Pixelworks Inc (PXLW) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to the second quarter earnings announcement for Pixelworks Incorporated. [OPERATOR INSTRUCTIONS] I’ll be turning the call over to Mr. Jeff Bouchard, Chief Financial Officer.

Please go ahead.

Good afternoon, and thank you for joining us.

With me today is Allen Alley, President, CEO and Chairman.

The press release we issued today includes an outlook section containing forward-looking statements about our business.

Additionally, on this conference call, we are going to be commenting on our business outlook and making forward-looking statements based on our current expectations.

All of our forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially.

Please refer to today’s press release for a description of factors that could cause actual results to differ materially from those forecasted.

The forward-looking statements we make today speak as of today, and we do not undertake any obligation to update any such statements to reflect events or circumstances occurring after today.

Our comments will also include references to certain pro forma financial results, which differ from results prepared in accordance with generally accepted accounting principles.

A detailed reconciliation between the statement of operations on a pro forma and GAAP basis is included with the financial statements that accompany the press release we issued today.

I will now turn it over to Allen.

Thanks, Jeff.

I will spend a few minutes providing an overview of the business, and then turn it over to Jeff to cover the second quarter financial results in detail, which will require a bit more time than usual as a result of the Equator Technologies acquisition.

The acquisition of Equator was completed on June 14, so second quarter financial results include Equator for the last two weeks of the quarter.

As a reminder, our April outlook did not include the Equator acquisition in our projected results, so comparing actual results to the outlook is not an apples-to-apples comparison.

Revenue in the second quarter of $41.3 million was in the middle of the outlook.

A small amount of revenue from Equator in the last two weeks of the quarter was almost completely offset by sales reserves that were necessary.

So, Equator contributed an immaterial amount of revenue to our combined results in the second quarter.

Prior to the acquisition, Equator recorded approximately $8 million in revenue in the second quarter that does not appear in our results.

On the bottom line, due to all of the unusual charges this quarter, we posted a GAAP loss of $0.05 per share and pro forma loss of $0.03 per share.

Again, the reported results cannot be directly compared to the April outlook because the April outlook did not include the acquisition of Equator, which was dilutive to earnings.

With the Equator Technologies acquisition just being recently completed, I would like to start by spending some time discussing the acquisition and the business.

When I look at the Equator acquisition, there are really two basic deal drivers for us.

First, our over-arching strategy is to “own the signal path.” Before the Equator acquisition, we analyzed our position and strategic direction and identified what we believe is a very significant market trend.

The next logical and technological step in the evolution of the television signal path is a transition in content delivery from a broadcast television, where you watch what is available at the time that it is available, to the Internet Protocol, or IPTV model that reflects the on-demand access of the Internet.

With IPTV, you get to watch what you want to watch, when you want to watch it, just like with a digital video recorder.

Based on market projections for the IPTV set-top box market, which is estimated to grow from 4 million units in 2005 to over 13 million units in 2008, it seems quite apparent that the Internet will likely revolutionize the way we view TV, just as it has revolutionized the way we publish, distribute and listen to music.

The second deal driver is related to software and programmable solutions.

An increasing amount of the value we provide to our customers is really in the software.

I think this is best illustrated by looking at the software complexity of our products by segment.

A typical monitor product for us requires something on the order of 5,000 lines of code for baseline picture tuning and source selection and synchronization functions.

It does not require an operating system.

A typical analog-only television requires approximately ten times the number of lines of code for controlling tuners, picture-in-picture, additional sources, and a more complex user interface.

When we get to a digital television like a North American high definition television that meets the ATFC standard, the number of lines of code necessary approaches 4 million, or almost 100 times the number of lines required for an analog TV.

These systems all require an operating system.

In our case, we use Linux, and are orders of magnitude more complex than a monitor or an analog television.

We believe this plays to our strength because our chips have always been at the forefront of our industry, and we have been leaders in providing total systems solutions.

Equator’s model of a very long instruction word, or VLIW, processor, combined with an application-specific software stack, is the next logical extension of this model.

We believe we have recognized a fundamental shift in our business from a silicon-centric view, where software is a necessary distraction, to where our products are really marketed as software solutions.

I will discuss some of these trends more in detail later in the call when I give you an update on our progress with our digital television products.

Now let me turn to a review of the markets for our various products, starting with projectors.

Projector business in the second quarter was a bright spot and came in quite a bit better than we anticipated.

Projector revenue was up 18% sequentially to a little more than $14 million, up from about $12 million in the first quarter.

