PIXELWORKS, INC 10-K

Item 8. Financial Statements and Supplementary Data. The following financial statements and reports are included in Item 8: Report of Independent Registered Public Accounting Firm (PCAOB ID: 32 ) Consolidated Balance Sheets as of December 31, 2022 and 2021 Consolidated Statements of Operations for the years ended December 31, 2022 and 2021 Consolidated Statements of Comprehensive Loss for the years ended December 31, 2022 and 2021 Consolidated Statements of Cash Flows for the years ended December 31, 2022 and 2021 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2022 and 2021 Notes to Consolidated Financial Statements 49 Report of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders Pixelworks, Inc. Portland, Oregon Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Pixelworks, Inc. and its subsidiaries (the Company) as of December 31, 2022 and 2021, and the related consolidated statements of operations, comprehensive loss, shareholders' equity, and cash flows for each of the two years ended December 31, 2022, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion The Company's management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on the Company's consolidated financial statements. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. 50 _____________________________________________________________________________________________ Revenue Recognition — Refer to Note 2 to the Consolidated Financial Statements ____________________________________________________________________________ Critical Audit Matter Description The Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company's contract may contain one or more performance obligations, including hardware, professional engineering services, internally developed intellectual property ("IP") and technical support services. Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following: • Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together. • Determination of stand-alone selling prices for each distinct performance obligation (i.e., for IP license fee and support service fee that are sold together under IP licensing arrangements). • The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation. • Estimation of variable consideration when determining the amount of revenue to recognize, primarily on product sale arrangements (e.g., customer credits pursuant to price protection rights, stock rotation rights and limited return rights). Given these factors, the related audit effort in evaluating management's judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment. ____________________________________________________________________________ How the Critical Audit Matter Was Addressed in the Audit Our principal audit procedures related to the Company's revenue recognition for these customer agreements included the following: • We selected a sample of customer agreements and performed the following procedures: ◦ Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement to identify significant terms. ◦ Tested management's identification of significant terms for completeness, including the identification of distinct performance obligations and variable consideration. ◦ Assessed the terms in the customer agreement and evaluated the appropriateness of management's application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions. • We evaluated the reasonableness of management's estimate of stand-alone selling prices for products and services that are not sold separately. • We evaluated the reasonableness and accuracy of management's judgements and estimates used in accounting for customer credits pursuant to price protection rights, stock rotation rights and limited return rights ("variable consideration"). This included testing management's estimate of calculating expected credits issued to customers and determining whether such credits were completely and accurately reserved as of December 31, 2022. • We tested the mathematical accuracy of management's calculations of revenue and the associated timing of recognizing the related revenue subject to any constraints in the consolidated financial statements. 51 _____________________________________________________________________________________________ Inventory Valuation— Refer to Note 2 to the Financial Statements ____________________________________________________________________________ Critical Audit Matter Description The Company computes inventory cost on a first-in-first out basis and applies judgment in determining the forecast for products and the valuation of inventories. The Company assesses inventory at each reporting date in order to assert that it is recorded at net realizable value, giving consideration to, among other factors: whether the product is valued at the lower of cost or net realizable value; and the estimation of excess and obsolete inventory or that which is not of saleable quality. Most of the Company's inventory provisions are based on the Company's inventory levels and future product purchase commitments compared to assumptions about future demand and market conditions. Significant judgment is exercised by the Company to determine inventory carrying value adjustments, specifically the provisions for excess or obsolete inventories, and includes the following: • Developing assumptions such as forecasts of future sales quantities, which are sensitive to the competitiveness of product offerings, customer requirements, and product life cycles. • Applying management judgment on not reserving certain inventory units (e.g. in case they are items that can be used for Return Merchandise Authorization "RMA"/warranty purpose). Given these factors and assumptions are forward-looking and could be affected by future economic and market conditions, the related audit effort to evaluate management's inventory valuation adjustments was extensive and required a high degree of auditor judgment. ____________________________________________________________________________ How the Critical Audit Matter Was Addressed in the Audit Our principal audit procedures related to the Company's inventory valuation methodology included the following: • We selected a sample of inventory items and performed the following procedures: ◦ Tested the mathematical accuracy of the schedule by comparing the quantities and carrying value of on-hand inventories to related unit sales, both historical and forecasted. ◦ Assessed and tested the reasonableness of the significant assumptions (e.g., sales and marketing forecast, build plans, RMA requirements, usage and open sales-orders). ◦ Inquired with the management team and evaluated the adequacy of management's sales forecasts by analyzing potential technological changes in line with product life cycles and/or identified alternative customer uses. ◦ Assessed whether there were any potential sources of contrary information, including historical forecast accuracy or history of significant revisions to previously recorded inventory valuation adjustments, and performed sensitivity analyses over significant assumptions to evaluate the changes in inventory valuation that would result from changes in the assumptions. /s/ Armanino LLP We have served as the Company’s auditor since 2020. San Ramon, California March 8, 2023 52 PIXELWORKS, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share data) December 31, 2022 2021 ASSETS Current assets: Cash and cash equivalents $ 56,821 $ 61,587 Accounts receivable, net 10,047 8,708 Inventories 1,760 1,469 Prepaid expenses and other current assets 3,745 2,732 Total current assets 72,373 74,496 Property and equipment, net 4,632 5,656 Operating lease right-of-use assets 3,331 4,789 Other assets, net 3,580 3,162 Acquired intangible assets, net — 90 Goodwill 18,407 18,407 Total assets $ 102,323 $ 106,600 LIABILITIES, REDEEMABLE NON-CONTROLLING INTEREST AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,143 $ 2,747 Accrued liabilities and current portion of long-term liabilities 8,849 13,563 Current portion of income taxes payable 519 128 Total current liabilities 12,511 16,438 Long-term liabilities, net of current portion 1,005 519 Deposit liability 13,537 12,716 Operating lease liabilities, net of current portion 2,148 2,853 Income taxes payable, net of current portion 872 2,948 Total liabilities 30,073 35,474 Commitments and contingencies (Note 10) Redeemable non-controlling interest 28,919 30,905 Shareholders' equity: Preferred stock, $ 0.001 par value, 50,000,000 shares authorized, none issued — — Common stock, $ 0.001 par value; 250,000,000 shares authorized, 55,113,186 and 53,367,136 shares issued and outstanding as of December 31, 2022 and 2021, respectively. 