Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
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. 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 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. 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.
Pixelworks was founded in 1997 and is incorporated under the laws of the state of Oregon. On August 2, 2017, we acquired ViXS Systems Inc., a corporation organized in Canada ("ViXS").
Historically, significant portions of our revenue have been generated by sales to a relatively small number of end customers and distributors. We sell our products worldwide through a direct sales force, distributors and manufacturers’ representatives. 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
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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.
Significant portions of our products are sold overseas. Sales outside the U.S. accounted for approximately 95% and 97% of revenue in 2022 and 2021, respectively. Our integrators, branded manufacturers and branded suppliers incorporate our products into systems that are sold worldwide. The majority of our revenue to date has been denominated in U.S. dollars.
For additional information regarding how the COVID-19 pandemic has affected us, please see “NOTE REGARDING COVID-19” above.
Seasonality
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 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.
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Results of Operations
For the year ended December 31, 2022 compared with year ended December 31, 2021.
Revenue, net
Net revenue was as follows (in thousands):
Year ended December 31, 2022 v. 2021
2022 2021 $ change % change
Revenue, net $ 70,146 $ 55,102 $ 15,044 27 %
Net revenue increased $15 million, or 27%, from 2021 to 2022.
Revenue recorded in 2022 consisted of $68.2 million in revenue from the sale of IC products and $1.9 million in revenue related to engineering services, license revenue and other. 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 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
Cost of revenue and gross profit were as follows (in thousands):
Year ended December 31,
2022 % of
revenue 2021 % of
revenue
Direct product costs and related overhead 1
$ 34,070 49 % $ 25,987 47 %
Amortization of acquired developed technology 72 0 899 2
Inventory charges 2
82 0 480 1
Stock-based compensation 41 0 43 0
Total cost of revenue $ 34,265 49 % $ 27,409 50 %
Gross profit $ 35,881 51 % $ 27,693 50 %
1 Includes purchased materials, assembly, test, labor, employee benefits and royalties.
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 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.
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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 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 $2.5 million, $1.9 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. 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):
Year ended December 31, 2022 v. 2021
2022 2021 $ change % change
Research and development $ 30,521 $ 27,250 $ 3,271 12 %
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
Selling, general and administrative expense includes compensation and related costs for personnel, sales commissions, allocations for facilities and information technology expenses, travel, outside services and other general expenses incurred in our sales, marketing, customer support, management, legal and other professional and administrative support functions.
Selling, general and administrative expense was as follows (in thousands):
Year ended December 31, 2022 v. 2021
2022 2021 $ change % change
Selling, general and administrative $ 22,177 $ 20,445 $ 1,732 8 %
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.
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Interest income and other, net
Interest income and other, net, consisted of the following (in thousands):
Year ended December 31,
2022 2021
Other income $ 80 $ 246
Interest income 670 211
Interest expense (50) —
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 benefit for income taxes was as follows (in thousands):
Year ended December 31,
2022 2021
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. Included in current tax expense is a tax benefit of $0.6 million associated with the reversal of withholding taxes on our China earnings as we now plan to reinvest these earnings indefinitely, which resulted from the changes made in the third quarter of 2021 related to our strategic plan with our PWSH subsidiary. 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.
We continue to record a full valuation allowance against our U.S. 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. As of December 31, 2022, we have available federal, state and foreign research and experimentation tax credit carryforwards of approximately $6.7 million, $5.2 million and $21.9 million respectively. The federal and state tax credits will begin expiring in 2023 while the foreign tax credits have an indefinite life. In addition, our Canadian subsidiary has unclaimed scientific and experimental expenditures to be carried forward and applied against future income in Canada of approximately $120.3 million. We have a general foreign tax credit of $0.1 million, which will begin expiring in 2023. Our ability to utilize our federal net operating losses may be limited by Section 382 of the Internal Revenue Code of 1986, as amended, which imposes an annual limit on the ability of a corporation that undergoes an "ownership change" to use its net operating loss carryforwards to reduce its tax liability. An ownership change is generally defined as a greater than 50% increase in equity ownership by 5% shareholders in any three-year period.
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Liquidity and Capital Resources
Cash and cash equivalents
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 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. Additionally, no maturities can extend beyond 24 months and concentrations with individual securities are limited. At the time of purchase, 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 NRSROs. Our investment policy is reviewed at least annually by our Audit Committee.
Accounts receivable, net
Accounts receivable, net increased to $10.0 million at December 31, 2022 from $8.7 million at December 31, 2021. 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 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
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.
Capital resources
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 $25.0 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 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.
There was no activity under this at the market offering during the year ended December 31, 2022.
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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). Additional information is provided in "Note 14: Redeemable Non-Controlling Interest and Equity Interest of PWSH Sold to Employees", which is incorporated by reference into this section.
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.
Liquidity
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. We may pursue financing arrangements including the issuance of debt or equity securities or reduce expenditures, or both, to meet the Company’s 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 results of operations, financial position 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 I, “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.
Critical Accounting Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and judgments that affect the amounts reported. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, inventories, property and equipment, impairment of long-lived assets, valuation of goodwill, valuation of share-based payments, income taxes, litigation and other contingencies. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
Revenue Recognition - Revenue is recognized when control of the promised good or service is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Our principal revenue generating activities consist of the following:
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. We generally satisfy our single performance obligation upon shipment of the goods to the customer and recognize revenue at a point in time upon shipment of the underlying product.