We were pleased to see strong growth for projectors again, after a couple of tough quarters.

We believe we are now seeing growth in the projector end market, and we are also benefiting from stabilization in DLP and polysilicon market share, with each representing roughly half of the projector market.

The project market has had to weather some significant turmoil this year.

Entering the year, industry analysts believe the market could reach as much as 5.8 million units.

According to Pacific Media Associates, a leading industry analyst, the market for business and consumer projectors is now expected to grow approximately 23% to 4.3 million units in 2005, which is down from a projected 4.6 million units in the previous forecast.

We believe the forecasts are now in line with the demand we are seeing with our customers.

We always keep close tabs on channel inventory, especially when the market moves.

We believe our main distributor, based on end-market uncertainty they were seeing in the last half of 2004 and into the first quarter of 2005, worked down inventory to about four weeks.

During the second quarter, they did increase inventory back up to about five weeks.

Looking forward, Q3 is usually seasonally soft, followed by a stronger Q4.

We believe that our Q3 will be down about 5% to 10%.

In spite of this, we are encouraged with many of the dynamics we see in our projector business right now.

Order rates significantly strengthened in Q2, the competitive landscape has settled down, and market share between DLP and polysilicon projectors appeared to have stabilized.

We have new products and are well positioned for the second half of 2005 and the design win cycle of 2006.

I will now turn to our monitors and panel products.

LCD monitor revenue in the second quarter was approximately $3 million, which was down 6% from the first quarter and roughly in line with our expectation.

Most of the revenue from this market is coming from higher end monitors, as we are not targeting the mainstream LCD monitor market.

We believe LCD monitor revenue will be down approximately 10% to 15% in the third quarter.

We continue to make progress on our programmable timing control product, code named “Peanut,” but have yet to ship any meaningful volume.

Our lead customer, Samsung, has been working closely with us to get over some technical hurdles to get us to mass production.

We remain cautiously optimistic, but until we get into production, there continues to be risk.

Our goal remains to begin shipping in the second half of this year.

I’ll now turn to advanced television, which is the largest revenue generator of our three end markets.

Advanced television business came in lighter than expected in the second quarter, down 3% to approximately $22.6 million.

Unit shipments grew 5% over the first quarter, but average selling prices declined 8%.

Flat panel television revenue, comprised of LCD and plasma TVs, were up slightly sequentially, while CRT television revenue declined.

Flat panel television revenue accounted for 96% of total advanced television revenue in the second quarter.

We believe the revenue shortfall compared to expectations for 5% to 10% sequential growth can be largely attributed to several factors.

During the quarter, we saw some very mixed performance from our customers who sell predominantly into Europe.

Some of these customers experienced significant channel inventory build-up during Q1 and Q2 that must be worked down.

On the other hand, we had customers who had excellent quarters but not enough to offset the former.

On balance, we believe Europe as an end market for our products came in flat to down for the quarter versus our expectation for growth.

Looking forward, Europe is seasonally slow in the summer, so we do not expect to see this situation change until we get into late Q3 or even Q4.

Secondly, we did not effectively manage a key product transition during the quarter.

We are currently engaged in the development of several new LCD and PDP televisions for one of our largest customers, scheduled for release later this fall.

These new TVs are slated to replace several existing models that use our current chip sets, as well as some that use our competitor’s chip sets.

During Q2, we saw a slowing of demand for the older generation plasma and LCD TVs that are being replaced by the new models.

The new models are largely very complex, North American, high definition, ATSC, digital televisions; and we underestimated the complexity of getting these products to market.

Let me take a moment to discuss our strategy and our experience.

At CES in January of this year, we announced our advanced DTV production reference design that included our PWM2000 MediaProcessor and our Indigo software to create an ATSC-compliant, DTV in a box for the North American market.

These systems are extremely complex and require something on the order of 100 times the lines of code used in an analog television.

In fact, when we sell these solutions to customers, we concentrate on promoting the features and advantages of the software, not the integrated circuits.

Even with our deep expertise in systems and software, we frankly underestimated the work required to get these projects into production.

After recognizing this, we have now focused our resources and drawn from every corner of Pixelworks to get our lead customers into production as soon as possible.

Unfortunately, the delay is having a negative effect on our revenue outlook for Q3.

However, the good news is we are one of the first companies to tackle television projects of this magnitude, and when we get these early customers into production, we believe we will be able to leverage this work to more rapidly expand our customer base.

As we move forward, we will continue to introduce new chips at lower cost with more features, while preserving the customer’s investment in software.

We have a large diverse number of television customers, totaling approximately 75 in the second quarter.

During the quarter, we continued to ramp the penetration of our Photopia family of products into this broad customer base.

Television revenue from our Photopia family of products increased over 60% sequentially.

Overall, looking at all applications, revenue from the Photopia family increased more than 70%.

The ramp of the Photopia family is especially significant because both Photopia and our new integrated all-in-one chip, code named Opal, both use our new Cobalt software.

This means Photopia customers are making the commitment to our new software platform and will be able to easily migrate to Opal for their next generation design.

We expect to see the ramp of our Photopia family of products continue through 2005.

We introduced Opal at the CES show in January 2005.

It is our most highly integrated product today that combines the features of our Photopia and Cheddar and Feta products into a single chip.

During Q2 we began to ship samples of Opal to our lead customers.

We expect to expand our shipments to meet our customers’ early pre-production builds in the third quarter.

We continue to develop our Shanghai Design Center.

Engineers from our Tualatin, Toronto and Campbell IC Design Centers have been sharing their experience on tools and methodologies, and these efforts have begun to show results.

During the quarter, we demonstrated the first chip from our Shanghai IC Design Center, which was a complete program from conception to silicon.

This program has two purposes.

It is an add-on video enhancement chip that we have targeted primarily for sale into the Chinese television market, and it also serves as a platform to test new video processing technology for future incorporation into our integrated products.

With respect to the overall market dynamics, LCD panel pricing has been somewhat stable over the past quarter.

Even with this panel price stability, we are continuing to see declines in the average selling prices of flat panel televisions.

For example, during last quarter’s conference all, we used Dell as a benchmark for aggressive pricing of a tier-one brand.

Dell’s 26-inch LCD TV was selling for $1,199 three months ago, and today it is selling for $1,099, an 8% decline.

Dell’s 42-inch high-definition plasma TV was selling for $2,799 and now three months later is selling for $2,599, a 7% decline.

In the mass market retail channel, we have generally seen white box brands for a 30-inch LCD TV crack the $1,000 barrier and, in some limited cases, of 32-inch LCD TVs dropping below $1,000.

While we believe this is a very positive sign that the manufacturers are capable of supplying products for below $1,000, the top-tier brands sold through the larger specialty electronic stores, have stubbornly stayed above $2,000.

In spite of the limited softness we are currently seeing in Europe, it seems that the overall flat panel TV market is going to do well or better than the numbers projected going into this year, especially LCD TVs.

LCD TVs were projected to do 14 to 16 million units entering the year, and most of the industry analysts now expect 18 million or more LCD TVs to be sold.

We believe if there is a major move by the top-tier brands to drop well below $2,000, there may be some upside to these numbers in Q4.

Looking forward at Q3, we believe that due to our reliance on Europe as an end market and the ramp of our new products, business will be somewhat back-end loaded.

Given our current visibility, we believe revenue will be coming in equal to or up to about 10% higher than what we saw in Q2.

I’ll now turn the call over the Jeff for his review of our financial results.

Thanks, Allen.

Before I begin my overview, I want to mention that I will be referring to both GAAP and pro forma numbers.

Please refer to the financial statements and notes in the earnings release for reconciliation of the differences between pro forma net income and the net income according to GAAP.

I’ll begin by giving you a financial overview of the Equator Technologies acquisition and its effect on our second quarter financial results.

As a result of the acquisition closing on June 14, the financial results include Equator Technologies for the last two weeks of the quarter.

The total purchase price was $117.9 million, with $109.6 million of that paid in cash and $8.3 million representing the fair value of 1.3 million Pixelworks options issued in exchange for Equator options.

In addition, there is up to 2.5 million in contingent consideration in the form of a bonus plan for Equator employees now employed by Pixelworks.

The actual amount of bonus to be paid will be determined by the amount of revenue from Equator products shipped through the first quarter of 2006.

The bonus will be paid to eligible employees over a four-quarter period, beginning in the second quarter of 2006.

There are a number of expenses that hit our income statement this quarter as a result of the acquisition.

I’ll highlight these so that you have an understanding of the differences between actual results and the outlook we provided in April, which did not contemplate the acquisition.

First, we incurred $585, 000 in incremental non-cash expenses for the amortization of various and tangible assets and stock compensation expense related to the acquisition. $248,000 of these expenses fell within operating expenses, and $337,000 within costs of sales.

Next, there was an additional $85,000 in non-cash expenses amortized as costs of sales as a result of the sale of Equator products.

These expenses resulted from purchase accounting, where we were required to mark up the cost of all inventory on hand at the time of acquisition to a cost representing the difference between the estimated average selling price of the inventory and a reasonable profit.

In our case, that meant marking up the actual cost of the inventory by roughly 80%.

As this inventory is sold, the additional cost markup is amortized to cost of sales, which reduces gross profit margin on the sale of these products from approximately 45% to approximately 12%.

We expect that all of the revenue from Equator products shift in the third quarter will also be from inventory on hand at the time of acquisition, so gross profit margins for GAAP purposes will be artificially low until all of the inventory is sold, which we expect will be some time in the fourth quarter.

We’ve excluded this cost markup when reporting pro forma financial results.

The largest single expense related to the acquisition was a $779,000 loss on the sale of investments.

We incurred this lost as a result of selling marketable securities before maturity in order to raise the cash necessary to pay for the acquisition.

Summarizing, in total we incurred over $1.4 million in non-cash or non-recurring expenses related to the Equator acquisition in the second quarter.

All of these expenses were excluded when reporting pro forma financial results.

In addition to these non-cash and one-time expenses, we incurred approximately $915,000 in operating losses from Equator in the second quarter that negatively impacted both GAAP and pro forma financial results.

These expenses were in the form of ongoing operations, R&D and SG&A expenses from the acquisition date through the end of the quarter.

So, in total, we had $2.4 million in expenses in the second quarter from the Equator acquisition that negatively affected GAAP pretax financial results and approximately $915,000 that negatively affected pro forma pretax financial results.

In addition to Equator expenses, we also had two other one-time expenses that negatively impacted our financial results in the second quarter.

First, we had a little over $300,000 in depreciation adjustment on some software development tools whose life was shorter than the estimated life originally used to depreciate the asset.

This expense fell within the depreciation line in R&D expenses.

We also had approximately $200,000 in expenses related to new product yield issues, which increased cost of sales and reduced gross profit margin by approximately 50 basis points.

Now that I’ve covered the acquisition-related and one-time expenses in the second quarter, I’ll take you through the line items in the income statement, starting with revenue.

Revenue in the second quarter of $41.3 million increased 3% over the first quarter.

This was in the middle of the range of $40 to $43 million in the April outlook.

Revenue contribution from Equator products was negligible as a small amount of shipments in the last two weeks in the quarter was offset by sales reserves.

Prior to the acquisition, Equator Technologies shipped about $8 million in revenue in the second quarter.

Our customer base remains diverse, with our largest customer at 13% of revenue.

No other customers were above 10% of revenue in the second quarter.

Gross profit margin on a GAAP basis in the second quarter was 39.2%, down 280 basis points from 42% in the first quarter.

Without Equator, GAAP gross profit margin would have been 40.4%.

Approximately 100 basis points of the decrease was from Equator acquisition-related expenses, about 50 basis points from new product yield issues, and the remainder from the less profitable customer mix.

On a pro forma basis, gross profit margin was 40.6% in the second quarter, down 170 basis points from 42.3% in the first quarter.

The decrease in pro forma gross profit margin resulted from the new product yield issues and less profitable customer mix that I just covered when discussing GAAP gross profit.

R&D and SG&A expenses combined increased to $18.5 million in the second quarter, up $2 million from the first quarter.

Of this increase, approximately $900,000 was attributable to Equator Technologies’ expenses for the last two weeks of the quarter.

The remaining $1.1 million increase resulted from the depreciation expense adjustment discussed earlier.

And the remaining portion of the increase came primarily from increased development expenses, as well as compensation expenses related to higher head count.

On a GAAP basis, the loss before taxes was $2.6 million, or 6.2% of revenue.

Without Equator, the pretax loss would have been approximately $214,000.

On a pro forma basis, the pretax loss was $860,000, or 2.1% of revenue.

Without Equator, we would have been profitable on a pro forma pretax basis with approximately $55,000 in income before taxes.

The tax provision in the second quarter, both on a GAAP and pro forma basis, was unusual due in large part to changes in our projected pretax income as a result of the acquisition.

The GAAP and pro forma tax provisions include a charge of approximately $650,000 as a result of an increase in valuation allowance on deferred tax assets related to Oregon R&E tax credits that are not expected to be utilized.

On the bottom line, the GAAP net loss was $2.3 million, or $0.05 per share.

This compared to GAAP net income of $836,000, or $0.02 per share, in the prior quarter.

On a pro forma basis, the pro forma net loss was $1.6 million, or $0.03 per share, which compared to pro forma net income of $1.1 million, or $0.02 per share, in the prior quarter.

Now turning to the balance sheet, cash and marketable securities consisting of cash and cash equivalents, short-term marketable securities, and long-term marketable securities were approximately $163 million at the end of the second quarter.

While we generated $1.7 million in cash from operations in the second quarter, cash and marketable securities decreased $107 million as a result of the acquisition.

Accounts receivable of $18.1 million increased to $2.9 million from $15.2 million in the first quarter. $2.4 million of that increase came from Equator Technologies.

Excluding accounts receivable from Equator, the number of day sales outstanding held in accounts receivable remained unchanged at 34 days.

With Equator receivables, DSO was 40 days.

Inventory of $25 million increased $11.4 million from the first quarter as a result of bringing on Equator inventory.

Included within the ending inventory balance was approximately $5 million from the cost markup on acquired Equator inventory required under purchase accounting.

This cost will be amortized to cost of sales as the inventory sells through.

I’ll now provide a few details behind the Q3 outlook provided in the earnings release issued earlier today.

We expect revenue in the third quarter to be approximately $47 to $51 million.

We expect advanced television revenue to be flat to up 10% from the second quarter, LCD monitors to be down 10% to 15%, and projector revenue to be down 5% to 10%.

We expect revenue from Equator products to be approximately $8.5 to $9.5 million.

At this time, we have approximately 70% of the midpoint of the estimated revenue range for the third quarter either shipped or booked and scheduled for shipment.

Gross profit margins in the third quarter are projected to be approximately 29% to 31% on a GAAP basis.

GAAP gross profit margins will decrease in the third quarter as a result of all the acquisition-related expenses that will flow through the income statement.

We estimate these charges will amount to $5.5 to $6 million in the quarter and have the effect of reducing gross profit margins by approximately 12 percentage points.

Pro forma gross profit margins, which exclude all of the non-cash, acquisition-related expenses, are expected to increase from 40.6% in the second quarter to approximately 41% to 43% in the third quarter.

The increase is primarily attributable to the inclusion of revenue from Equator products, which have product margins higher than average corporate margin when not burdened by non-cash expenses resulting from purchase accounting.

R&D and SG&A expenses combined are expected to be $23.5 to $24.5 million in the third quarter.

The majority of the increase from $18.5 million in combined expenses in the second quarter result from including Equator’s expenses for a full quarter compared to only two weeks in the second quarter.

Other income consisting of interest income less interest expense and amortization of debt issuance cost is expected to be approximately $225,000 in the third quarter, which is down from the second quarter as a result of the cash outlay for the acquisition of Equator.

The effective tax rate, both on a GAAP and pro forma basis, is very difficult to accurately predict because of its sensitivity to changes in levels of income or loss before taxes.

Our best estimate at this time is that it will be approximately 40% to 50% on a GAAP basis and 75% to 80% on a pro forma basis.

On the bottom line, we expect a loss per share of $0.10 to $0.13 on a GAAP basis and $0.01 to $0.02 on a pro forma basis.

That concludes a review of the second quarter financial results and the third quarter business outlook.

For information on all elements of our financial results and business outlook, please refer to the press release issued earlier today announcing second quarter financial results.

The press release is available on the Investor section on our Website at www.pixelworks.com.

I will now turn the call back to Allen for his closing comments.

Thank you, Jeff.

We are rolling out some of the most complex IC software and systems products in our history.

The Photopia family has been joined by Opal, the PDM2000 MediaProcessor, the Equator PWBSP-16 Broadband Signal Processor, and our new software platforms, Cobalt and Indigo.

The projector business, after several quarters of weakness, has come back, and the project market appears to be returning to normal seasonal patterns for the balance of the year.

The split between polysilicon and LCD-based projectors and DLP projectors seems to be stabilizing at around 50/50.

We are seeing lower panel costs drive new price points for LCD and plasma television.

Three months ago, the 27-inch LCD TV broke the $1,000 barrier, and we have now seen 30-inch LCD and even 32-inch TVs break it.

We are currently facing some challenges in our television business as we phase in our new products and take on new customer development programs that require us to deliver an unprecedented level of complex software and systems.

We are addressing these challenges, and when we are successful, we believe we will have built a new core competency that can be leveraged to broaden our base of digital television design wins.

The market opportunity is clear.

The march of LCD and plasma displays to replace the CRT continues.

We believe that IPTV will revolutionize the way we view TV, just as the Internet has revolutionized the way we publish, distribute and listen to music.

We are making the investments necessary to harvest these opportunities and to complete our strategy to own the signal path.

We will now open the call for questions.

[OPERATOR INSTRUCTIONS] Rueben Roy;

Pacific Crest Securities.

A couple of questions.

First, Allen, you talked both about white box brands and top-tier brands out there and 75 customers that you have as your TV customer base.

Can you give us kind of the mix between where you’re selling into white box brands and top-tier brands?

Yes.

With 75 customers, it’s not as straightforward.

Many of our customers sell to top-tier brands.

In Taiwan, for example -- Jeff, do you have the number of customers, just a ball park, in Taiwan?

25 to 30.

So, you’ve got about 25 to 30 guys in Taiwan.

Mostly, they don’t sell under their brand.

They sell in top-tier brands.

They sell to the Japanese brands and the European brands.

For us, it is difficult to break it out - much more difficult than some of our other competitors.

But, if you look -- I think we talked on the call a couple of calls ago about the number of top-tier brands that we have and the number of accounts that we have, that hasn’t changed materially from a couple of calls ago.

If you looked at our customer list of the end brands that are selling products with Pixelworks’ parts in it, you’d see many, many of the top-tier brands, both from Japan, from the United States, and from Europe.

What do you need to happen to hit the higher end of the guidance for the ATV segment of 10%?

We need to have some of the European customers, and these are the end customers, sell through.

The design wins are all in place there.

The other thing is we need to ramp those North American ATSC designs and actually get them into production at the end of Q3 rather than the beginning of Q4.

That would have a material effect on hitting the top end of the range as well.

Okay.

I have one for Jeff, and then I’ll pass it on.

Jeff, in terms of the OpEx numbers that you gave us to guide us going forward of $23.5 to $24 million, can you give us a breakout between R&D and SG&A?

Yes.

I would estimate R&D will be probably somewhere in the $13.5 to $14 million range, and then the balance of course in SG&A.

So, it looks like you’re at around 50% of revs in operating expenses.

Would you expect that to kind of continue through?

Well, we need to bring that down as a percentage of revenue, so we’re going to be working on that as we move forward.

But, just looking at the next quarter, that’s what it would be roughly.

Brian Alger of Pacific Growth Equities.

Not wanting to get into the months of the charges here, your competition, i.e., Trident and Genesis, have posted phenomenal numbers in terms of growth, both in the June quarter and in terms of what they’re guiding to for September.

I’m trying to understand how much market share you guys have really lost and whether or not you guys can actually get it back.

Both Genesis and Pixelworks were talking about 50% plus growth in September; you’re talking 5% to 10%.

How much exposure can you possibly have in Europe to explain this?

Brian, obviously, with the numbers that they’re posting, there has been a market share loss.

As we look at our customer base, and we look at all the major design wins that we have, we can’t think of any major design wins that we’ve lost in the last quarter or so that would be affecting us in Q2, Q3 or Q4.

We do see this transition where we had a design win, it went out of production or is going out of production, and we’re ramping new design wins there.

There’s some GAAP there as well.

But, obviously, they’ve done a good job.

And, we’ve got a ways to go to hone our design win base and get our customers into production, and that’s what we’re really focused on for the next quarter or two here.

Okay.

You talked about an execution issue that you had with a particular account ramping an ATSC-based solution for the North American market.

Is this a U.S.-based customer, or is this a customer from Taiwan?

We can’t really comment on who the customer is, Brian.

It’s one of our larger customers.

It’s specifically for the North American market.

There’s also a model for the European market that we’re working on with them, but the ones that were really critical for us are North American products.

Do you know if this customer has second-source supply agreements with some of your competition?

Yes.

These products are -- specifically, they’re large and complex.

We don’t believe that they have second-source agreements with anybody.

These are the kind of products where you sole-source them and replace the previous product and roll into the new one.

Okay.

Fair enough.

We obviously seem to be on track with your original expectations for Equator in terms of revenue growth.

Are there any potential designs that you’re chasing right now that could post some upside in terms of extended beyond that 10% to 15% quarterly growth that you eluded to in the last conference call?

We’re really active in a lot of designs with Equator right now, and designs wins with Equator right now -- competing for design wins for Equator.

We’ll get more clear on the next call and the call after that in terms of the status of that, but its’ a very, very active, dynamic market right now, and we’re very active with a lot of different customers working on design win activity with them.

One final question.

The end market according to display searches is expected to see its peak period or peak period of growth in this September for you guys, with the end market growing about 53% in Q4.

The outlook for you guys going into Q4 based on the end market in Q1 for TVs isn’t nearly as strong.

In fact, sequential decline is what’s seasonally the pattern.

How long do you think it will take for you guys to return to sustainable profits?

That’s something that’s really important to us, so obviously for the next quarter at least, we haven’t projected that.

We did talk a quarter ago when we went into the Equator acquisition that it would be diluted by a few pennies as we entered the third quarter, so that’s certainly a little bit of a drag here in the short term.

We’re going to need a few quarters to work through that.

And, then, also, hopefully see some uplift in the TV business that those dollars not at the gross profit level can kind of drop to the bottom line.

I can’t really go beyond this current quarter, but, obviously, it’s a very, very high priority for us to return to profitability.

Hey, Brian, in terms of the design wins, let me talk and just move back a little bit more on that.

In Q1 and Q2, we had, I think we said, about 75 different customers in the advanced television business.

That’s actually expected to grow in Q3 as we roll forward.

We have a very, very, very broad set of design wins.

I think the thing that’s different about us is there’s probably a higher percentage of ours that are kind of two-tiered, people selling to a brand.

So, in some cases, I think our visibility is a little bit cloudier than some others’ visibility if you’re selling directly to the brand.

Where we do sell directly to the brand, we do tend to have a little better visibility.

Alright.

Well, that’s hopeful.

[OPERATOR INSTRUCTIONS] Jennifer West;

Merriman.

I was wondering if you can give us the breakout of what your end customers in TV are by geography?

Are you weighted more heavily towards Europe than maybe the average TV shipments are?

Jeff will pull out the numbers for you, but when we talk about being weighted toward Europe, it’s not necessarily chips that we sell to people that are European customers, it’s the end market for our products.

For example, we’ll sell chips to a Taiwanese integrator, who then sells to a Japanese brand, who is selling a European television set.

I think Jeff can give you the break out by region, but that won’t necessarily reflect the effect that I’m talking about.

We do think we’re probably higher weighted towards Europe as an end customer market than some of our competition.

Roughly, Jennifer, for us last quarter the top three regions were China -- this is where the end customers are not -- our customer is located.

It was fairly equally weighted between China, Europe and Taiwan at roughly 25% of our TV revenues shipping to customers in those regions.

Then, Japan and Korea is kind of roughly 10% or so each.

That’s how it breaks down.

As Allen mentioned, a lot of the customers in Taiwan end up building products, in our case, at least, for sale in Europe.

In fact, one of our major Japanese customers is a European design win.

It’s a Japanese brand that sells in Europe.

Okay.

And, can you talk to what your unit and ASP trends in projector were during the quarter?

Overall, project units were up about 25% sequentially, and that was offset a little bit by ASP declines of 5%.

Net/net, it was up 18% on a revenue basis.

But, the thing that you need to understand a little bit within that mix is that we sell coprocessors and then image processors.

The coprocessors sell at roughly a third of the price of an image processor.

So, depending on the overall mix within any quarter, that does influence the ASP number that I just gave you.

So, to give you a little bit more color, image processors’ ASPs went down 3% sequentially, and our coprocessor chips that we bundle with some of our image processor sales actually increased on average about 3%.

Some of that change in the ASP overall was related to the mix of those chips.

Can you do the same thing for TVs?

Is that mix related too, or is that a part-for-part basis decline that you guys saw there?

Yes.

Definitely a lot of mixed things going on within that number.

I don’t have those at my fingertips though.

Roughly speaking, I would say ASPs on a chip-by-chip basis have been declining in kind of the mid- to single digits per quarter.

I guess I’m just struggling with your margins.

I thought your margins for projector were higher than your corporate average, so when you saw the mix swing this quarter more weighted towards projectors, was there something going on in the margins of projector and TV that kind of offset that?

Yes.

You’re right.

Projector margins are the highest, and that did help our average margins this quarter.

At the same time, primarily in the TV part of our business, just the customer mix that we ended up having-- You know we have some customers that are much more profitable than others.

It was unfavorable relative to the mix that we had last quarter.

The other dynamic, certainly in the TV part of our business, is the particular mix of more mature products to our newer products is changing all the time.

So, depending on the specific mix, again, the margins are dramatically different from our newer products to our older products.

Net/net, we did see some margin erosion in the TV part of our business, mainly because of the mix of customers.

Daniel Gilpa [ph];

CIBC.

This is actually Dan Morris calling for Daniel.

I wanted to ask a question - a couple of competitive landscape questions to begin with.

In the projector market, have you seen any new entrants that seem to be making any progress?

We’re thinking maybe Silicon Optics on the high end, for example.

You know, Silicon Optics has been around in the projector business for a couple of years now, and they have had some very high-end designs.

But, it’s really not material in a unit number for our business.

It may be material for them because their chips are very, very expensive.

So, no.

Nothing dramatic in the competitive landscape, and things have pretty much stabilized for the TI.

Okay.

And, on the TV side, especially in light of a lot of your customers being the second tier there, have you been seeing any pickup in competition in the lower end?

We know that Phillips has an internal solution that they’ve been rolling out, as well as MediaTech.

Have you seen any more pressure from them?

They’re around.

Phillips is certainly around, especially in their own TVs.

They’ve been very, very strong kind of in their own supplier base.

MediaTech and the other Taiwanese guys?

Yes, they’re around, and they’re sampling parts.

But, I wouldn’t say that there’s been a dramatic swing to a different set of competitors than what we’ve had before.

I think it’s about what we’ve seen in the past couple of quarters.

One last question.

In light of the execution issues that you’ve identified and their impact on the near-term results, have you seen or do you anticipate any impact on design wins with these customers for the future?

The only impact I expect to see is a positive impact from getting these designs out and being able to shrink wrap these rather complicated solutions and ramping people into production very, very quickly.

Once we get past these, we think we’ve got a very strong position to do that.

Jason Blum;

Thomas Weisel Partners.

Hi.

This is Alex Kim calling in for Jason.

Just a question on Europe specifically.

Obviously, there’s some weakness that you’re experiencing there.

Can you give a little bit more color to the dynamic that’s going on there?

And, when can we see things get a little bit healthier in your view with respect to Europe?

Yes.

It’s been very, very choppy.

Like we mentioned in the call, we’ve seen some customers that had a great quarter, some customers that went from a great Q1 to a terrible Q2, and it’s the same designs - the same design win slots for us.

It’s just, in some cases, they had some channel inventory issues that they were working through.

In others, they didn’t.

There’s not one clear thread, except that it feels like overall the European market was slow for us in Q2 because of these spot issues.

Looking at Q3, again, because we seem to have a larger exposure in Europe maybe than some of our competitors, and Q3 is always slow in Europe, we’re not forecasting a dramatic flip in that trend.

We’re cautiously optimistic as we get out to the end of Q3 and look into Q4 when Europe comes back that we could see a rebound there.

But, we’re not forecasting that yet.

Just a question on the breadth of customers.

I know that over the last few quarters, we’ve seen a pretty sizeable increase in the number of customers.

Has the number of customers increased significantly again this quarter?

About 10% or so.

I would expect to see that slow down as we go forward.

I don’t know how many more TV customers we could have.

As you get up into 75, 80 or 85 TV customers, I just don’t think there’s that many more people out there building TVs.

In fact, I think we’ve done a very, very, very good job of having these shrink-wrapped solutions that we can ramp these customers and get them into production fairly quickly.

I think we’ve got a lot of design wins out there, and we’re in a good position for them to see some uplift as we get through Q3 and into Q4.

I think that’s one thing that certainly differentiates you is the wide customer base.

And, then, finally, just a question on inventories.

As far as inventories, I think we’ve seen certainly a rise there from the previous quarter.

What percent of that is Equator related, and are you comfortable with your current levels of inventory?

Yes.

About 11 million out of the 25 is Equator related.

And, within that 11 million, 5 million of that is that cost markup that you get from purchase accounting.

So, the true inventory levels from Equator are about 6 million and then about 14 from Pixelworks’ products.

That’s pretty flat with the prior quarter.

The level of inventory I think we’re very comfortable with at this point.

Okay.

That helps out a lot.

Thanks, guys.

[OPERATOR INSTRUCTIONS] Gentlemen, it does appear there are no further questions in the queue.

I’d like to turn things back over to Allen for any closing remarks.

Okay.

Great.

Before signing off, I’d like to mention that we’ll be participating in the Pacific Crest Technology Forum in Vail, Colorado on August 8, in the Oregon Technology Tour on August 10 at our offices here in Oregon.

We’ll also be attending the Merriman Curran Ford Investor Summit in San Francisco on September 19 through the 21.

Thank you for joining us today.

Once again, that does conclude today’s conference call.

Thank you all for your participation, and have a great day.