481,229 475,644 Accumulated other comprehensive income (loss) 2,178 ( 468 ) Accumulated deficit ( 450,985 ) ( 434,955 ) Total Pixelworks, Inc. shareholders’ equity 32,422 40,221 Non-controlling interest 10,909 — Total shareholders' equity 43,331 40,221 Total liabilities, redeemable non-controlling interest and shareholders' equity $ 102,323 $ 106,600 See accompanying notes to consolidated financial statements. 53 PIXELWORKS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Year Ended December 31, 2022 2021 Revenue, net $ 70,146 $ 55,102 Cost of revenue (1) 34,265 27,409 Gross profit 35,881 27,693 Operating expenses: Research and development (2) 30,521 27,250 Selling, general and administrative (3) 22,177 20,445 Total operating expenses 52,698 47,695 Loss from operations ( 16,817 ) ( 20,002 ) Interest income and other, net 700 457 Loss before income taxes ( 16,117 ) ( 19,545 ) Benefit for income taxes ( 884 ) ( 133 ) Net loss ( 15,233 ) ( 19,412 ) Less: Net income attributable to non-controlling interests and redeemable non-controlling interests ( 797 ) ( 409 ) Net loss attributable to Pixelworks, Inc. $ ( 16,030 ) $ ( 19,821 ) Net loss attributable to Pixelworks, Inc. per share - basic and diluted $ ( 0.30 ) $ ( 0.38 ) Weighted average shares outstanding - basic and diluted 54,335 52,509 (1) Includes: Amortization of acquired intangible assets 72 899 Stock-based compensation 41 43 (2) Includes stock-based compensation 2,351 2,363 (3) Includes: Stock-based compensation 2,806 3,678 Amortization of acquired intangible assets 18 219 See accompanying notes to consolidated financial statements. 54 PIXELWORKS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (In thousands) Year Ended December 31, 2022 2021 Net loss $ ( 15,233 ) $ ( 19,412 ) Other comprehensive loss: Foreign currency translation adjustment 2,612 ( 520 ) Foreign pension adjustment 53 6 Tax effect of foreign pension adjustment ( 19 ) ( 1 ) Comprehensive loss ( 12,587 ) ( 19,927 ) Less: comprehensive income attributable to redeemable non-controlling interest ( 797 ) ( 409 ) Total comprehensive loss attributable to Pixelworks, Inc. $ ( 13,384 ) $ ( 20,336 ) See accompanying notes to consolidated financial statements. 55 PIXELWORKS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Year Ended December 31, 2022 2021 Cash flows from operating activities: Net loss $ ( 15,233 ) $ ( 19,412 ) Adjustments to reconcile net loss to net cash used in operating activities: Stock-based compensation 5,198 6,084 Depreciation and amortization 4,657 3,648 Reversal of uncertain tax positions ( 2,171 ) ( 2 ) Deferred income tax expense (benefit) 428 ( 768 ) Amortization of acquired intangible assets 90 1,118 Other 8 10 Changes in operating assets and liabilities: Accounts receivable, net ( 1,339 ) ( 4,036 ) Inventories ( 291 ) 976 Prepaid expenses and other current and long-term assets, net 1,535 ( 46 ) Accounts payable 486 1,282 Accrued current and long-term liabilities ( 6,688 ) 1,537 Income taxes payable 486 452 Net cash used in operating activities ( 12,834 ) ( 9,157 ) Cash flows from investing activities: Purchases of property and equipment ( 1,592 ) ( 3,475 ) Purchases of licensed technology ( 1,415 ) — Proceeds from sales and maturities of marketable securities — 250 Net cash used in investing activities ( 3,007 ) ( 3,225 ) Cash flows from financing activities: Net proceeds from issuance of equity interest to non-controlling interest 10,738 — Payments on asset financings ( 1,457 ) ( 1,195 ) Net proceeds from issuance of equity interest to certain entities owned by employees 1,407 12,329 Proceeds from issuances of common stock under employee equity incentive plans 387 1,282 Net proceeds from issuance of equity interest to redeemable non-controlling interest — 29,976 Net proceeds from "at the market" equity offering — 320 Net cash provided by financing activities 11,075 42,712 Net increase (decrease) in cash and cash equivalents ( 4,766 ) 30,330 Cash and cash equivalents, beginning of period 61,587 31,257 Cash and cash equivalents, end of period $ 56,821 $ 61,587 Supplemental disclosure of cash flow information: Cash paid during the year for interest $ 196 $ 162 Cash paid for income taxes, net of refunds received 188 376 Non-cash investing and financing activities: Acquisitions of property and equipment and other assets under extended payment terms $ 1,674 $ 1,229 See accompanying notes to consolidated financial statements. 56 PIXELWORKS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except share data) Common Stock Accumulated Other Comprehensive Income (Loss) Accumulated Deficit Non-Controlling Interest Total Shareholders' Equity Shares Amount Balance as of December 31, 2020 51,078,942 467,957 47 ( 415,134 ) — 52,870 Stock issued under employee equity incentive plans 2,227,176 1,282 — — — 1,282 "At the market" equity offering 61,018 321 — — — 321 Stock-based compensation expense — 6,084 — — — 6,084 Foreign currency translation adjustment — — ( 520 ) — — ( 520 ) Net loss attributable to Pixelworks, Inc. — — — ( 19,821 ) — ( 19,821 ) Foreign pension adjustment, net of tax of $ 1 — — 5 — — 5 Balance as of December 31, 2021 53,367,136 475,644 ( 468 ) ( 434,955 ) — 40,221 Stock issued under employee equity incentive plans 1,746,050 387 — — — 387 Stock-based compensation expense — 5,198 — — — 5,198 Foreign currency translation adjustment — — 2,612 — — 2,612 Net proceeds from issuance of equity interest to non-controlling interest — — — — 10,738 10,738 Net income attributable to non-controlling interest — — — — 171 171 Net loss attributable to Pixelworks, Inc. — — — ( 16,030 ) — ( 16,030 ) Foreign pension adjustment, net of tax of $ 19 — — 34 — — 34 Balance as of December 31, 2022 55,113,186 $ 481,229 $ 2,178 $ ( 450,985 ) $ 10,909 $ 43,331 See accompanying notes to consolidated financial statements. 57 PIXELWORKS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In thousands, except share and per share data) NOTE 1. BASIS OF PRESENTATION Nature of Business 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. Our consolidated financial statements include the accounts of Pixelworks and its subsidiaries. Intercompany accounts and transactions have been eliminated. All foreign subsidiaries use the U.S. dollar as the functional currency, and as a result, transaction gains and losses are included in the consolidated statements of operations. Transaction (gains) and losses were $ 394 and $( 258 ) for the years ended December 31, 2022 and 2021, respectively. 58 Use of Estimates The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles ("U.S. GAAP") requires us to make estimates and judgments that affect amounts reported in the financial statements and accompanying notes. Our significant estimates and judgments include those related to revenue recognition, valuation of excess and obsolete inventory, lives and recoverability of equipment and other long-lived assets, valuation of goodwill, stock-based compensation and income taxes. The actual results experienced could differ materially from our estimates. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash and Cash Equivalents We classify all cash and highly liquid investments with original maturities of three months or less at the date of purchase as cash and cash equivalents. Cash equivalents totaled $ 18,836 and $ 15,254 as of December 31, 2022 and 2021, respectively and consisted of U.S. denominated money market funds and certificates of deposit. Marketable Securities Our investments in marketable securities are classified as available-for-sale. Available-for-sale securities are stated at fair value based on quoted market prices with unrealized holding gains or losses, net of tax, included in accumulated other comprehensive income, a component of shareholders’ equity. The cost of securities sold is based on the specific identification method. Accounts Receivable Accounts receivable are recorded at invoiced amount and do not bear interest when recorded or accrue interest when past due. We maintain an allowance for doubtful accounts for estimated losses that may result from the inability of our customers to make required payments. At the end of each reporting period, we estimate the allowance for doubtful accounts based on an account-by-account risk analysis of outstanding receivable balances. The determination to write-off specific accounts receivable balances is made based on the likelihood of collection and past due status. Past due status is based on invoice date and terms specific to each customer. Inventories Inventories consist of finished goods and work-in-process, and are stated at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or net realizable value. Property and Equipment Property and equipment are stated at cost. Depreciation and amortization is calculated on a straight-line basis over the estimated useful life of the assets which are generally as follows: Software Lesser of 3 years or contractual license term Equipment, furniture and fixtures 2 years Tooling 2 to 4 years Leasehold improvements Lesser of lease term or estimated useful life The cost of property and equipment repairs and maintenance is expensed as incurred. Licensed Technology We have capitalized licensed technology assets in other long-term assets. These assets are stated at cost and are amortized on a straight-line basis over the term of the license or the estimated life of the asset, if the license is not contractually limited, which is generally two to five years . 