Quarterly Report (10-q)

Date : 08/12/2019 @ 11:02AM
Source : Edgar (US Regulatory)
Stock : Pixelworks Inc (PXLW)
Quote : 3.69  -0.02 (-0.54%) @ 12:00AM

Quarterly Report (10-q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________________ 
FORM 10-Q
________________________________
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     .
Commission File Number: 000-30269
 ____________________________________
PIXELWORKS, INC .
(Exact name of registrant as specified in its charter)
Oregon
 
91-1761992
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
 
 
226 Airport Parkway, Suite 595
 
 
San Jose
,
California
 
95110
(Address of principal executive offices)
 
(Zip Code)
( 408 ) 200-9200
(Registrant’s telephone number, including area code)
____________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
PXLW
The Nasdaq Global Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes        No  
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes        No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
 
Accelerated Filer
Non-accelerated Filer
 
Smaller Reporting Company
Emerging Growth Company
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  
Securities registered pursuant to Section 12(b) of the Act:
The number of outstanding shares of the registrant’s common stock, par value $0.001 per share, was 37,931,783 as of August 2, 2019



PIXELWORKS, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2019
TABLE OF CONTENTS
 

2


PART I – FINANCIAL INFORMATION
 
Item 1.
Financial Statements.
PIXELWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
 
 
June 30,
2019
 
December 31,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
16,746

 
$
17,944

Short-term marketable securities
6,575

 
6,069

Accounts receivable, net
7,353

 
6,982

Inventories
2,842

 
2,954

Prepaid expenses and other current assets
2,303

 
1,494

Total current assets
35,819

 
35,443

Property and equipment, net
4,817

 
6,151

Operating lease right of use assets
5,173

 

Other assets, net
1,606

 
1,132

Acquired intangible assets, net
3,452

 
4,208

Goodwill
18,407

 
18,407

Total assets
$
69,274

 
$
65,341

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,183

 
$
2,116

Accrued liabilities and current portion of long-term liabilities
9,158

 
10,256

Current portion of income taxes payable
578

 
263

Total current liabilities
11,919

 
12,635

Long-term liabilities, net of current portion
674

 
1,017

Operating lease liabilities, net of current portion
3,595

 

Income taxes payable, net of current portion
2,335

 
2,299

Total liabilities
18,523

 
15,951

Commitments and contingencies (Note 14)


 


Shareholders’ equity:
 
 
 
Preferred stock

 

Common stock
432,572

 
428,903

Accumulated other comprehensive income
22

 
15

Accumulated deficit
(381,843
)
 
(379,528
)
Total shareholders’ equity
50,751

 
49,390

Total liabilities and shareholders’ equity
$
69,274

 
$
65,341

See accompanying notes to condensed consolidated financial statements.

3


PIXELWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Revenue, net
$
18,027

 
$
19,251

 
$
34,675

 
$
34,543

Cost of revenue (1)
8,651

 
9,717

 
16,827

 
17,207

Gross profit
9,376

 
9,534

 
17,848

 
17,336

Operating expenses:
 
 
 
 
 
 
 
Research and development (2)
6,364

 
6,423

 
12,836

 
10,886

Selling, general and administrative (3)
4,935

 
4,959

 
10,395

 
9,573

Restructuring
398

 
602

 
398

 
621

Total operating expenses
11,697

 
11,984

 
23,629

 
21,080

Loss from operations
(2,321
)
 
(2,450
)
 
(5,781
)
 
(3,744
)
Gain on sale of patents

 

 
3,905

 

Interest income and other, net (4)
104

 
40

 
200

 
1,177

Total other income, net
104

 
40

 
4,105

 
1,177

Loss before income taxes
(2,217
)
 
(2,410
)
 
(1,676
)
 
(2,567
)
Provision for income taxes
231

 
32

 
639

 
308

Net loss
$
(2,448
)
 
$
(2,442
)
 
$
(2,315
)
 
$
(2,875
)
Net loss per share - basic and diluted
$
(0.06
)
 
$
(0.07
)
 
$
(0.06
)
 
$
(0.08
)
Weighted average shares outstanding - basic and diluted
37,688

 
35,704

 
37,469

 
35,445

 
 
 
 
 
 
 
 
(1) Includes:
 
 
 
 
 
 
 
Amortization of acquired intangible assets
298

 
298

 
596

 
596

Stock-based compensation
83

 
78

 
178

 
144

Inventory step-up and backlog amortization

 
239

 
12

 
361

(2) Includes stock-based compensation
703

 
627

 
1,364

 
1,222

(3) Includes:
 
 
 
 
 
 
 
Stock-based compensation
879

 
682

 
1,812

 
1,221

Amortization of acquired intangible assets
76

 
101

 
160

 
202

(4) Includes:
 
 
 
 
 
 
 
Gain on debt extinguishment

 

 

 
(1,272
)
Discount accretion on convertible debt fair value

 

 

 
69

See accompanying notes to condensed consolidated financial statements.

4


PIXELWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Net loss
$
(2,448
)
 
$
(2,442
)
 
$
(2,315
)
 
$
(2,875
)
Other comprehensive loss:
 
 
 
 
 
 
 
Unrealized gain (loss) on available-for-sale securities
3

 
(2
)
 
7

 
(2
)
Total comprehensive loss
$
(2,445
)
 
$
(2,444
)
 
$
(2,308
)
 
$
(2,877
)
See accompanying notes to condensed consolidated financial statements.


5


PIXELWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)  
 
Six Months Ended June 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net loss
$
(2,315
)
 
$
(2,875
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Gain on sale of patents
(3,905
)
 

Stock-based compensation
3,354

 
2,587

Depreciation and amortization
1,800

 
1,749

Amortization of acquired intangible assets
756

 
798

Accretion on short-term marketable securities
(52
)
 
(2
)
Reversal of uncertain tax positions
(31
)
 
(19
)
Inventory step-up and backlog amortization
12

 
361

Deferred income tax benefit

 
(63
)
Gain on debt extinguishment

 
(1,272
)
Discount accretion on convertible debt fair value

 
69

Changes in operating assets and liabilities, net of acquisition:
 
 
 
Accounts receivable, net
(371
)
 
(1,949
)
Inventories
100

 
(405
)
Prepaid expenses and other current and long-term assets, net
207

 
(703
)
Accounts payable
37

 
1,492

Accrued current and long-term liabilities
(2,230
)
 
(3,174
)
Income taxes payable
382

 
(12
)
Net cash used in operating activities
(2,256
)
 
(3,418
)
Cash flows from investing activities:
 
 
 
Purchases of short-term marketable securities
(6,045
)
 
(2,725
)
Proceeds from maturities of short-term marketable securities
5,600

 

Proceeds from sale of patents
4,250

 

Purchases of property and equipment
(1,859
)
 
(1,326
)
Purchases of licensed technology
(521
)
 

Payment associated with sale of patents
(345
)
 

Net cash provided by (used in) investing activities
1,080

 
(4,051
)
Cash flows from financing activities:
 
 
 
Payments on asset financings
(337
)
 
(636
)
Proceeds from issuance of common stock under employee equity incentive plans
315

 
245

Payments on convertible debt

 
(2,220
)
Net cash used in financing activities
(22
)
 
(2,611
)
Net decrease in cash and cash equivalents
(1,198
)
 
(10,080
)
Cash and cash equivalents, beginning of period
17,944

 
27,523

Cash and cash equivalents, end of period
$
16,746

 
$
17,443

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes, net of refunds received
$
291

 
$
383

Cash paid during the period for interest
66

 
307

Non-cash investing and financing activities:
 
 
 
Value of debt converted into shares
$

 
$
2,644

See accompanying notes to condensed consolidated financial statements.