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Our shipments are subject to limited return rights subject to our limited warranty for our products sold. In addition, we may provide other credits to certain customers pursuant to price protection and stock rotation rights, all of which are considered variable consideration when estimating the amount of revenue to recognize. We use the “most likely amount” method to determine the amount of consideration to which we are entitled. Our estimate of variable consideration is reassessed at the end of each reporting period based on changes in facts and circumstances. Historically, returns and credits have not been material.
Engineering Services - We enter into contracts for professional engineering services that include software development and customization. We identify each performance obligation in our engineering services agreements ("ESAs") at contract inception. The ESA generally includes project deliverables specified by the customer. The performance obligations in the ESA are generally combined into one deliverable, with the pricing for services stated at a fixed amount. Services provided under the ESA generally result in the transfer of control over time. We recognize revenue on ESAs based on the proportion of labor hours expended to the total hours expected to complete the contract performance obligation. ESAs could include substantive customer acceptance provisions. In ESAs that include substantive customer acceptance provisions, we recognize revenue upon customer acceptance.
License Revenue - On occasion, we derive revenue from the license of our internally developed intellectual property ("IP"). Additionally, for certain IP license agreements, royalties are collected as customers sell their own products that incorporate our IP. IP licensing agreements that we enter into generally provide licensees the right to incorporate our IP components in their products with terms and conditions that vary by licensee. Fees under these agreements generally include license fees or royalty fees relating to our IP and support service fees, resulting in two performance obligations. We evaluate each performance obligation, which generally results in the transfer of control at a point in time for the license fee and over time for support services. Royalties are recognized as revenue is earned, generally when the customer sells its products that incorporate our IP.
Other - From time-to-time, we enter into arrangements for other revenue generating activities, such as providing technical support services to customers through technical support agreements. In each circumstance, we evaluate such arrangements for our performance obligations which generally results in the transfer of control for such services over time. Historically, such arrangements have not been material to our operating results.
Inventory Valuation. We value inventory at the lower of cost or net realizable value. In addition, we write down any obsolete, unmarketable or otherwise impaired inventory to net realizable value. The determination of obsolete or excess inventory requires us to estimate the future demand for our products. The estimate of future demand is compared to inventory levels to determine the amount, if any, of obsolete or excess inventory. If actual market conditions are less favorable than those we projected at the time the inventory was written down, additional inventory write-downs may be required. Inventory valuation is re-evaluated on a quarterly basis.
Useful Lives and Recoverability of Equipment and Other Long-Lived Assets. We evaluate the recoverability of equipment and other assets, including identifiable intangible assets, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If there is an indicator of impairment, we prepare an estimate of future, undiscounted cash flows expected to result from the use of each asset and its eventual disposition. If these cash flows are less than the carrying value of the asset, we adjust the carrying amount of the asset to its estimated fair value. We have concluded that the carrying value of our long-lived assets is recoverable as of December 31, 2022.
Goodwill. Goodwill is not amortized, rather tested, at least annually, for impairment at a reporting unit level. Impairment of goodwill is the condition that exists when the carrying amount of a reporting unit that includes goodwill exceeds its fair value. A goodwill impairment loss is recognized for the amount that the carrying amount of the reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. 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 ("ASU") No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04") which states that an entity may first assess qualitative factors to determine whether it is necessary to perform the quantitative goodwill impairment test. If determined to be necessary, the quantitative impairment test shall be used to identify goodwill impairment and measure the amount of goodwill impairment loss to be recognized. An entity has an unconditional option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to the quantitative goodwill impairment test. Accordingly, we have elected to bypass the qualitative assessment and proceed directly to the quantitative goodwill impairment test. We tested goodwill for impairment under the quantitative goodwill impairment test during the fourth quarter and concluded that goodwill was not impaired.
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Stock-Based Compensation . Stock-based compensation expense is measured at the grant date, based on the estimated fair value of the award using the Black-Scholes option pricing model for stock options and market price for restricted stock units. The use of the Black-Scholes option pricing model, requires certain estimates, including expected term of options granted, the method of calculating expected volatilities and the risk-free interest rate used in the option-pricing model. The resulting calculated fair value of stock options is recognized as compensation expense over the requisite service period, which is generally the vesting period. When there are changes to the assumptions used in the option-pricing model, including fluctuations in the market price of our common stock, there will be variations in the calculated fair value of our future stock option awards, which results in variation in the stock-based compensation expensed recognized. Additionally, any modification of an award that increases its fair value will require us to recognize additional expense.
Income Taxes. We record deferred income taxes for temporary differences between the amount of assets and liabilities for financial and tax reporting purposes and we record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We also regularly conduct a comprehensive review of our uncertain tax positions. In this regard, an uncertain tax position represents our expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. Until these positions are sustained by the taxing authorities, we do not recognize the tax benefits resulting from such positions and report the tax effects for uncertain tax positions in our consolidated balance sheets.
Recent Accounting Pronouncements
See "Note 2: Summary of Significant Accounting Policies" in Part II, Item 8 of this Form 10-K for a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Not applicable.