59 Useful Lives and Recoverability of Equipment and Other Long-Lived Assets We evaluate the remaining useful life and 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 it is 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 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 of 2022 and concluded that goodwill was not impaired. Warranty Program We warrant that our products will be free from defects in material and workmanship for a period of twelve months from delivery. Warranty repairs are guaranteed for the remainder of the original warranty period. Our warranty is limited to repairing or replacing products, or refunding the purchase price. At the end of each reporting period, we estimate a reserve for warranty returns based on historical experience and knowledge of any applicable events or transactions. The reserve for warranty returns is included in accrued liabilities in our consolidated balance sheets. Stock-Based Compensation We currently sponsor a stock incentive plan that allows for issuance of employee stock options and restricted stock awards, including restricted stock units. We also have an employee stock purchase plan for all eligible employees. The fair value of share-based payment awards is expensed straight-line over the requisite service period, which is generally the vesting period, for the entire award. Additionally, any modification of an award that increases its fair value will require us to recognize additional expense. The fair value of our stock option grants and purchase rights under our employee stock purchase plan are estimated as of the grant date using the Black-Scholes option pricing model which is affected by our estimates of the risk free interest rate, our expected dividend yield, expected term and the expected share price volatility of our common shares over the expected term. The fair value of our restricted stock awards are based on the market value of our stock on the date of grant. Research and Development Costs associated with research and development activities are expensed as incurred, except for items with alternate future uses which are capitalized and depreciated over their estimated useful lives. On occasion, we enter into co-development arrangements with current or prospective customers to defray a portion of the research and development expenses we expect to incur in connection with our development of an IC product. As amounts become due and payable, they are offset against research and development expense on a pro-rata basis. 60 Income Taxes We account for income taxes under the asset and liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between financial statement carrying amounts and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We establish a valuation allowance to reduce deferred tax assets if it is "more likely than not" that a portion or all of the asset will not be realized in future tax returns. An uncertain tax position represents 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. Risks and Uncertainties Concentration of Suppliers We do not own or operate a semiconductor fabrication facility and do not have the resources to manufacture our products internally. We rely on a limited number of foundries and assembly and test vendors to produce all of our wafers and for completion of finished products. We do not have any long-term agreements with any of these suppliers. In light of these dependencies, it is reasonably possible that failure to perform by one of these suppliers could have a severe impact on our results of operations. Additionally, the concentration of these vendors within Taiwan and the People’s Republic of China increases our risk of supply disruption due to natural disasters, economic instability, political unrest or other regional disturbances. Risk of Technological Change The markets in which we compete, or seek to compete, are subject to rapid technological change, frequent new product introductions, changing customer requirements for new products and features, and evolving industry standards. The introduction of new technologies and the emergence of new industry standards could render our products less desirable or obsolete, which could harm our business. Concentrations of Credit Risk Financial instruments that potentially subject us to concentrations of credit risk consist of cash equivalents and accounts receivable. We limit our exposure to credit risk associated with cash equivalent balances by holding our funds in high quality, highly liquid money market accounts. We limit our exposure to credit risk associated with accounts receivable by carefully evaluating creditworthiness before offering terms to customers. Recent Accounting Pronouncements In December 2019, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2019-12, Simplifying the Accounting for Income Taxes ("ASU 2019-12"). ASU 2019-12 removes certain exceptions to the general principles in Accounting Standards Codification ("ASC") 740 and also clarifies and amends existing guidance to provide for more consistent application. ASU 2019-12 became effective for us in the first quarter of fiscal year 2021, and early adoption is permitted. The adoption of ASU 2019-12 did not have a material impact on our financial position, results of operations and cash flows. 61 NOTE 3. BALANCE SHEET COMPONENTS Accounts Receivable, Net Accounts receivable consists of the following: December 31, 2022 2021 Accounts receivable, gross $ 10,124 $ 8,744 Allowance for doubtful accounts ( 77 ) ( 36 ) Accounts receivable, net $ 10,047 $ 8,708 The following is a summary of the change in our allowance for doubtful accounts: Year Ended December 31, 2022 2021 Balance at beginning of year $ 36 $ 41 Additions charged (reductions credited) 41 ( 5 ) Balance at end of year $ 77 $ 36 Inventories Inventories consist of the following: December 31, 2022 2021 Finished goods $ 480 $ 461 Work-in-process 1,280 1,008 Inventories $ 1,760 $ 1,469 We recorded inventory write-downs of $ 99 and $ 488 for the years ended December 31, 2022 and 2021, respectively. The inventory write-downs were for lower of cost or net realizable value and excess and obsolescence exposure. The inventory write-downs were offset by sales of previously written-down inventory of $ 17 and $ 9 for the years ended December 31, 2022 and 2021, respectively. Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consist of current prepaid expenses, deposits, income taxes receivable and other receivables. 62 Property and Equipment, Net Property and equipment consists of the following: December 31, 2022 2021 Equipment, furniture and fixtures $ 9,637 $ 9,463 Tooling 2,903 5,749 Software 6,739 5,230 Leasehold improvements 1,513 1,375 20,792 21,817 Accumulated depreciation and amortization ( 16,160 ) ( 16,161 ) Property and equipment, net $ 4,632 $ 5,656 Software amortization was $ 1,505 and $ 1,214 for the years ended December 31, 2022 and 2021, respectively. Depreciation and amortization expense for equipment, furniture, fixtures, tooling and leasehold improvements was $ 2,620 and $ 2,281 for the years ended December 31, 2022 and 2021, respectively. Other Assets, Net Other assets consist primarily of deposits, deferred tax assets and licensed technology. Amortization of licensed technology was $ 532 and $ 153 for the years ended December 31, 2022 and 2021, respectively. Acquired Intangible Assets, Net In connection with the Acquisition, we recorded certain identifiable intangible assets. Acquired intangible assets resulting from this transaction consist of the following: December 31, 2022 2021 Developed technology $ 5,050 $ 5,050 Customer relationships 1,270 1,270 Backlog and tradename 410 410 6,730 6,730 Less: accumulated amortization ( 6,730 ) ( 6,640 ) Acquired intangible assets, net $ — $ 90 Developed technology and customer relationships were fully amortized as of March 31, 2022, tradename was fully amortized as of March 31, 2019 and backlog was fully amortized as of September 30, 2018. Amortization expense for intangible assets was $ 90 for the year ended December 31, 2022, $ 72 was included in cost of revenue and $ 18 was included in selling, general and administrative for the year ended December 31, 2022, in the condensed consolidated statements of operations. 