6


PIXELWORKS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands, except share data)
(Unaudited)  
 
 
Common Stock
 
Accumulated
Other
Comprehensive
Income
 
Accumulated
Deficit
 
Total
Shareholders'
Equity
2019
Shares
 
Amount
 
Balance as of December 31, 2018
36,937,458

 
$
428,903

 
$
15

 
$
(379,528
)
 
$
49,390

Stock issued under employee equity incentive plans
605,911

 
315

 

 

 
315

Stock-based compensation expense

 
1,689

 

 

 
1,689

Unrealized gain on available for sale securities

 

 
4

 

 
4

Net income

 

 

 
133

 
133

Balance as of March 31, 2019
37,543,369

 
$
430,907

 
$
19

 
$
(379,395
)
 
$
51,531

Stock issued under employee equity incentive plans
290,422

 

 

 

 

Stock-based compensation expense

 
1,665

 

 

 
1,665

Unrealized gain on available for sale securities

 

 
3

 

 
3

Net loss

 

 

 
(2,448
)
 
(2,448
)
Balance as of June 30, 2019
37,833,791

 
$
432,572

 
$
22

 
$
(381,843
)
 
$
50,751

 
 
 
 
 
 
 
 
 
 
2018
 
 
 
 
 
 
 
 
 
Balance as of December 31, 2017
34,651,087

 
$
418,891

 
$
20

 
$
(375,615
)
 
$
43,296

Stock issued under employee equity incentive plans
495,686

 
233

 

 

 
233

Stock-based compensation expense

 
1,200

 

 

 
1,200

Debt conversion
435,353

 
2,644

 

 

 
2,644

Net loss

 

 

 
(433
)
 
(433
)
Balance as of March 31, 2018
35,582,126

 
$
422,968

 
$
20

 
$
(376,048
)
 
$
46,940

Stock issued under employee equity incentive plans
240,589

 
12

 

 

 
12

Stock-based compensation expense

 
1,387

 

 

 
1,387

Unrealized loss on available for sale securities

 

 
(2
)
 

 
(2
)
Net loss

 

 

 
(2,442
)
 
(2,442
)
Balance as of June 30, 2018
35,822,715

 
$
424,367

 
$
18

 
$
(378,490
)
 
$
45,895

See accompanying notes to consolidated financial statements.



7


PIXELWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
(Unaudited)

NOTE 1: BASIS OF PRESENTATION
Nature of Business
Pixelworks designs, develops and markets visual display processing semiconductors, intellectual property cores, software and custom application specific integrated circuits ("ASIC") solutions for high-quality energy efficient video applications. In addition, we offer a suite of solutions for advanced media processing and the efficient delivery and streaming of video.
We enable worldwide manufacturers to offer leading-edge consumer electronics and professional display products, as well as video delivery and streaming solutions for content service providers. Our core visual display processing technology intelligently processes digital images and video from a variety of sources and optimizes the content for a superior viewing experience. Pixelworks’ video coding technology reduces storage requirements, significantly reduces bandwidth constraint issues and converts content between multiple formats to enable seamless delivery of video, including over-the-air (OTA) streaming, while also maintaining end-to-end content security.
The rapid growth in video-capable consumer devices, especially mobile, has increased the demand for visual display processing and video delivery technology in recent years. Our technologies can be applied to a wide range of devices from large-screen projectors to low-power mobile tablets, smartphones, high-quality video infrastructure equipment and streaming devices. Our products are architected and optimized for power, cost, bandwidth, and overall system performance, according to the requirements of the specific application. Our primary target markets include digital projection systems, tablets, smartphones, and OTA streaming devices.
As of June 30, 2019, we had an intellectual property portfolio of 349 patents related to the visual display of digital image data. We focus our research and development efforts on developing video algorithms that improve quality, and architectures that reduce system power, cost, bandwidth and increase overall system performance and device functionality. We seek to expand our technology portfolio through internal development and co-development with business partners, and we continually evaluate acquisition opportunities and other ways to leverage our technology into other high-value markets.
Pixelworks was founded in 1997 and is incorporated under the laws of the state of Oregon. On August 2, 2017, we acquired ViXS Systems, Inc., a corporation organized in Canada (“ViXS”).
Condensed Consolidated Financial Statements
The financial information included herein for the three and six month periods ended June 30, 2019 and 2018 is prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and is unaudited. Such information reflects all adjustments, consisting of only normal recurring adjustments, except as discussed below, that are, in the opinion of management, necessary for a fair presentation of the Company's condensed consolidated financial statements for these interim periods. The financial information as of December 31, 2018 is derived from our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2018, included in Item 8 of our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 13, 2019 and as amended on August 9, 2019, and should be read in conjunction with such consolidated financial statements.
The results of operations for the three and six month periods ended June 30, 2019 are not necessarily indicative of the results expected for future periods or for the entire fiscal year ending December 31, 2019.


8


Immaterial Error Correction
During the second quarter of 2019, the Company determined that the statute of limitations had previously expired related to a portion of a liability that had been accrued in prior periods. Management evaluated the materiality of the error, both quantitatively and qualitatively, and concluded that it was not material to the financial statements of any period presented. The Company has revised beginning retained earnings and corrected the error in the accompanying prior period financial information in these condensed consolidated financial statements.
The following table sets forth the effect this immaterial error correction had on the Company’s unaudited condensed consolidated statements of operations for the three and six month periods ended June 30, 2018:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2018
 
June 30, 2018
 
Previously Reported
 
Correction
 
Revised
 
Previously Reported
 
Correction
 
Revised
Interest income (expense) and other, net
$
(131
)
 
$
171

 
$
40

 
$
841

 
$
336

 
$
1,177

Total other income (expense), net
(131
)
 
171

 
40

 
841

 
336

 
1,177

Income (loss) before income taxes
(2,581
)
 
171

 
(2,410
)
 
(2,903
)
 
336

 
(2,567
)
Net loss
(2,613
)
 
171

 
(2,442
)
 
(3,211
)
 
336

 
(2,875
)
Net loss per share - basic and diluted
$
(0.07
)
 
$

 
$
(0.07
)
 
$
(0.09
)
 
$
0.01

 
$
(0.08
)

The following table sets forth the effect this immaterial error correction had on the Company's unaudited condensed consolidated balance sheet as of December 31, 2018:
 
