included in operating expenses

During 2021, we did not record any restructuring expense.

During 2020, we recorded $1.6 million in restructuring expense related to the August 2020 Plan and $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.

The August 2020 Plan was complete in the fourth quarter of 2020 and we did not incur any further expenses related to the August 2020 Plan after the fourth quarter of 2020.

Selling, general and administrative expense increased $1.7 million, or 8%, from 2021 to 2022 due to the following factors:

• Compensation expense increased $1.0 million due to an increase in headcount and annual merit salary increases.

• Foreign currency gains and losses increased $0.7 million primarily due to the change in the CNY exchange rate.

• Various professional fees increased $0.7 million as a result of our strategic plan with our PWSH subsidiary.

• Marketing expenses increased $0.2 million due to increased focus on marketing to expand our gaming eco-system.

• These increases were partially offset by a $0.9 million decrease in stock based compensation expense due the timing of awards granted and due to the resignation of our former Chief Financial Officer in January 2022.

Interest income and other, net

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Total interest income and other, net $ 700 $ 457

The increase in interest income in 2022 compared to 2021 is due to increased interest earned on our cash and cash equivalents balance due to our increased average cash balance throughout the year in 2022 compared to 2021.

Provision (benefit) for income taxes

The provision (benefit) for income taxes was as follows (in thousands):

The benefit for income taxes was as follows (in thousands):

Year ended December 31,

Provision (benefit) for income taxes $ (133) $ 598

Benefit for income taxes $ (884) $ (133)

The income tax benefit of $0.9 million recorded for the year ended December 31, 2022 is primarily composed of $1.8 million of tax benefit for the reversal of tax contingencies in foreign jurisdictions, partially offset by tax expense of $0.3 million for our profitable cost-plus jurisdictions and deferred tax expense of approximately $0.6 million related to a change in the realizability of our Canadian deferred tax assets.

The income tax benefit of $0.1 million recorded for the year ended December 31, 2021 is primarily comprised of current tax expense of approximately $0.6 million for our profitable cost-plus foreign jurisdictions and accruals for tax contingencies in foreign jurisdictions offset by a deferred tax benefit of approximately $0.7 million primarily associated with recognition of Canadian deferred tax assets.

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Also included in current tax expense is $0.8 million of expense resulting from the revaluation of our uncertain tax position in China to the statutory tax rate as we no longer qualify for the tax holiday we were under.

The income tax expense recorded for the year ended December 31, 2020 is primarily comprised of $0.6 million in current and deferred tax expense for our profitable cost-plus foreign jurisdictions and accruals for tax contingencies in foreign jurisdictions, partially offset by the reversal of previously recorded tax contingencies due to the expiration of the applicable statute of limitations.

We continue to record a full valuation allowance against our U.S.

net deferred tax assets as of December 31, 2021 and 2020, as it is not more likely than not that we will realize a benefit from these assets in a future period.

In the third quarter of 2021, we recorded a valuation allowance against our net deferred tax assets in China in conjunction with the restructuring of our intercompany agreements and intellectual property.

In the fourth quarter of 2021, we recognized $0.6 million of our Canadian net deferred tax assets as we are more likely than not to realize a benefit from these assets in a future period.

and China net deferred tax assets as of December 31, 2022 and 2021, as it is not more likely than not that we will realize a benefit from these assets in a future period.

In the fourth quarter of 2021, we recognized $0.6 million of our Canadian net deferred tax assets.

As of December 31, 2022, we are no longer more-likely-than-not to realize our remaining Canadian deferred tax assets and have recorded a full valuation allowance.

We have not provided a valuation allowance against our other foreign net deferred tax assets as we have concluded it is more-likely-than-not that we will realize a benefit from these assets in a future period because our subsidiaries in these jurisdictions are cost-plus taxpayers.

The net valuation allowance decreased $4.4 million for the year ended December 31, 2022 and decreased $4.6 million for the year ended December 31, 2021.

As of December 31, 2022, we have federal, state and foreign net operating loss carryforwards of approximately $155.0 million, $9.6 million, and $42.7 million respectively, which will begin expiring in 2024.

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Cash and cash equivalents

Total cash and cash equivalents increased $30.3 million from $31.3 million at December 31, 2020 to $61.6 million at December 31, 2021.

Short-term marketable securities decreased $0.3 million from $0.3 million at December 31, 2020 to zero at December 31, 2021.

The net increase in cash, cash equivalents and short-term marketable securities of $30.0 million was the result of $42.3 million in proceeds from equity interests issued to the redeemable non-controlling interest and certain entities owned by employees, $1.3 million in proceeds from the issuances of common stock under our employee equity incentive plans and $0.3 million in net proceeds from our "at the market" equity offering.