63 Goodwill Goodwill resulted from the Acquisition, whereby we recorded goodwill of $ 18,407 . See Note 2: "Summary of Significant Accounting Policies" for information on our assessment of goodwill impairment. Accrued Liabilities and Current Portion of Long-Term Liabilities Accrued liabilities and current portion of long-term liabilities consist of the following: December 31, 2022 2021 Accrued payroll and related liabilities $ 3,632 $ 3,490 Operating lease liability, current 1,391 2,439 Current portion of accrued liabilities for asset financings 876 1,077 Accrued interest payable 246 361 Deferred revenue 230 50 Accrued commissions and royalties 210 259 Liability for warranty returns 15 — Deferred research and development reimbursement — 1,838 Other 2,249 4,049 Accrued liabilities and current portion of long-term liabilities $ 8,849 $ 13,563 The following is a summary of the change in deferred revenue: Year Ended December 31, 2022 2021 Deferred revenue: Balance at beginning of period $ 50 $ 179 Revenue recognized ( 1,474 ) ( 1,127 ) Revenue deferred 1,654 998 Balance at end of period $ 230 $ 50 64 NOTE 4. FAIR VALUE MEASUREMENTS Fair Value Measurements Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Three levels of inputs may be used to measure fair value: Level 1: Valuations based on quoted prices in active markets for identical assets and liabilities. Level 2: Valuations based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3: Valuations based on unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions. The following table presents information about our assets and liabilities measured at fair value on a recurring basis in the consolidated balance sheets as of December 31, 2022 and 2021: Level 1 Level 2 Level 3 Total As of December 31, 2022: Assets: Cash equivalents: Money market funds $ 18,836 $ — $ — $ 18,836 Certificates of deposit 5,000 — — 5,000 As of December 31, 2021: Assets: Cash equivalents: Money market funds $ 15,254 $ — $ — $ 15,254 We primarily use the market approach to determine the fair value of our financial instruments. The fair value of our current assets and liabilities, including accounts receivable and accounts payable approximates the carrying value due to the short-term nature of these balances. We have currently chosen not to elect the fair value option for any items that are not already required to be measured at fair value in accordance with U.S. GAAP. NOTE 5. LEASES We determine if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets, other current liabilities, and operating lease liabilities in our consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Operating lease ROU assets also exclude lease incentives received. For purposes of calculating operating lease liabilities, lease terms may be deemed to include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. We have operating leases for office buildings and one vehicle. Our leases have remaining lease terms of 1 year to 5 years. Supplemental information related to lease expense and valuation of the ROU assets and lease liabilities was as follows: 65 Year Ended December 31, 2022 2021 Operating lease cost $ 2,657 $ 2,622 Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows from operating leases 2,676 2,809 Leased assets obtained in exchange for new operating lease liabilities 994 629 Weighted average remaining lease term (in years) 3.12 2.95 Weighted average discount rate 5.55 % 4.96 % Future minimum lease payments under non-cancellable leases as of December 31, 2022 were as follows: Operating Lease Payments Years ending December 31: 2023 $ 1,553 2024 1,223 2025 638 2026 342 2027 86 Total operating lease payments 3,842 Less imputed interest ( 303 ) Total operating lease liabilities $ 3,539 As of December 31, 2022, the Company had no operating lease liabilities that had not commenced. NOTE 6. REVENUE 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 end 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. 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. 66 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. The following table provides information about disaggregated revenue based on the preceding categories, with IC sales disaggregated further into net revenue from external customers for each group of similar products, for the years ended December 31, 2022 and 2021: Year ended December 31, 2022 2021 IC sales $ 68,168 $ 50,807 Engineering services, license and other 1,978 4,295 Total revenues $ 70,146 $ 55,102 IC sales by end market: Year ended December 31, 2022 2021 Mobile market $ 21,160 $ 16,113 Home & Enterprise market 47,008 34,694 Total IC sales $ 68,168 $ 50,807 For segment information, including revenue by geographic region, see "Note 13. Segment Information". Our contract balances include accounts receivable, deferred revenue and our liability for warranty returns. For information concerning these contract balances, see "Note 3. Balance Sheet Components". Payment terms and conditions for goods and services provided vary by contract; however, payment is generally required within 30 to 60 days of invoicing. We have not identified any material costs incurred associated with obtaining a contract with a customer which would meet the criteria to be capitalized, therefore, these costs are expensed as incurred. There is no amount of transaction price allocated to unsatisfied performance obligations with an original expected duration of greater than one year. 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. 67 NOTE 7. INTEREST INCOME AND OTHER, NET Interest income and other, consists of the following: 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. NOTE 8. RESEARCH AND DEVELOPMENT 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, $ 5,800 was payable by the customer within 60 days of the date of the agreement and three additional payments of $ 2,500 , $ 1,900 and $ 1,300 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 $ 4,338 and $ 3,962 during the years ended December 31, 2022 and 2021, respectively. NOTE 9. INCOME TAXES Current and Deferred Income Tax Expense Domestic and foreign pre-tax loss is as follows: Year Ended December 31, 2022 2021 Domestic $ ( 20,196 ) $ ( 10,967 ) Foreign 4,079 ( 8,578 ) Domestic and foreign pre-tax loss $ ( 16,117 ) $ ( 19,545 ) Income tax expense (benefit) attributable to operations is comprised of the following: Year Ended December 31, 2022 2021 Current: Federal $ 396 $ ( 27 ) State 14 19 Foreign ( 1,722 ) 643 Total current ( 1,312 ) 635 Deferred: Federal ( 364 ) — Foreign 792 ( 768 ) Total deferred 428 ( 768 ) Income tax benefit $ ( 884 ) $ ( 133 ) 68 The reconciliation of the U.S. federal statutory income tax rate to our effective income tax rate is as follows: Year Ended December 31, 2022 2021 Federal statutory rate 21 % 21 % Impact of foreign earnings ( 27 ) 3 Change in valuation allowance 28 24 Tax contingencies, net of reversals 13 ( 5 ) Corporate restructuring ( 11 ) ( 38 ) Expiration of tax attributes ( 12 ) ( 6 ) Permanent items ( 2 ) 4 Research and development credits 4 2 Stock-based compensation ( 4 ) ( 1 ) Other ( 5 ) ( 3 ) Effective income tax rate 5 % 1 % Deferred Tax Assets, Liabilities and Valuation Allowance Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Significant components of our deferred tax assets and liabilities are as follows: December 31, 2022 2021 Deferred tax assets: Research and experimentation credit and deduction carryforwards $ 60,041 $ 62,771 Net operating loss carryforwards 44,424 45,985 Depreciation and amortization 5,568 5,664 Reserves and accrued expenses 1,000 992 Deferred stock-based compensation 821 994 Foreign tax credit carryforwards 163 208 Other 1,201 1,451 Total gross deferred tax assets 113,218 118,065 Deferred tax liabilities: Foreign earnings ( 212 ) — Other ( 620 ) ( 812 ) Total gross deferred tax liabilities ( 832 ) ( 812 ) Less valuation allowance ( 111,941 ) ( 116,372 ) Net deferred tax assets $ 445 $ 881 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 released a portion of the valuation allowance against our Canadian deferred tax assets in conjunction with forecasted income within our Canada subsidiary. During the year ended December 31, 2022, our Canadian subsidiary generated taxable profits which were able to be offset by our Canadian deferred tax assets. As of December 31, 2022, a valuation allowance against our remaining net Canadian deferred tax assets was established as future utilization is uncertain based upon updated projections of income within our Canada Subsidiary. 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 $ 4,431 for the year ended December 31, 2022 and decreased $ 4,609 for the year ended December 31, 2021. As of December 31, 2022, we had federal, state and foreign net operating loss carryforwards of $ 154,992 , $ 9,600 and $ 42,668 respectively, which will begin to expire in 2024 with $ 31,705 of our federal net operating loss carryforward lasting indefinitely. As of December 31, 2022, we had available federal, state and foreign research and experimentation tax credit carryforwards of 69 $ 6,747 , $ 5,173 , and $ 21,850 respectively. The federal and state tax credits will begin expiring in 2023 while the foreign 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 $ 120,277 . We have a general foreign tax credit of $ 84 which will begin to expire 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. We are not indefinitely reinvested in the earnings of our subsidiaries in Canada, Japan and Taiwan and have accrued tax on the future repatriation of cash for jurisdictions where withholding taxes would apply . The Tax Cuts and Jobs Act ("TCJA") was enacted on December 22, 2017. Included in the TCJA is the requirement to capitalize and amortize research and experimental expenditures starting with the first tax year after December 31, 2021. The required capitalization and amortization of these costs resulted in an increase to our taxable income before utilization of our operating loss carryforward. The capitalization did not have a significant impact to our income tax benefit in the current year. Uncertain Tax Positions We have recorded tax liabilities to address potential exposures involving positions that could be challenged by taxing authorities. As of December 31, 2022, the amount of our uncertain tax positions was a liability of $ 378 and a reduction to deferred tax assets of $ 1,353 . As of December 31, 2021, the amount of our uncertain tax positions was a liability of $ 2,493 and a reduction to deferred tax assets of $ 1,254 . The following is a summary of the change in our liability for uncertain tax positions and interest and penalties: 2022 2021 Uncertain tax positions: Balance at beginning of year $ 3,646 $ 2,711 Accrual for positions taken in a prior year ( 214 ) 825 Accrual for positions taken in current year 117 121 Reversals due to lapse of statute of limitations ( 97 ) ( 11 ) Reversals due to positions taken in the current year ( 1,809 ) — Balance at end of year $ 1,643 $ 3,646 Interest and penalties: Balance at beginning of year $ 101 $ 88 Accrual for positions taken in prior year 11 16 Accrual for positions taken in current year — — Reversals due to lapse of statute of limitations ( 24 ) ( 3 ) Balance at end of year $ 88 $ 101 During the years ended December 31, 2022 and 2021 we recognized $ 11 and $ 16 , respectively, of interest and penalties in income tax expense in our consolidated statements of operations. During the year ended December 31, 2022, our China subsidiary settled a portion of the outstanding intercompany debt with the US parent, Pixelworks, Inc. The portion that was not able to be settled was forgiven and was recognized as taxable income in China. We previously accrued for a long term liability in the event that the full amount of the intercompany debt would be recognized as taxable income in China. The related uncertain tax position was reversed as a part of the settlement of the intercompany debt. We file income tax returns in the U.S. and various foreign jurisdictions. A number of years may elapse before an uncertain tax position is resolved by settlement or statute of limitations. Settlement of any particular position could require the use of cash. If the uncertain tax positions we have accrued for are sustained by the taxing authorities in our favor, the reduction of the liability will reduce our effective tax rate. We reasonably expect reductions in the liability for unrecognized tax benefits and interest and penalties of approximately $ 1 within the next twelve months due to the expiration of statutes of limitation in federal, state and foreign jurisdictions. 70 We are no longer subject to U.S. federal, state, and foreign examinations for years before 2019, 2018 and 2015, respectively. Our net operating loss and tax credit carryforwards from all years may be subject to adjustment for three years following the year in which utilized. We do not anticipate that any potential tax adjustments will have a significant impact on our financial position or results of operations. We were not subject to, nor have we received any notice of, income tax examinations in any jurisdiction as of December 31, 2022. NOTE 10. COMMITMENTS AND CONTINGENCIES Royalties We license technology from third parties and have agreed to pay certain suppliers a royalty based on the number of chips sold or manufactured, the net sales price of the chips containing the licensed technology or a fixed non-cancelable fee. Royalty expense is recognized based on our estimated average unit cost for royalty contracts with non-cancelable prepayments and the stated contractual per unit rate for all other agreements. Royalty expense was $ 272 and $ 225 for the years ended December 31, 2022 and 2021, respectively, which is included in cost of revenue in our consolidated statements of operations. 401(k) Plan We sponsor a 401(k) plan for eligible employees. Participants may defer a percentage of their annual compensation on a pre-tax basis, not to exceed the dollar limit that is set by law. A discretionary matching contribution by the Company is allowed and is equal to a uniform percentage of the amount of salary reduction elected to be deferred, which percentage will be determined each year by the Company. We made contributions of $ 54 and $ 55 to the 401(k) plan during the years ended December 31, 2022 and 2021, respectively. Software licenses We acquire rights to use certain software engineer design tools under software licenses. As of December 31, 2022, future minimum payments under non-cancelable software licenses are as follows: Year Ending December 31, Software licenses 2023 $ 898 2024 520 2025 400 2026 40 1,858 Less: Interest component ( 95 ) Present value of minimum software license payments 1,763 Less: Current portion ( 876 ) Long-term portion of obligations $ 887 Other Contractual Obligation As part of the acquisition of ViXS Systems, Inc. ("ViXS") in 2017, we acquired debt associated with an agreement with the Government of Canada called Technology Partnerships Canada ("TPC"). As part of the TPC agreement, ViXS was provided funding to assist in research and development expenses of which a portion was later required to be repaid because the conditions for repayment were met. The scheduled payments are made on a quarterly basis and end in January 2024. $ 308 and $ 504 are included in accrued liabilities and current portion of long-term liabilities in our consolidated balance sheet as of December 31, 2022 and 2021, respectively. $ 0 and $ 57 are included in long-term liabilities, net of current portion in our consolidated balance sheets as of December 31, 2022 and 2021, respectively. Contract Manufacturers In the normal course of business, we commit to purchase products from our contract manufacturers to be delivered within the next 90 days. In certain situations, should we cancel an order, we could be required to pay cancellation fees. Such obligations could impact our immediate results of operations but would not materially affect our business. 71 Indemnifications Certain of our agreements include limited indemnification provisions for claims from third-parties relating to our products and technology. It is not possible for us to predict the maximum potential amount of future payments or indemnification costs under these or similar agreements due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. We have not made any payments under these agreements in the past, and as of December 31, 2022, we have not incurred any material liabilities arising from these indemnification obligations. In the future, however, such obligations could immediately impact our results of operations but are not expected to materially affect our business. Legal Proceedings We are subject to legal matters that arise from time to time in the ordinary course of our business. Although we currently believe that resolving such matters, individually or in the aggregate, will not have a material adverse effect on our financial position, our results of operations, or our cash flows, these matters are subject to inherent uncertainties and our view of these matters may change in the future. NOTE 11. EARNINGS PER SHARE Basic earnings per share amounts are computed based on the weighted average number of common shares outstanding. Diluted weighted average shares outstanding include the weighted average number of common shares outstanding plus potentially dilutive common shares outstanding during the period. The following schedule reconciles the computation of basic and diluted net loss per share (in thousands, except per share data): Year Ended December 31, 2022 2021 Net loss $ ( 15,233 ) $ ( 19,412 ) Less: Net income attributable to non-controlling interests and redeemable non-controlling interests ( 797 ) ( 409 ) Less: Net income attributable to certain entities owned by employees ( 89 ) ( 198 ) Net loss attributable to Pixelworks Inc. - for purposes of earnings per share calculation $ ( 16,119 ) $ ( 20,019 ) Weighted average shares outstanding - basic and diluted 54,335 52,509 Net loss attributable to Pixelworks, Inc. per share - basic and diluted $ ( 0.30 ) $ ( 0.38 ) Basic and diluted earnings (loss) per share was computed by dividing the net income (loss) by the weighted-average number of common shares outstanding for the period. The numerator adjustments include an allocation of PWSH income to the non-controlling interests, the redeemable non-controlling interests and the employee owned entities. The equity interest associated with the employee-owned entities are considered participating securities at PWSH and will be allocated income, however, they are not required to fund losses, and therefore, no allocations of losses will be made to the employee owned entities in periods of loss at PWSH. Potentially dilutive common shares from employee equity incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options, the assumed vesting of outstanding restricted stock units, and the assumed issuance of common stock under the employee stock purchase plan. The following shares were excluded from the calculation of diluted net loss per share as their effect would have been anti-dilutive (in thousands): Year Ended December 31, 2022 2021 Employee equity incentive plans 4,071 3,832 Potentially dilutive common shares from employee equity incentive plans are determined by applying the treasury stock method to the assumed exercise of outstanding stock options, the assumed vesting of outstanding restricted stock units, and the assumed issuance of common stock under the employee stock purchase plan. 72 NOTE 12. SHAREHOLDERS’ EQUITY Preferred Stock The Company is authorized to issue 50,000,000 shares of preferred stock with a par value of $ 0.001 per share. The Board of Directors is authorized to fix or alter the rights, preferences, privileges and restrictions granted to, or imposed on, each series of preferred stock. There were no shares of preferred stock issued as of December 31, 2022 and 2021. Common Stock The Company is authorized to issue 250,000,000 shares of common stock with a par value of $ 0.001 per share. Shareholders of common stock have unlimited voting rights and are entitled to receive the net assets of the Company upon dissolution, subject to the rights of the preferred shareholders, if any. 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, 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 $ 321 . There was no activity under this at the market offering during the year ended December 31, 2022. Employee Equity Incentive Plans On May 23, 2006, our shareholders approved the adoption of the Pixelworks, Inc. 2006 Stock Incentive Plan (the "2006 Plan"). The 2006 Plan has since been amended and restated on certain occasions, most recently on May 12, 2022 when our shareholders approved an increase to the total number of authorized shares to 24,533,333 shares. As of December 31, 2022, 1,996,019 shares were available for grant under the 2006 Plan. Stock Options The contractual life of newly issued stock option awards is six years . Our new hire vesting schedule provides that each option becomes exercisable at a rate of 25 % on the first anniversary date of the grant and 2.083 % on the last day of every month thereafter for a total of 36 additional increments. Our merit vesting schedule provides that merit-type awards become exercisable monthly over a period of three years . The following is a summary of stock option activity: Number of shares Weighted average exercise price Options outstanding as of December 31, 2021: 354,609 $ 2.52 Granted 108,891 1.97 Exercised — — Canceled and forfeited — — Expired ( 63,500 ) 2.75 Options outstanding as of December 31, 2022: 400,000 $ 2.33 73 The following table summarizes information about options outstanding as of December 31, 2022: Options Outstanding Options Exercisable Range of exercise prices Number outstanding as of December 31, 2022 Weighted average remaining contractual life Weighted average exercise price Number exercisable as of December 31, 2022 Weighted average exercise price $ 1.86 - $ 1.86 52,745 5.69 $ 1.86 — $ — 2.00 - 2.00 234,000 3.85 2.00 234,000 2.00 2.07 - 6.05 113,255 3.52 3.25 55,016 4.42 $ 1.86 - $ 6.05 400,000 4.00 $ 2.33 289,016 $ 2.46 During the years ended December 31, 2022 and 2021, the total intrinsic value of options exercised was $ 0 and $ 445 , respectively, for which no income tax benefit has been recorded because a full valuation allowance has been provided for our U.S. deferred tax assets. As of December 31, 2022, options outstanding had a total intrinsic value of $ 0 . Options outstanding that have vested and are expected to vest as of December 31, 2022 are as follows: Number of shares Weighted average exercise price Weighted average remaining contractual term Aggregate intrinsic value Vested 289,016 $ 2.46 3.44 $ — Expected to vest 99,081 2.01 5.44 — Total 388,097 $ 2.35 3.95 $ — Restricted Stock The 2006 Plan provides for the issuance of restricted stock, including restricted stock units. During the years ended December 31, 2022 and 2021 we granted 2,289,418 and 2,123,844 shares, respectively, of restricted stock with a weighted average grant date fair value of $ 2.58 and $ 3.70 per share, respectively. The following is a summary of restricted stock activity: Number of shares Weighted average grant date fair value Unvested at December 31, 2021: 3,316,035 $ 3.69 Granted 2,289,418 2.58 Vested ( 1,574,430 ) 3.51 Canceled ( 655,269 ) 3.59 Unvested at December 31, 2022: 3,375,754 $ 2.99 Expected to vest after December 31, 2022 3,122,812 $ 3.01 74 Employee Stock Purchase Plans On May 18, 2010, our shareholders approved the adoption of the 2010 Pixelworks, Inc. Employee Stock Purchase Plan (the "ESPP") for U.S. employees and for certain foreign subsidiary employees. The ESPP provides for separate offering periods commencing on February 1 and August 1, with the first offering period beginning August 1, 2010. Each offering period continues for a period of 18 months with purchases every six months . Each eligible employee may purchase up to 3,000 shares of stock on each purchase date, with a maximum annual purchase amount of $ 25 . The purchase price is equal to 85 % of the lesser of the fair market value of the shares on the offering date or on the purchase date. On May 15, 2020 the ESPP was amended when our shareholders approved an increase to the total number of shares of common stock reserved for issuance to 3,300,000 . During the years ended December 31, 2022 and 2021, we issued 171,620 and 159,177 shares, respectively for proceeds of $ 388 and $ 411 , respectively, under the ESPP. Stock-Based Compensation Expense The fair value of stock-based compensation was determined using the Black-Scholes option pricing model and the following weighted average assumptions: Year Ended December 31, 2022 2021 Stock Option Plans: Risk free interest rate 3.08 % 0 % Expected dividend yield 0 % 0 % Expected term (in years) 5.00 0.00 Volatility 71 % 0 % Employee Stock Purchase Plan: Risk free interest rate 2.30 % 0.12 % Expected dividend yield 0 % 0 % Expected term (in years) 1.33 1.17 Volatility 104 % 75 % The weighted average fair value of options granted during the years ended December 31, 2022 and 2021 was $ 1.19 and $ 0.00 , respectively. The risk free interest rate is estimated using an average of treasury bill interest rates. The expected dividend yield is zero as we have not paid any dividends to date and do not expect to pay dividends in the future. Expected volatility is estimated based on the historical volatility of our common stock over the expected term as this represents our best estimate of future volatility. The contractual life of newly issued stock options is six years , and we have elected to use the "simplified method" to estimate expected term. Under the simplified method, an option's expected term is calculated as the average of its vesting period and original contractual life. The expected term of ESPP purchase rights is based on the estimated weighted average time to purchase. As of December 31, 2022, unrecognized stock-based compensation expense is $ 4,696 , which is expected to be recognized as stock-based compensation expense over a weighted average period of 1.05 years. 75 NOTE 13. SEGMENT INFORMATION We operate in one segment: the design, development, marketing and sale of IC solutions for use in electronic display devices. We generate our revenue from two broad product markets: the Mobile market and the Home & Enterprise market. The chief operating decision maker, or CODM, is our CEO. Our CODM evaluates financial performance and allocates resources using financial information reported on a company-wide basis. The Cinema market does not contribute material revenue and is therefore being included in this one segment. Geographic Information Revenue by geographic region, was as follows: Year Ended December 31, 2022 2021 Japan $ 37,675 $ 27,001 China 25,570 23,977 U.S. 3,442 1,624 Taiwan 3,032 2,142 Korea 277 116 Europe 150 242 $ 70,146 $ 55,102 Significant Customers The percentage of revenue attributable to our distributors, top five end customers, and individual distributors or end customers that represented more than 10% of revenue in at least one of the periods presented, is as follows: Year Ended December 31, 2022 2021 Distributors: All distributors 57 % 56 % Distributor A 29 % 27 % Distributor B 17 % 13 % End Customers: 1 Top five end customers 76 % 76 % End customer A 37 % 35 % End customer B 14 % 22 % End customer C 13 % 8 % 1 End customers include customers who purchase directly from us, as well as customers who purchase our products indirectly through distributors. Each of the following accounts represented 10% or more of total accounts receivable in at least one of the periods presented: December 31, 2022 2021 Account W 31 % 41 % Account X 27 % 27 % Account Y 12 % 1 % Account Z 11 % 15 % 76 NOTE 14. REDEEMABLE NON-CONTROLLING INTEREST AND EQUITY INTEREST OF PWSH SOLD TO EMPLOYEES During the third quarter of 2021, Pixelworks and our subsidiary, PWSH, entered into a capital increase agreement (the "Capital Increase Agreement") with certain private equity and strategic investors based in China (collectively, the “Investors”) and certain entities which collectively are owned by approximately 75 % of the employees of PWSH and its subsidiaries (collectively, the “ESOP”) (together, the “Investors” and the “ESOP” are referred to below as the “Capital Contributors”). The ESOP entities do not qualify as Employee Share Ownership Programs under IRC 4975(e)(7), but do qualify as employee share ownership plans qualified under the laws of China, under which the employees hold a pro rata share of an ESOP partnership entity that then holds an equity ownership in trust for employees. Under the Capital Increase Agreement, during 2021, the Investors invested approximately $ 30,844 in exchange for a redeemable non-controlling equity interest of 10.45 % of PWSH and the ESOP entities invested approximately $ 12,329 in exchange for a redeemable non-controlling equity interest representing 5.95 % of PWSH, which includes a discount of 30 % from the valuation paid by the Investors. The agreement further provided that the Capital Contributors have a liquidation preference in PWSH, a right to co-sell their interest in PWSH along with Pixelworks on the same terms and conditions as Pixelworks, a right to participate on a pro rata basis in any future financing rounds of PWSH, and Pixelworks’ agreement while it remains an owner of PWSH and for two (2) years thereafter to not compete with the business of PWSH, nor solicit or otherwise cause any of PWSH’s core employees or customers to end their relationship with PWSH. These rights all expire upon initial public offering on the STAR Market. Prior to entering into a certain supplemental agreement, each Investor had the right to require PWSH to redeem the entire equity interest held by such Investor, at the original purchase price paid plus 3 % annual interest, if PWSH did not consummate an initial public offering on the STAR Market on or before June 30, 2024. Based on this contingency, the initial carrying amount of the redeemable non-controlling interests was recorded at fair value on the date of issuance of PWSH equity interests, net of issuance costs and presented in temporary equity on the condensed consolidated balance sheets. Until the interest that was to accrue on the redeemable non-controlling interest was deleted with the Supplemental Agreement, the Company had elected to accrete changes in the redemption value of the redeemable non-controlling interests from the issuance date through the earliest redemption date of June 30, 2024 using the interest method (as the non-controlling interest was probable of becoming redeemable upon the passage of time for the original issuance price plus 3 % annual interest). On March 24, 2022, Pixelworks and our subsidiary, PWSH, entered into a supplemental agreement to the Capital Increase Agreement (the “Supplemental Agreement”) with the Capital Contributors. The Supplemental Agreement, among other things, deletes the interest that was to accrue on the redemption obligation of affiliated entities of PWSH, and adds a provision that will suspend the redemption obligation on the date PWSH files its initial public offering listing documents pending the approval of such documents by the applicable authorities. The suspension ends if PWSH withdraws the listing application or such application is finally rejected, at which point the redemption obligation will once again become effective with a deadline of the later of the date of the withdrawal/rejection and June 30, 2024. In connection with the Supplemental Agreement, on March 24, 2022, Pixelworks and the Capital Contributors entered into a side letter to the Capital Increase Agreement (the “Side Letter”) which provides that, in the event of a change in control of Pixelworks, Pixelworks shall ensure that the definitive agreement related to such transaction includes a post-closing repurchase covenant that requires the successor entity in such transaction to repurchase all of PWSH’s equity held by a Capital Contributor at the original subscription price plus 20 % upon the request of the Capital Contributor within 60 days after (a) the change in control; or (b) if PWSH fails to consummate its initial public offering by June 30, 2024, because Pixelworks decides against pursuing the offering. If PWSH continues to diligently pursue the application but the initial public offering still fails to launch by June 30, 2024, the redemption obligation of the Supplemental Agreement would instead apply. The Side Letter terminates on the launch date of PWSH’s initial public offering. After entering into the Supplemental Agreement, the redeemable non-controlling interest will no longer accrete up to a redemption amount because the interest component has been removed. The Investors will continue to hold PWSH equity and be considered as a redeemable non-controlling interest, however, the redeemable non-controlling interest is only probable of becoming redeemable upon the passage of time for its original issuance price. Therefore, until the redemption feature expires, we will only allocate profits to the redeemable non-controlling interest and continue to recognize the non-controlling interest at an amount at least equal to its redemption value. Because the redeemable non-controlling interest is denominated in RMB, it will be revalued to USD at the end of each reporting period, with the changes in carrying value attributable to foreign currency being reflected within accumulated other comprehensive income on the condensed consolidated balance sheets. Each of the ESOP entities has the right to require PWSH to redeem the entire equity interest held by such ESOP entities at the original purchase price paid plus 5 % annual interest, if PWSH does not achieve its Listing on or before December 31, 2024. 77 Because the ESOP entities are owned by employees of PWSH and its subsidiaries and employees are required to render service until either the initial public offering on the STAR Market or repurchase date, the equity interest owned by the ESOP entities will be accounted for under ASC 718 (Compensation - Stock Compensation). The initial carrying amount of the investment has been recorded as a long-term deposit liability on the condensed consolidated balance sheets as the initial public offering cannot be considered probable at this time. We will recognize the periodic interest component of the award as compensation expense and accrete the long-term deposit liability to its redemption value as of December 31, 2024. Because the long-term deposit liability is denominated in RMB and is considered a monetary liability as defined in ASC 255 (Changing Prices), it will be revalued to USD at the end of each reporting period, with the changes in carrying value recorded as foreign currency gain/loss in our condensed consolidated statements of operations. The Supplemental Agreement does not remove the obligation of PWSH to repurchase the ESOP interests if PWSH fails to consummate an initial public offering by December 31, 2024 along with the 5 % annual simple interest. On December 21, 2022, the Company and its subsidiary, PWSH, entered into a capital increase agreement (the “CIA”) with Jing Xin Ying (Shanghai) Management Consulting Partnership (Limited Partnership), an entity owned by certain of the employees of PWSH (the “ESOP”). The ESOP invested approximately $ 1,407 in exchange for an equity interest in PWSH of 0.54 %, based on a pre-money valuation of PWSH of RMB 1,750,000 ($ 251,256 USD), which includes a discount of 50 %. The CIA provides that if there is a change in control of PWSH that closes prior to its filing an application for the Listing, each capital contributor would be entitled to a minimum return of 10% on the price they paid for their respective equity interest, payable by Company in cash at the close of the change in control transaction, with such right terminating automatically upon the filing by PWSH of the Listing. The ESOP has a redemption right that is identical to that held by the other ESOP investors from the financing round that closed in 2021: if the Listing is not consummated prior December 31, 2024, the 2022 ESOP may elect to require a repurchase of its respective equity interest for a price equal to the initial purchase price paid plus annual simple interest at a rate of 5 %. The process of going public on the STAR Market includes several periods of review and is therefore a lengthy process. There can be no assurances that PWSH will complete the Listing by June 30, 2024, or at all. In the event Pixelworks is required to redeem the entire equity interest held by the Investors or the ESOP entities, we may be required to seek additional capital in order to redeem their PWSH shares and there would be no assurances that such capital would be available on terms acceptable to us, if at all. Any redemptions could have a material adverse effect on our business, financial condition and results of operations. The listing of PWSH on China's STAR Market will not change our status as a U.S. public company. The components of the change in redeemable non-controlling interests for the year ended December 31, 2022 are presented in the following table (in thousands): Carrying Value of Redeemable NCI as of January 1, 2022 $ 30,905 Net income attributable to redeemable non-controlling interest 626 Effect of foreign currency translation attributable to redeemable non-controlling interest ( 2,612 ) Carrying Value of Redeemable NCI as of December 31, 2022 $ 28,919 NOTE 15: NON-CONTROLLING INTEREST On August 15, 2022, the Company entered into an Equity Transfer Agreement with certain private equity investors based in China (Hainan Qixin Investment Partnership (Limited Partnership) and Suzhou Saixiang Equity Investment Partnership (Limited Partnership)) (collectively, the “Purchasers”). Under this agreement, the Purchasers agreed to pay to the Company, subject to customary closing conditions, a total of 87,500 RMB, approximately $ 10,738 (net of issuance costs) at closing, in exchange for a 2.74 % equity interest in PWSH. The Company incurred costs related to the sale of equity in PWSH of $ 275 paid to a third party for assisting in the transaction close as well as 8,408 RMB to fulfill Chinese withholding tax requirements. Both of these costs are direct and incremental and related to the sale of equity in PWSH and as such will be included as costs that reduce proceeds and carrying amount of the NCI in the Company’s balance sheet. The Equity Transfer Agreement provides the Purchasers with some additional rights: (1) if there is a change in control of PWSH that closes prior to its filing an application for a listing on the STAR Board of the Shanghai Stock Exchange (the “Listing Application”), each Purchaser would be entitled to a minimum return of 10 % on the price they paid for their respective equity interest, payable by Company in cash at the close of the change in control transaction, with such right terminating automatically upon the filing by PWSH of the Listing Application; and (2) the Company would cause PWSH to give each Purchaser a right to participate on a pro rata basis in any future financing rounds of PWSH, which right also would expire on the filing of a Listing Application. 78 When the Company’s relative ownership interest in PWSH changes, adjustments to non-controlling interest and paid-in capital, tax effected, will occur. Because these changes in the ownership interest in PWSH do not result in a change of control, the transactions are accounted for as equity transactions under ASC Topic 810, (-Consolidations), which requires that any differences between the carrying value of the Company’s interest in PWSH and the fair value of the consideration received are recognized directly in equity and attributed to the controlling interest. Additionally, there are no substantive profit-sharing arrangements that would cause distributions to be other than pro rata. Therefore, profits and losses are attributed to the common shareholders of PWSH and non-controlling interest pro rata based on ownership interests in PWSH. The following table reconciles the initial investment by the Purchasers and the carrying value of their non-controlling interest as of the Closing Date (as defined in the Equity Transfer Agreement): Carrying Value of Permanent Equity Non-Controlling Interest as of January 1, 2022 $ — Increase in additional paid-in capital 12,184 Closing and direct costs incurred ( 1,446 ) Net income attributable to non-controlling interest 171 Carrying Value of Permanent Equity Non-Controlling Interest as of December 31, 2022 $ 10,909 79 NOTE 16. QUARTERLY FINANCIAL DATA (UNAUDITED) Quarterly Period Ended March 31 June 30 September 30 December 31 2022 Revenue, net $ 16,628 $ 19,078 $ 17,552 $ 16,888 Gross profit 8,763 9,348 8,796 8,974 Loss from operations ( 3,881 ) ( 5,197 ) ( 4,731 ) ( 3,008 ) Loss before income taxes ( 3,719 ) ( 5,096 ) ( 4,566 ) ( 2,736 ) Net loss attributable to Pixelworks Inc. ( 4,592 ) ( 5,008 ) ( 4,496 ) ( 1,934 ) Net loss attributable to Pixelworks Inc. per share - basic and diluted ( 0.09 ) ( 0.09 ) ( 0.08 ) ( 0.04 ) 2021 Revenue, net $ 9,270 $ 14,050 $ 15,196 $ 16,586 Gross profit 3,725 7,110 7,985 8,873 Loss from operations ( 7,914 ) ( 4,457 ) ( 3,904 ) ( 3,727 ) Loss before income taxes ( 7,858 ) ( 4,275 ) ( 3,850 ) ( 3,562 ) Net loss attributable to Pixelworks Inc. ( 8,075 ) ( 4,382 ) ( 4,073 ) ( 3,291 ) Net loss attributable to Pixelworks Inc. per share - basic and diluted ( 0.16 ) ( 0.08 ) ( 0.08 ) ( 0.06 ) NOTE 17. SUBSEQUENT EVENTS On December 21, 2022, the Company and its subsidiary, PWSH, entered into a capital increase agreement (the “CIA”) with certain private equity investors based in China who have agreed to pay a total of RMB 100,000 ($ 14,300 USD) in exchange for an equity interest in PWSH of 2.76 %, based on a pre-money value of PWSH of RMB 3,500,000 ($ 501,400 USD). This transaction closed in February 2023. The CIA provides that if there is a change in control of PWSH that closes prior to its filing an application for the Listing, each capital contributor would be entitled to a minimum return of 10 % on the price they paid for their respective equity interest, payable by Company in cash at the close of the change in control transaction, with such right terminating automatically upon the filing by PWSH of the Listing. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. None.