December 31, 2018
 
Previously Reported
 
Correction
 
Revised
Accrued liabilities and current portion of long-term liabilities
$
14,823

 
$
(4,567
)
 
$
10,256

Total current liabilities
17,202

 
(4,567
)
 
12,635

Total liabilities
20,518

 
(4,567
)
 
15,951

Accumulated deficit
(384,095
)
 
4,567

 
(379,528
)
Total shareholders’ equity
44,823

 
4,567

 
49,390


The following table sets forth the effect this immaterial error correction had on the Company's unaudited condensed consolidated statement of cash flows for the six month period ended June 30, 2018:
 
Six Months Ended June 30, 2018
 
Previously Reported
 
Correction
 
Revised
Operating activities:
 
 
 
 

Net loss
(3,211
)
 
336

 
(2,875
)
Change in accrued current and long-term liabilities
(2,838
)
 
(336
)
 
(3,174
)
Net cash used in operating activities
(3,418
)
 

 
(3,418
)

Recent Accounting Pronouncements
In November 2018, the FASB issued Accounting Standards Update No. 2018-18, Collaborative Arrangements: Clarifying the Interaction Between Topic 808 and Topic 606 ("ASU 2018-18"). ASU 2018-18 requires transactions in collaborative arrangements to be accounted for under ASC 606 if the counter-party is a customer for a good or service (or bundle of goods and services) that is a distinct unit of account. The amendment also precludes entities from presenting consideration from transactions with a collaborator that is not a customer together with revenue recognized from contracts with customers. ASU 2018-18 is effective for fiscal years beginning after December 15, 2019, and interim periods in those fiscal years. We are currently assessing the impact of this update on our financial position, results of operations and cash flows.

9


In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) ("ASC 842"), which requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842 ; ASU No. 2018-10, Codification Improvements to Topic 842 ; and ASU No. 2018-11, Targeted Improvements . The new standard establishes a right-of-use model ("ROU") that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.
We adopted the new standard on January 1, 2019 and used the effective date as our date of initial application under the modified retrospective approach. Under the effective date method, financial information and disclosures prior to January 1, 2019 are not required to be restated.
We elected the “practical expedient package,” which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. We did not elect the use-of-hindsight or the practical expedient pertaining to land easements; the latter not being applicable to us. We elected the short-term lease recognition exemption for all leases that qualify. This means, for those leases that qualify, we will not recognize ROU assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases of those assets in transition. We also elected the practical expedient to not separate lease and non-lease components for all of our leases.
The adoption of this standard had the effect of increasing the assets and liabilities on our condensed consolidated balance sheet by $6,224 and $6,847 , respectively, but did not have a material impact on our condensed consolidated statements of operations or cash flows. The most significant impact relates to (1) the recognition of new ROU assets and lease liabilities on our balance sheet for our office operating leases; and (2) providing significant new disclosures about our leasing activities.
Upon adoption, we recognized operating lease liabilities of $6,847 based on the present value of the remaining minimum rental payments under current leasing standards for existing operating leases. We also recognized ROU assets of $6,224 which represents the operating lease liability adjusted for accrued rent and cease-use liabilities.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with 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, valuation of share-based payments, income taxes, litigation and other contingencies. The actual results experienced could differ materially from our estimates.

NOTE 2: BALANCE SHEET COMPONENTS
Accounts Receivable, Net
Accounts receivable are contract assets that arise from the performance of our performance obligation pursuant to our contracts with our customers and represent our unconditional right to payment for the satisfaction of our performance obligations. They are recorded at invoiced amount and do not bear interest when recorded or accrue interest when past due. Accounts receivable are stated net of an allowance for doubtful accounts, which is maintained for estimated losses that may result from the inability of our customers to make required payments.

10


Accounts receivable consists of the following:
 
June 30,
2019
 
December 31,
2018
Accounts receivable, gross
$
7,398

 
$
7,003

Less: allowance for doubtful accounts
(45
)
 
(21
)
Accounts receivable, net
$
7,353

 
$
6,982



The following is the change in our allowance for doubtful accounts:  
 
Six Months Ended
 
June 30,
 
2019
 
2018
Balance at beginning of period
$
21

 
$
47

Additions charged (reductions credited)
24

 
(25
)
Balance at end of period
$
45

 
$
22



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 market (net realizable value).
Inventories consist of the following:  
 
June 30,
2019
 
December 31,
2018
Finished goods
$
1,675

 
$
1,577

Work-in-process
1,167

 
1,377

Inventories
$
2,842

 
$
2,954



Property and Equipment, Net
Property and equipment consists of the following:
 
June 30,
2019
 
December 31,
2018
Gross carrying amount
$
23,249

 
$
22,882

Less: accumulated depreciation and amortization
(18,432
)
 
(16,731
)
Property and equipment, net
$
4,817

 
$
6,151



Acquired Intangible Assets, Net
In connection with the acquisition of ViXS ("the Acquisition"), we recorded certain identifiable intangible assets. Acquired intangible assets resulting from this transaction were assigned to Pixelworks, Inc., and consist of the following:
 
June 30,
2019
 
December 31,
2018
Developed technology
$
5,050

 
$
5,050

Customer relationships
1,270

 
1,270

Backlog and tradename
410

 
410

 
6,730

 
6,730

Less: accumulated amortization
(3,278
)
 
(2,522
)
Acquired intangible assets, net
$
3,452

 
$
4,208



Developed technology and customer relationships are amortized over a useful life of 3 to 5 years. Backlog was fully amortized as of September 30, 2018 and tradename was fully amortized as of March 31, 2019.

11



Amortization expense for intangible assets was $374 and $756 for the three and six months ended June 30, 2019, respectively, $298 and $596 were included in cost of revenue for the three and six month periods ended June 30, 2019, respectively, and $76 and $160 were included in selling, general and administrative for the three and six months ended June 30, 2019, respectively, in the condensed consolidated statements of operations. As of June 30, 2019, future estimated amortization expense is as follows:
Six months ending December 31:
 
2019
$
749

Years ending December 31:
 
2020
1,496

2021
1,117

2022
90

 
$
3,452


Acquired intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Conditions that would trigger an impairment assessment include, but are not limited to, past, current, or expected cash flow or operating losses associated with the asset. There were no such triggering events requiring an impairment assessment of other intangible assets during the three months ended June 30, 2019.
Goodwill
Goodwill resulted from the Acquisition, whereby we recorded goodwill of $18,407 .
Goodwill is not amortized; however, we review goodwill for impairment annually and whenever events or changes in circumstances indicate that the fair value of the reporting unit may be less than it's carrying value. Conditions that would trigger an impairment assessment include, but are not limited to, a significant adverse change in our business climate or a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continued losses or adverse changes in legal factors, regulation or business environment. There were no such triggering events requiring a goodwill impairment assessment during the three months ended June 30, 2019. We perform our annual impairment assessment for goodwill on November 30 of each year.
Accrued Liabilities and Current Portion of Long-Term Liabilities
Accrued liabilities and current portion of long-term liabilities consist of the following:
 
June 30,
2019
 
December 31,
2018
Accrued payroll and related liabilities
$
3,180

 
$
4,428

Operating lease liabilities, current
2,037

 

Accrued royalties
779

 
900

Current portion of accrued liabilities for asset financings
411

 
748

Accrued interest payable
398

 
403

Accrued costs related to restructuring
224

 
200

Deferred revenue
156

 
96

Liability for warranty returns
9

 
13

Other
1,964

 
3,468

Accrued liabilities and current portion of long-term liabilities
$
9,158

 
$
10,256


Deferred revenues are contract liabilities that arise when cash payments are received or due in advance of the satisfaction of our performance obligations. Any increase in deferred revenues is driven by cash payments received or due in advance of satisfying our performance obligation pursuant to the contract with the customer. Any decrease in deferred revenues is due to the recognition of revenue related to satisfying our performance obligation.

12


The changes in deferred revenue and the liability for warranty returns are as follows:
 
Six Months Ended
 
June 30,
 
2019
 
2018
Deferred revenue:
 
 
 
Balance at beginning of period
$
96

 
$
418

Revenue deferred
335

 
550

Revenue recognized
(275
)
 
(713
)
Balance at end of period
$
156

 
$
255

Liability for warranty returns:
 
 
 
Balance at beginning of period
$
13

 
$
17

Charge-offs
(2
)
 
(4
)
Provision
(2
)
 
(1
)
Balance at end of period
$
9

 
$
12



Short-Term Line of Credit
On December 21, 2010, we entered into a Loan and Security Agreement with Silicon Valley Bank (the "Bank"), which was amended on December 14, 2012, December 4, 2013, December 18, 2015, December 15, 2016, July 21, 2017, December 21, 2017 and December 18, 2018 (as amended, the "Revolving Loan Agreement"). The Revolving Loan Agreement provides a secured working capital-based revolving line of credit (the "Revolving Line") in an aggregate amount of up to the lesser of (i)  $10,000 , or (ii)  $1,000 plus 80% of eligible domestic accounts receivable and certain foreign accounts receivable. The Revolving Line has a maturity date of December 27, 2019. In addition, the Revolving Loan Agreement provides for non-formula advances of up to $10,000 which may be made solely during the last five business days of any fiscal month or quarter and which must be repaid by us on or before the fifth business day after the applicable fiscal month or quarter end. Due to their repayment terms, non-formula advances do not provide us with usable liquidity.
The Revolving Loan Agreement, as amended, contains customary affirmative and negative covenants as well as customary events of default. The occurrence of an event of default could result in the acceleration of our obligations under the Revolving Loan Agreement, as amended, and an increase to the applicable interest rate, and would permit the Bank to exercise remedies with respect to its security interest. As of June 30, 2019, we were in compliance with all of the terms of the Revolving Loan Agreement, as amended.
As of June 30, 2019 and December 31, 2018, we had no outstanding borrowings under the Revolving Line.

NOTE 3: CONVERTIBLE DEBT
As part of the Acquisition, we assumed secured convertible debt and as a result of the change in control of ViXS, the convertible debt holders had a right to put the debt to the Company. A majority of the holders agreed to waive their right to accelerate and to accept 0.04836 share of our common stock for each share of ViXS common stock the holder would have been entitled to receive upon the exercise of the conversion option.
On January 12, 2018, the Company provided notice to the holders of the convertible debt of its election to redeem the convertible debt in full as of March 13, 2018. Subsequently, certain holders of the convertible debt elected to convert their convertible debt into shares of common stock of Pixelworks pursuant to the terms of the convertible debt. This resulted in the issuance of 435,353 shares of our common stock which was valued at an aggregate of $2,644 . We paid an aggregate of CAD $2,875 (equivalent to $2,220 USD) to redeem the convertible debt of those holders who did not elect to convert their convertible debt. The extinguishment of the debt during the first quarter of 2018 resulted in a gain of $1,272 which is recorded in interest income (expense) and other, net within our condensed consolidated statement of operations.
For the three months ended March 31, 2018, interest expense consisted of $66 related to the contractual rate of interest and $69 related to accretion of the discount. During the three months ended March 31, 2018, we recorded net foreign currency losses of approximately $15 in other expense. Because the convertible debt was redeemed or paid in full as of March 31, 2018, there were no further expenses related to the convertible debt after that date.


13



NOTE 4: MARKETABLE SECURITIES AND FAIR VALUE MEASUREMENTS
Marketable Securities
As of June 30, 2019 and December 31, 2018, all of our marketable securities are classified as available-for-sale, have contractual maturities of one year or less and consist of the following:
 
Cost
 
Unrealized Gain (Loss)
 
Fair Value
Short-term marketable securities:
 
 
 
 
 
As of June 30, 2019:
 
 
 
 

Corporate debt securities
$
2,493

 
$
6

 
$
2,499

Commercial paper
2,481

 

 
2,481

U.S. government treasury bills
1,594

 
1

 
1,595

 
$
6,568

 
$
7

 
$
6,575

 
 
 
 
 
 
As of December 31, 2018:
 
 
 
 
 
Corporate debt securities
$
3,238

 
$
(2
)
 
$
3,236

Commercial paper
992

 

 
992

U.S. government treasury bills
1,841

 

 
1,841

 
$
6,071

 
$
(2
)
 
$
6,069



Unrealized holding gains and losses are recorded in accumulated other comprehensive income, a component of shareholders’ equity, in the condensed consolidated balance sheets.

14


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 measured at fair value on a recurring basis in the condensed consolidated balance sheets as of June 30, 2019 and December 31, 2018:  
 
Level 1
 
Level 2
 
Level 3
 
Total
As of June 30, 2019:
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
6,759

 
$

 
$

 
$
6,759

Short-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasury bills
1,595

 

 

 
1,595

Corporate debt securities

 
2,499

 

 
2,499

Commercial paper

 
2,481

 

 
2,481

 
 
 
 
 
 
 
 
As of December 31, 2018:
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 


 


 


Money market funds
$
13,388

 
$

 
$

 
$
13,388

Commercial paper

 
250

 

 
250

Corporate debt securities

 
249

 

 
249

Short-term marketable securities:
 
 
 
 
 
 
 
U.S. government treasury bills
1,841

 

 

 
1,841

Corporate debt securities

 
3,236

 

 
3,236

Commercial paper

 
992

 

 
992


We primarily use the market approach to determine the fair value of our financial assets. 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.



15


NOTE 5: RESTRUCTURINGS
In June 2019, we executed a restructuring plan to make the operation of the Company more efficient (the "2019 Plan"). The 2019 Plan included an approximately 2% reduction in workforce, primarily in the areas of sales and operations.
In April 2018, we executed a restructuring plan to make the operation of the Company more efficient (the "2018 Plan"). The 2018 Plan included an approximately 5% reduction in workforce, primarily in the areas of development, marketing and administration. The 2018 plan also included closing the Hong Kong office and reducing the size of the Toronto office.
In September 2017, in connection with the Acquisition, we executed a restructuring plan to secure significant synergies between ViXS and Pixelworks (the "2017 Plan"). The 2017 Plan included an approximately 15% reduction in workforce, primarily in the area of development, however, it also impacted administration and sales.
Total restructuring expense included in our statement of operations for the three and six month periods ended June 30, 2019 and 2018 is comprised of the following:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Operating expenses — restructuring:
 
 
 
 
 
 
 
Employee severance and benefits
$
398

 
$
602

 
$
398

 
$
621

Total restructuring expense
$
398

 
$
602

 
$
398

 
$
621



During the three and six months ended June 30, 2019, we recorded $398 in restructuring expense related to the 2019 Plan. During the three months ended June 30, 2018, we recorded $602 in restructuring expense related to the 2018 Plan. During the six months ended June 30, 2018, we recorded  $19  in restructuring expense related to the 2017 Plan and  $602  related to the 2018 Plan.

The following is a rollforward of the accrued liabilities related to restructuring for the six month period ended June 30, 2019:
 

Balance as of December 31, 2018
 
Adjustment
 
Expensed
 
Payments
 

Balance as of
June 30, 2019
Facility closure and consolidations
$
360

 
$
(360
)
 
$

 
$

 
$

Employee severance and benefits

 

 
398

 
(174
)
 
224

Accrued costs related to restructuring
$
360

 
$
(360
)
 
$
398

 
$
(174
)
 
$
224


The adjustment to accrued costs related to restructuring was due to adjusting the ROU asset associated with cease-use liabilities upon the adoption of ASC 842 and did not result in an adjustment to restructuring expense.

NOTE 6: RESEARCH AND DEVELOPMEN T
During the first quarter of 2017, we entered into a best efforts co-development agreement (the "Co-Development Agreement") with a customer to defray a portion of the research and development expenses that would be incurred in connection with our development of an integrated circuit product to be sold exclusively to the customer. Under the Co-Development Agreement, 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,  $4,000  was payable by the customer within 60 days of the date of the agreement and two additional payments of  $2,000  were each payable upon completion of certain development milestones. As amounts became due and payable, they were offset against research and development expense on a pro rata basis. We recognized offsets to research and development expense of $4,000 related to the Co-development Agreement during each of 2018 and 2017. All milestones under the Co-development Agreement were completed as of December 31, 2018.


16


NOTE 7: LEASES
On January 1, 2019, we adopted the new requirements of ASC 842, under the modified retrospective approach, using the effective date method. Under the effective date method, financial information and disclosures prior to January 1, 2019 are not required to be restated.
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 condensed 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 6 years . Supplemental information related to lease expense and valuation of the ROU assets and lease liabilities was as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2019
 
June 30, 2019
Operating lease cost:
$
657

 
$
1,286


 
Six Months Ended June 30, 2019
Cash paid for amounts included in the measurement of lease liabilities:
 
Operating cash flows from operating leases:
$
1,339

Weighted average remaining lease term (in years):
3.58

Weighted average discount rate:
5.75
%

Future minimum lease payments under non-cancellable leases as of June 30, 2019 were as follows:
Operating Lease Payments
 
Six months ending December 31, 2019
$
1,195

Years ending December 31:
 
2020
1,936

2021
1,244

2022
760

2023
624

Thereafter
513

Total operating lease payments
6,272

Less imputed interest
(640
)
Total operating lease liabilities
$
5,632



As of June 30, 2019, the Company had no operating lease liabilities that had not commenced.


17


As required, the following disclosure is provided for periods prior to adoption of ASC 842. Minimum lease commitments as of December 31, 2018 that had initial or remaining lease terms in excess of one year were as follows:

 
Operating Leases
2019
1,856

2020
1,039

2021
708

2022
539

2023
492

2024
378



NOTE 8: 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. 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"). 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 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.
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.

18


The following table provides information about disaggregated revenue based on the preceding categories for the three and six months ended June 30, 2019 and 2018:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
IC sales
$
17,588

 
$
18,575

 
$
32,662

 
$
33,131

Engineering services, license and other
439

 
676

 
2,013

 
1,412

Total revenues
$
18,027

 
$
19,251

 
$
34,675

 
$
34,543


For segment information, including revenue by geographic region, see "Note 12: Segment Information".
Our contract balances include accounts receivable, deferred revenue and our liability for warranty returns. For information concerning these contract balances, see "Note 2: 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.
The aggregate amount of the transaction price allocated to unsatisfied performance obligations with an original expected duration of greater than one year is $330 , which we expect to recognize ratably over the next 33 months .

NOTE 9: INTEREST INCOME (EXPENSE) AND OTHER, NET
Interest income (expense) and other, consists of the following:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Interest income
$
85

 
$
67

 
$
185

 
$
124

Other income
53

 
54

 
97

 
105

Interest expense
(34
)
 
(81
)
 
(82
)
 
(255
)
Gain on debt extinguishment

 

 

 
1,272

Discount accretion on convertible debt fair value

 

 

 
(69
)
Total interest income (expense) and other, net
$
104

 
$
40

 
$
200

 
$
1,177




NOTE 10: INCOME TAXES
The provision for income taxes during the 2019 and 2018 periods is primarily comprised of current and deferred tax expense in profitable cost-plus foreign jurisdictions, accruals for tax contingencies in foreign jurisdictions and benefits for the reversal of previously recorded foreign tax contingencies due to the expiration of the applicable statutes of limitation. We recorded a benefit for the reversal of previously recorded foreign tax contingencies of $31 and $19 during the first six months of 2019 and 2018, respectively.
As we do not believe that it is more likely than not that we will realize a benefit from our U.S. net deferred tax assets, including our U.S. net operating losses, we continue to provide a full valuation allowance against essentially all of those assets, therefore, we do not incur significant U.S. income tax expense or benefit. We have not recorded a valuation allowance against our other foreign net deferred tax assets, with the exception of Canada, as we believe that it is more likely than not that we will realize a benefit from those assets.

19


As of June 30, 2019 and December 31, 2018, the amount of our uncertain tax positions was a liability of $1,651 and $1,661 , respectively, as well as a contra deferred tax asset of $1,039 and $925 , respectively. A number of years may elapse before an uncertain tax position is resolved by settlement or statute of limitation. 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 $112 within the next twelve months due to the expiration of statutes of limitation in foreign jurisdictions. We recognize interest and penalties related to uncertain tax positions in income tax expense in our condensed consolidated statements of operations.

NOTE 11: EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share data):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Net loss
$
(2,448
)
 
$
(2,442
)
 
$
(2,315
)
 
$
(2,875
)
Weighted average shares outstanding - basic and diluted
37,688

 
35,704

 
37,469

 
35,445

Net loss per share - basic and diluted
$
(0.06
)
 
$
(0.07
)
 
$
(0.06
)
 
$
(0.08
)


The following shares were excluded from the calculation of diluted net loss per share as their effect would have been anti-dilutive (in thousands):  
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Employee equity incentive plans
3,423

 
3,441

 
3,353

 
3,438


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.