These increases were partially offset by $9.2 million used in operating activities, $3.5 million used for purchases of property and equipment and $1.2 million used for payments on other asset financings.

Total cash and cash equivalents decreased $4.8 million from $61.6 million at December 31, 2021 to $56.8 million at December 31, 2022.

The net decrease was the result of $12.8 million used in operating activities, $3.0 million used for purchases of property and equipment and licensed technology and $1.5 million used for payments on other asset financings.

These decreases were partially offset by increases of $12.1 million received in net proceeds from our non-controlling interest and certain entities owned by employees and $0.4 million in proceeds from the issuances of common stock under our employee equity incentive plans.

As of December 31, 2022, our cash and cash equivalents balance consisted of $33.0 million in cash and $18.8 million in cash equivalents held in U.S.

dollar denominated money market funds.

dollar denominated money market funds and $5.0 million held in U.S.

dollar denominated certificates of deposit.

Our investment policy requires that our portfolio maintains a weighted average maturity of less than 12 months.

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Average number of days sales outstanding increased to 54 days at December 31, 2022 from 47 days at December 31, 2021.

The increase in accounts receivable was due to normal fluctuations in the timing of sales and customer receipts within the fourth quarter of 2021, and the fourth quarter of 2020.

Inventories decreased to $1.5 million at December 31, 2021 from $2.4 million at December 31, 2020.

Inventory turnover increased to 19.5 at December 31, 2021 from 6.0 at December 31, 2020 primarily due to lower average inventory balances and higher cost of goods sold during the fourth quarter of 2021 compared to the fourth quarter of 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 fourth quarter of 2022, and the fourth quarter of 2021.

Inventories increased to $1.8 million at December 31, 2022 from $1.5 million at December 31, 2021.

Inventory turnover decreased to 13.7 at December 31, 2022 from 19.5 at December 31, 2021 primarily due to higher average inventory balances in the fourth 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.

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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.

During the year ended December 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.

Capital Increase Agreement

There was no activity under this at the market offering during the year ended December 31, 2022.

Capital Increase Agreements

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 of RMB 279.7 million ($42.3 million USD).

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Redeemable Non-Controlling Interest and Equity Interest of PWSH Sold to Employees", which is incorporated by reference into this section.

As of December 31, 2021, our cash, cash equivalents and short-term marketable securities balance of $61.6 million was highly liquid.

On December 21, 2022, the Company and its subsidiary, PWSH, entered into a Capital Increase Agreement with certain private equity investors based in China who have agreed to pay a total of RMB 100.0 million ($14.3 million USD).

Additional information is provided in "Note 17:

Subsequent Events", 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 15:

Non-Controlling Interest", which is incorporated by reference into this section.

As of December 31, 2022, our cash and cash equivalents balance of $56.8 million was highly liquid.

We currently anticipate that our existing working capital will be adequate to fund our operating, investing and financing needs for the twelve months following our 2022 fiscal year end and beyond.

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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

A summary of our contractual obligations as of December 31, 2021 is as follows:

Payments Due By Period

Contractual Obligation Total Less than

1 year 1-3 years 3-5 years More than 5 years

Operating leases $ 5,724 $ 2,652 $ 2,253 $ 728 $ 91

Estimated purchase commitments to contract manufacturers 6,598 6,598 — — —

Payments on accrued balances related to asset financings 1,498 1,133 365 — —

Other purchase obligations and commitments 619 275 344 — —

$ 14,439 $ 10,658 $ 2,962 $ 728 $ 91

1 We are unable to reliably estimate the timing of future payments related to uncertain tax positions and repatriation of foreign earnings;

therefore, $3.1 million of income taxes payable has been excluded from the table above.

Critical Accounting Policies and Estimates

Critical Accounting Estimates

The preparation of financial statements in conformity with U.S.

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Product Sales - We sell integrated circuit products, also known as "chips" or "ICs", based upon a customer purchase order, which includes a fixed price per unit.

ICs are sold into two target markets:

Mobile and Home & Enterprise.

We have elected to account for shipping and handling as activities to fulfill the promise to transfer the goods, and not evaluate whether these activities are promised services to the customer.

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If the fair value of a reporting unit exceeds the carrying amount, goodwill of the reporting unit is not considered impaired.

We evaluate impairment using the guidance set forth in FASB Accounting Standards Update No.

We evaluate impairment using the guidance set forth in FASB Accounting Standards Update ("ASU") No.

2017-04, Intangibles-Goodwill and Other (Topic 350):

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis