What changed in this filing

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Item 7. Management’s Discussion and Analysis

2024-03-13 compared with 2023-03-08 · 50 added, 101 removed, 165 unchanged (48% of the section changed)

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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.

During 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.

One of our Chinese subsidiaries, 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”).

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

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

PWSH has a branch office located in Shenzhen, China (Pixelworks Semiconductor Technology (Shanghai) Co.

Shenzhen Branch Office No.

1), which is primarily for sales and customer support for PWSH, and a subsidiary located in Hong Kong (Pixelworks Hong Kong Limited), which has no employees and is used for distribution of PWSH products.

Pixelworks has an additional subsidiary in China (Frame Shadow Technology (Shanghai) Co., Ltd.

(formerly called Mucheng Huai Management Consulting (Shanghai) Co., Ltd)) which is a research and development center for our TrueCut business.

This subsidiary does not operate under PWSH, but rather is owned by Pixelworks through our Oregon limited liability company, Pixelworks Semiconductor Technology Company, LLC.

We continue to prepare PWSH 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”) once market conditions in China are supportive.

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”).

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 (“SSE”) and the China Securities Regulatory Commission (“CSRC”).

The CSRC and the SSE have recently tightened the standards for the STAR Market and are currently advising companies that are not yet profitable under China GAAP standards against filing an IPO application in the present environment.

The Company believes this is in large part due to the current economic conditions in China and the recent performance of companies already listed on the STAR Market that were not profitable at the time of their IPO.

PWSH is not currently profitable under China GAAP standards.

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

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public company.

More than a majority of our operations are in China, but our executive officers and all of our directors but one are located in the United States (and he resides in Singapore).

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

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

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

We sell to distributors in China, Japan and Taiwan.

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

In certain countries in which we operate, it is

customary to sell to distributors.

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

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

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

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

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

For example, we have historically experienced higher revenue from the digital projector 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.

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

We have typically experienced higher revenue from the mobile market in the fourth quarter, and lower revenue in the first quarter, as mobile phone OEMs ramp production in advance of Chinese New Year.

Results of Operations

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Revenue, net $ 59,677 $ 70,146 $ (10,469) (15) %

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.

Net revenue decreased $10.5 million, or 15%, from 2022 to 2023.

Revenue recorded in 2023 consisted of $58.6 million in revenue from the sale of integrated circuits ("IC") products and $1.1 million in revenue related to engineering services, license revenue and other.

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.

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.

The decrease in IC revenue from 2022 compared to 2023 is due to the following factors:

• Sales into the Home & Enterprise market decreased $17.8 million or 38%, primarily due to a decrease in customer demand resulting from customers absorbing inventory purchased with long lead times during the supply shortage in 2022, as well as implementing an end-of-life in 2022 on some of our legacy products sold into what we previously referred to as the Video Delivery market.

• Sales into the Mobile market increased $8.3 million or 39%, primarily due to i ncreased average selling prices as our customers adopt and transition to our next generation mobile product.

Revenue related to engineering services, license revenue and other decreased $0.9 million or 46% primarily due to a decrease in licensing revenue in the Mobile market.

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$ 33,599 56.3 % $ 34,070 48.6 %

Amortization of acquired developed technology 72 0 899 2

Inventory charges 2

280 0.5 82 0.1

Stock-based compensation 89 0.1 41 0.1

Amortization of acquired developed technology — 0.0 72 0.1

Total cost of revenue $ 33,968 56.9 % $ 34,265 48.8 %

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

Gross profit margin increased to 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.

Gross profit margin decreased to 43% in 2023 compared to 51% in 2022, primarily due to product mix.

The decrease in sales into the Home & Enterprise market as well as the increase in sales into the Mobile market both unfavorably impacted gross profit margin.

The decrease was also due to lower absorption of fixed overhead costs.

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

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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.

During 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.

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• Compensation expense increased $1.0 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.

• The credit recognized related to the co-development agreement decreased by $1.1 million in 2023 compared to the credit recognized in 2022.

• These increases were partially offset by a $1.7 million decrease in non-recurring engineering expense due to the timing of development activities.

Selling, general and administrative

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Selling, general and administrative expense increased $1.3 million, or 6%, from 2022 to 2023 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.

• Compensation expense increased $0.8 million due to an increased management bonus accrual and one time reversal of a payroll tax accrual in 2022.

• Accounting and other professional fees increased $0.5 million primarily due to fees incurred related to our strategic plan with our subsidiary, PWSH.

Interest income and other, net

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Year ended December 31,

Other income $ 80 $ 246

Interest income $ 1,950 $ 670

Other income 125 80

Interest expense (25) (50)

Total interest income and other, net $ 2,050 $ 700

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.

The increase in interest income in 2023 compared to 2022 is due to increased interest earned on our cash and cash equivalents balance due to the increase in the interest rate available throughout the full year in 2023 compared to the full year in 2022.

Provision (benefit) for income taxes

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Year ended December 31,

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

Provision (benefit) for income taxes $ 357 $ (884)

The income tax expense of $0.4 million recorded for the year ended December 31, 2023 is primarily composed of tax expense of $0.1 million for our profitable cost-plus jurisdictions and deferred tax expense of approximately $0.3 million.

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 continue to record a full valuation allowance against our U.S., Canada and China net deferred tax assets as of December 31, 2023 and 2022, as it is not more likely than not that we will realize a benefit from these assets in a future period.

As of December 31, 2022, we were 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.

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As of December 31, 2023, we have available federal, state and foreign research and experimentation tax credit carryforwards of approximately $5.7 million, $5.4 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.

The federal tax credits will begin expiring in 2024 while the state and 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 $120.5 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.

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Average number of days sales outstanding increased to 56 days at December 31, 2023 from 54 days at December 31, 2022.

The increase in accounts receivable and days sales outstanding was due to normal fluctuations in the timing of sales and customer receipts within the fourth quarter of 2022, and the fourth quarter of 2021.

Inventories increased to $4.0 million at December 31, 2023 from $1.8 million at December 31, 2022.

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.

Inventory turnover decreased to 8.6 at December 31, 2023 from 16.6 at December 31, 2022 primarily due to higher average inventory balances in 2023 compared to 2022.

Inventory turnover is calculated based on annual operating results and average inventory balances during the year.

Capital resources

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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.

There was no activity under this at the market offering during the years ended December 31, 2023 and December 31, 2022.

Capital Increase Agreements

We have entered into a Capital Increase Agreement pursuant to which our subsidiary PWSH, received net proceeds from the sale of its securities pursuant thereto in an amount of RMB 279.7 million ($42.3 million USD).

We have entered into a Capital Increase Agreement pursuant to which PWSH, one of our Chinese subsidiaries, 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 15:

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

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

Equity Transfer Agreement

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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.

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.

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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 is not amortized, rather tested, at least annually, for impairment at a reporting unit level.

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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.

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

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.

We performed a qualitative assessment during the fourth quarter of 2023 and concluded that it was not more likely than not that the fair value of the reporting unit was less than its carrying amount.

As a result, we concluded that a quantitative impairment test was not required and that goodwill was not impaired.

Quantitative and Qualitative Disclosures about Market Risk.

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

What changed 10-K

Item 7. Management’s Discussion and Analysis