20


NOTE 12: SEGMENT INFORMATION
We function as a single operating segment: the design and development of integrated circuits for use in electronic display devices. The majority of our assets are located in the United States.
Geographic Information
Revenue by geographic region, is as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Japan
$
15,234

 
$
17,057

 
$
28,694

 
$
30,402

China
1,686

 
1,712

 
3,548

 
2,638

United States
623

 
283

 
1,337

 
873

Taiwan
380

 
97

 
899

 
266

Europe
71

 

 
104

 
50

Korea
33

 
102

 
93

 
314

 
$
18,027

 
$
19,251

 
$
34,675

 
$
34,543



Significant Customers
The percentage of revenue attributable to our distributors, top five end customers, and individual distributors or end customers that represented 10% or more of revenue in at least one of the periods presented, is as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Distributors:
 
 
 
 
 
 
 
All distributors
45
%
 
35
%
 
36
%
 
36
%
Distributor A
37
%
 
27
%
 
30
%
 
25
%
End customers: 1
 
 
 
 
 
 
 
Top five end customers
81
%
 
82
%
 
80
%
 
81
%
End customer A
45
%
 
58
%
 
50
%
 
56
%
End customer B
12
%
 
6
%
 
14
%
 
6
%

1  
End customers include customers who purchase directly from us, as well as customers who purchase our products indirectly through distributors.
The following accounts represented 10% or more of total accounts receivable in at least one of the periods presented:
 
June 30,
2019
 
December 31,
2018
Account X
41
%
 
54
%
Account Y
36
%
 
34
%




21


NOTE 13: 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.

NOTE 14: COMMITMENTS AND CONTINGENCIES
Indemnifications
Certain of our agreements include indemnification provisions for claims from third-parties relating to our intellectual property. 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 June 30, 2019, we have not incurred any material liabilities arising from these indemnification obligations. In the future, however, such obligations could materially impact our results of operations.
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.
Other Contractual Obligation
As part of the Acquisition, we acquired debt associated with an agreement with the Government of Canada called Technology Partnerships Canada ("TPC"). As part of the TPC agreement, ViXS Systems Inc. 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. As of June 30, 2019, $478 is included in accrued liabilities and current portion of long-term liabilities in our consolidated balance sheet and $516 is included in long-term liabilities, net of current portion in our consolidated balance sheet.



22


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward-looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements” that are based on current expectations, estimates, beliefs, assumptions and projections about our business. Words such as "may," "will," "appears," "predicts," "continue," "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and the negative or other variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements include, but are not limited to, statements regarding: the anticipated features, benefits and market opportunities for our products; our technologies and intellectual property; our international operations; our strategy, including with respect to our intellectual property portfolio, research and development efforts and acquisition and investment opportunities; our gross profit margin; our restructuring programs, including estimates, timing and impact thereof, as well as any future restructuring programs; our liquidity, capital resources and the sufficiency of our working capital and need for, or ability to secure, additional financing and the potential impact thereof; our contractual obligations, exchange rate and interest rate risks; our income taxes, including our ability to realize the benefit of net deferred tax assets, our uncertain tax position liability; accounting policies and use of estimates and potential impact of changes thereto; our material weakness remediation efforts and timeline; our revenue, the potential impact on our business of certain risks, including the concentration of our suppliers, risks of technological change, concentration of credit risk, changes in the markets in which we operate, our international operations, including in Asia and our exchange rate risks, our indemnification obligations and litigation risks. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict and which may cause actual outcomes and results to differ materially from what is expressed or forecasted in such forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in Part II, Item 1A of this Quarterly Report on Form 10-Q. These forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q. If we do update or correct one or more forward-looking statements, you should not conclude that we will make additional updates or corrections with respect thereto or with respect to other forward-looking statements. Except where the context otherwise requires, in this Quarterly Report on Form 10-Q, the "Company," "Pixelworks," “we," "us" and "our" refer to Pixelworks, Inc., an Oregon corporation, and its wholly-owned subsidiaries.

Overview
Pixelworks designs, develops and markets visual display processing semiconductors, intellectual property cores, software and custom application specific integrated circuits ("ASIC") solutions for high-quality energy efficient video applications. In addition, we offer a suite of solutions for advanced media processing and the efficient delivery and streaming of video.
We enable worldwide manufacturers to offer leading-edge consumer electronics and professional display products, as well as video delivery and streaming solutions for content service providers. Our core visual display processing technology intelligently processes digital images and video from a variety of sources and optimizes the content for a superior viewing experience. Pixelworks’ video coding technology reduces storage requirements, significantly reduces bandwidth constraint issues and converts content between multiple formats to enable seamless delivery of video, including over-the-air (OTA) streaming, while also maintaining end-to-end content security.
The rapid growth in video-capable consumer devices, especially mobile, has increased the demand for visual display processing and video delivery technology in recent years. Our technologies can be applied to a wide range of devices from large-screen projectors to low-power mobile tablets, smartphones, high-quality video infrastructure equipment and streaming devices. Our products are architected and optimized for power, cost, bandwidth, and overall system performance, according to the requirements of the specific application. Our primary target markets include digital projection systems, tablets, smartphones, and OTA streaming devices.
As of June 30, 2019, we had an intellectual property portfolio of 349 patents related to the visual display of digital image data. We focus our research and development efforts on developing video algorithms that improve quality, and architectures that reduce system power, cost, bandwidth and increase overall system performance and device functionality. We seek to expand our technology portfolio through internal development and co-development with business partners, and we continually evaluate acquisition opportunities and other ways to leverage our technology into other high-value markets.




23


Results of Operations
Revenue, net
Net revenue for the three and six month periods ended June 30, 2019 and 2018, was as follows (dollars in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Revenue, net
$
18,027

 
$
19,251

 
(6
)%
 
$
34,675

 
$
34,543

 
0
%

Net revenue decreased $1.2 million, or 6%, in the second quarter of 2019 compared to the second quarter of 2018 and increased $0.1 million, or less than 1% in the first half of 2019 compared to the first half of 2018.
Revenue recorded in the second quarter of 2019 consisted of $17.6 million in revenue from the sale of integrated circuit ("IC") products and $0.4 million in revenue related to engineering services, license revenue and other. Revenue recorded in the second quarter of 2018 consisted of $18.6 million in revenue from the sale of IC products and $0.7 million in revenue related to engineering services, license revenue and other.
Revenue recorded in the first half of 2019 consisted of $32.7 million in revenue from the sale of IC products and $2.0 million in revenue related to engineering services, license revenue and other. Revenue recorded in the first half of 2018 consisted of $33.1 million in revenue from the sale of IC products and $1.4 million in revenue related to engineering services, license revenue and other.
The decrease in IC revenue in both periods presented is primarily due to decreased unit sales into the digital projector market as customers make an effort to correct their inventory levels. This decrease is partially offset by increased unit sales into the video delivery market.
The increase in revenue related to engineering services, license revenue and other in the first half of 2019 compared to the first half of 2018 is primarily due to the recognition of license revenue during the first quarter of 2019.
Cost of revenue and gross profit
Cost of revenue and gross profit for the three and six month periods ended June 30, 2019 and 2018, was as follows (dollars in thousands):  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
% of
revenue
 
2018
 
% of
revenue
 
2019
 
% of
revenue
 
2018
 
% of
revenue
Direct product costs and related overhead 1
$
8,151

 
45
%
 
$
9,177

 
48
 %
 
$
15,945

 
46
%
 
$
16,193

 
47
 %
Amortization of acquired intangible assets
298

 
2

 
298

 
2

 
596

 
2

 
596

 
2

Inventory charges 2
119

 
1

 
(75
)
 
0

 
96

 
0

 
(87
)
 
0

Stock-based compensation
83

 
0

 
78

 
0

 
178

 
1

 
144

 
0

Inventory step-up and backlog amortization

 
0

 
239

 
1

 
12

 
0

 
361

 
1

Total cost of revenue
$
8,651

 
48
%
 
$
9,717

 
50
 %
 
$
16,827

 
49
%
 
$
17,207

 
50
 %
Gross profit
$
9,376

 
52
%
 
$
9,534

 
50
 %
 
$
17,848

 
51
%
 
$
17,336

 
50
 %
 
1  
Includes purchased materials, assembly, test, labor, employee benefits and royalties.
2  
Includes charges to reduce inventory to lower of cost or market and a benefit for sales of previously written down inventory.
Gross profit margin was 52% in the second quarter of 2019 compared to 50% in the second quarter of 2018. The increase in gross profit margin was primarily due to a more favorable product mix of sales into the digital projector market.
Gross profit margin in the first half of 2019 was 51% compared to 50% in the first half of 2018. The increase in gross profit margin was primarily due to increased sales into the video delivery market combined with the recognition of high margin license revenue in the first quarter of 2019.
The backlog asset generated as a result of the acquisition of ViXS (the "Acquisition") was fully amortized as of September 30, 2018 and the inventory step up asset that was generated as a result of the Acquisition was fully recognized as of March 31, 2019.

24


Pixelworks’ gross profit margin is subject to variability based on changes in revenue levels, product mix, average selling prices, startup costs, restructuring charges, amortization related to acquired intangible assets, inventory step-up and backlog, and the timing and execution of manufacturing ramps as well as other factors.
Research and development
Research and development expense includes compensation and related costs for personnel, development-related expenses, including non-recurring engineering expenses and fees for outside services, depreciation and amortization, expensed equipment, facilities and information technology expense allocations and travel and related expenses.

Co-development agreement
During the first quarter of 2017, we entered into a best efforts co-development agreement (the "Co-Development Agreement") with a customer to defray a portion of the research and development expenses that would be incurred in connection with our development of an integrated circuit product to be sold exclusively to the customer. Under the Co-Development Agreement, 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, $4.0 million was payable by the customer within 60 days of the date of the agreement and two additional payments of $2.0 million were each payable upon completion of certain development milestones. As amounts became due and payable, they were offset against research and development expense on a pro rata basis. We recognized offsets to research and development expense of $4.0 million related to the Co-development Agreement during each of 2018 and 2017. All milestones under the Co-development Agreement were completed as of December 31, 2018.
Research and development expense for the three and six month periods ended June 30, 2019 and 2018, was as follows (dollars in thousands):  
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Research and development
$
6,364

 
$
6,423

 
(1
)%
 
$
12,836

 
$
10,886

 
18
%
Research and development expense decreased $0.1 million, or 1% in the second quarter of 2019 compared to the second quarter of 2018. There were no individually significant decreases contributing to the overall decrease in the second quarter of 2019 compared to the second quarter of 2018.
Research and development expense increased $2.0 million, or 18% in the first half of 2019 compared to the first half of 2018. The increase in the first half of 2019 compared to the first half of 2018 was primarily due to a benefit recognized in the first half of 2018 related to the Co-development Agreement. There was no benefit related to the Co-development Agreement recognized in the first half of 2019.
Selling, general and administrative
Selling, general and administrative expense includes compensation and related costs for personnel, sales commissions, facilities and information technology expense allocations, travel, outside services and other general expenses incurred in our sales, marketing, customer support, management, legal and other professional and administrative support functions.
Selling, general and administrative expense for the three and six month periods ended June 30, 2019 and 2018, was as follows (dollars in thousands):  
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
% Change
 
2019
 
2018
 
% Change
Selling, general and administrative
$
4,935

 
$
4,959

 
0
 %
 
$
10,395

 
$
9,573

 
9
%
Selling, general and administrative expense in the second quarter of 2019 was consistent with the second quarter of 2018. There were no individually significant changes to selling, general and administrative expense in the second quarter of 2019 compared to the second quarter of 2018.
Selling, general and administrative expense increased $0.8 million, or 9% in the first half of 2019 compared to the first half of 2018. The increase in the first half of 2019 compared to the first half of 2018 was primarily due to an increase in stock based compensation expense due to the timing of awards granted as well as an increase in compensation expense due to annual merit salary increases.

25


Restructurings
In June 2019, we executed a restructuring plan ("the 2019 Plan") to make the operation of the Company more efficient. The 2019 Plan included an approximately 2% reduction in workforce, primarily in the areas of sales and operations.
In April 2018, we executed a restructuring plan ("the 2018 Plan") to make the operation of the Company more efficient. The 2018 Plan included an approximately 5% reduction in workforce, primarily in the areas of development, marketing and administration. The 2018 Plan also included closing the Hong Kong office and reducing the size of the Toronto office.
In September 2017, in connection with the Acquisition, we executed a restructuring plan ("the 2017 Plan") to secure significant synergies between ViXS and Pixelworks. The 2017 Plan included an approximately 15% reduction in workforce, primarily in the area of development, however, it also impacted administration and sales.
Restructuring expense for the three and six month periods ended June 30, 2019 and 2018, was as follows and was included in operating expenses (dollars in thousands):  
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2019
 
2018
 
2019
 
2018
Employee severance and benefits
$
398

 
$
602

 
398

 
621

Total restructuring expense
$
398

 
$
602

 
$
398

 
$
621

During the second quarter and the first half of 2019, we recorded $0.4 million in restructuring expense related to the 2019 Plan, which consisted of costs associated with employee severance and benefits. The 2019 Plan was complete as of the second quarter of 2019 and we do not expect to incur any further charges related to the 2019 Plan. Through June 30, 2019, the cumulative amount incurred related to the 2019 Plan is $0.4 million, none of which is included in cost of revenue.
During the second quarter and the first half of 2018, we incurred expenses of $0.6 million related to the 2018 Plan and the 2017 Plan, which consisted of costs associated with employee severance and benefits. The 2017 Plan and the 2018 Plan were completed in 2018 and we did not incur any further restructuring charges related to the 2017 Plan or the 2018 Plan in 2019.
Provision for income taxes
The provision for income taxes during the 2019 and 2018 periods is primarily comprised of current and deferred tax expense in profitable cost-plus foreign jurisdictions, accruals for tax contingencies in foreign jurisdictions and benefits for the reversal of previously recorded foreign tax contingencies due to the expiration of the applicable statutes of limitation. We recorded a negligible benefit for the reversal of previously recorded foreign tax contingencies during the first half of 2019 and during the first half of 2018.

26


Liquidity and Capital Resources
Cash, cash equivalents and short-term marketable securities
Total cash and cash equivalents decreased $1.2 million to $16.7 million at June 30, 2019 from $17.9 million at December 31, 2018. Short-term marketable securities increased $0.5 million to $6.6 million at June 30, 2019 from $6.1 million at December 31, 2018. The net decrease in cash, cash equivalents and short-term marketable securities of $0.7 million during the first half of 2019 was the result of $2.4 million used for purchases of property and equipment and licensed technology, $2.2 million used in operating activities and $0.3 million used in payments on other asset financings. These decreases were partially offset by $3.9 million in net proceeds from the sale of patents and $0.3 million in proceeds from the issuances of common stock under our employee equity incentive plans.
As of June 30, 2019, our cash, cash equivalents and short-term marketable securities balance consisted of $6.8 million in cash equivalents held in U.S. dollar denominated money market funds, $9.9 million in cash, $2.5 million in corporate debt securities, $2.5 million in commercial paper and $1.6 million in U.S. government treasury bills. Our investment policy requires that our portfolio maintain a weighted average maturity of less than 12 months. Additionally, no maturities can extend beyond 24 months and concentrations with individual securities are limited. At the time of purchase, the short-term credit rating must be rated at least A-2 / P-2 / F-2 by at least two Nationally Recognized Statistical Rating Organizations ("NRSRO") and securities of issuers with a long-term credit rating must be rated at least A or A3 by at least two NRSRO. Our investment policy is reviewed at least annually by our Audit Committee.
Accounts receivable, net
Accounts receivable, net increased to $7.4 million as of June 30, 2019 from $7.0 million as of December 31, 2018. The average number of days sales outstanding increased to 37 days as of June 30, 2019 from 31 days as of December 31, 2018. The increase in accounts receivable and days sales outstanding was due to normal fluctuations in the timing of sales and customer receipts within the second quarter of 2019, and the fourth quarter of 2018.
Inventories
Inventories were $2.8 million as of June 30, 2019 and $3.0 million  at December 31, 2018. Inventory turnover decreased to 11.0 as of June 30, 2019 from 12.3 as of December 31, 2018 primarily due to lower cost of goods sold during the second quarter of 2019 compared to the fourth quarter of 2018. Inventory turnover is calculated based on annualized quarterly operating results and average inventory balances during the quarter.
Capital resources
Short-term line of credit
On December 21, 2010, we entered into a Loan and Security Agreement with Silicon Valley Bank (the "Bank"), which was amended on December 14, 2012, December 4, 2013, December 18, 2015, December 15, 2016, July 21, 2017, December 21, 2017 and December 18, 2018 (as amended, the "Revolving Loan Agreement"). The Revolving Loan Agreement provides a secured working capital-based revolving line of credit (the "Revolving Line") in an aggregate amount of up to the lesser of (i) $10.0 million, or (ii) $1.0 million plus 80% of eligible domestic accounts receivable and certain foreign accounts receivable. The Revolving Line has a maturity date of December 27, 2019. In addition, the Revolving Loan Agreement provides for non-formula advances of up to $10.0 million which may be made solely during the last five business days of any fiscal month or quarter and which must be repaid by us on or before the fifth business day after the applicable fiscal month or quarter end. Due to their repayment terms, non-formula advances do not provide us with usable liquidity.
The Revolving Loan Agreement, contains customary affirmative and negative covenants as well as customary events of default. The occurrence of an event of default could result in the acceleration of our obligations under the Revolving Loan Agreement, and an increase to the applicable interest rate, and would permit the Bank to exercise remedies with respect to its security interest. As of June 30, 2019, we were in compliance with all of the terms of the Revolving Loan Agreement.
As of June 30, 2019 and December 31, 2018, we had no outstanding borrowings under the Revolving Line.
Liquidity
As of June 30, 2019, our cash and cash equivalents balance of $23.3 million was highly liquid. We anticipate that our existing working capital will be adequate to fund our operating, investing and financing needs for at least the next twelve months. We may pursue financing arrangements including the issuance of debt or equity securities or reduce expenditures, or both, to meet our cash requirements, including in the longer term. There is no assurance that, if required, we will be able to raise additional capital or reduce discretionary spending to provide the required liquidity which, in turn, may have an adverse effect on our financial position, results of operations and cash flows.

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From time to time, we evaluate acquisitions of businesses, products or technologies that complement our business. For example, on August 2, 2017 we closed the Acquisition and issued 3,708,263 of our shares of common stock as consideration. Any additional transactions, if consummated, may consume a material portion of our working capital or require the issuance of equity securities that may result in dilution to existing shareholders. Our ability to generate cash from operations is also subject to substantial risks described in Part II, “Item 1A., Risk Factors.” If any of these risks occur, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash and cash equivalents to support our working capital and other cash requirements. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through debt financing, equity financing or from other sources. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our shareholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing shareholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility, and would also require us to incur interest expense. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us.
Contractual Payment Obligations
Our contractual obligations for 2019 and beyond are included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2019, filed with the Securities and Exchange Commission on May 10, 2019. Our obligations for 2019 and beyond have not changed materially as of June 30, 2019.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Item 3.         Quantitative and Qualitative Disclosure About Market Risk.
Not applicable.


Item 4.
Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Based on management’s evaluation (with the participation of our Chief Executive Officer (our Principal Executive Officer) and Chief Financial Officer (our Principal Financial Officer)), our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) to determine if they provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this report, due to a previously reported material weakness related to not having a control to review the appropriateness of an accrual based on applicable statutes of limitation due to ineffective risk assessment of the continued existence of the liability, the Company’s disclosure controls and procedures were not effective at the reasonable assurance level.
This material weakness is described in Item 9A, “Controls and Procedures,” of our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2018 filed on August 9, 2019.
There were no material errors in the financial results identified as a result of this control deficiency, and there were no material restatements of prior period financial statements and no material changes in previously released financial results as a result of these control deficiencies. Additionally, the immaterial error correction resulted in no impact on the Company’s cash balances at any point in time. Please refer to “Note 1: Basis of Presentation” in Item 1 of this Form 10-Q for description and impact of an immaterial error correction related to the material weakness described herein.


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Remediation effort to address material weakness
As previously described in Item 9A of our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2018, the Company began implementing a remediation plan to address the material weakness mentioned above. This included the implementation of controls over the process of reviewing significant aged liabilities with internal legal counsel for appropriate application of any statute of limitation. We believe that our remediation efforts to establish controls surrounding aged liabilities are significant improvements t