Pixelworks Inc (PXLW) 2005 Q3 法說會逐字稿

Good day, and welcome to the third quarter earnings announcement conference call for Pixelworks, Incorporated.

Today's call is being recorded.

At this time I would like to turn the call over to Mr. Jeff Bouchard, Chief Financial Officer.

Please go ahead, Mr. Bouchard.

Thank you.

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 forecast.

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 non-GAAP financial results, which differ from results prepared in accordance with Generally Accepted Accounting Principles.

A detailed reconciliation between the statement of operations on a GAAP and non-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'll spend a few minutes providing an overview of the business, and then I'll turn it over to Jeff to cover third quarter financial results and fourth quarter outlook.

Third quarter revenue of $46.8 million came in just shy of the bottom end of the outlook but due to higher-than-expected gross profit margins and expenses coming in on the lower end of our range, the loss on a GAAP and a non-GAAP basis was at the better end of our outlook.

The revenue shortfall was primarily attributable to the later-than-anticipated ramp of our new product introductions, particularly in the television business.

We continue to believe strongly in the market opportunity that we have.

Flat-panel televisions alone comprised of LCD and plasma TVs are expected to grow from 22 million units this year to 60 million units in 2008.

The delivery of video via the Internet is growing every day.

The introduction of the video iPod is the latest confirmation of this trend and is gaining momentum.

We have made investments to take advantage of these opportunities, and we believe we must continue to make these investments.

However, our short-term revenue is not increasing at the rate that allows us to continue to add the critical resources to execute our product roadmap.

We have undertaken a restructuring to improve the operations of our company.

The primary goal of the reorganization is to improve product development efficiency.

The changes we are making will, in the short-term, reduce operating expenses but, more importantly, allow us to add people, tools, and the intellectual property that is essential to building out our product roadmap.

The net result of these organizational changes is that we have reduced 36 positions across our Oregon and Silicon Valley facilities and, short-term, this will reduce quarterly operating costs by approximately $1 million.

Let me give you an overview of the changes.

We have made broad changes in our engineering organization.

We have unified worldwide engineering under our new Vice President of Engineering and CTO, Richard Tobias.

Richard joined us in June from Toshiba.

He has more than 20 years of experience and has run geographically distributed engineering groups.

He specifically brings deep experience and complex system-on-a-chip design.

We have already made significant changes to our product development process, tools, people, and structure that makes me very confident we will soon be delivering improved results.

We have also accelerated the integration of Advanced Media Processor group formerly Equator.

We originally thought we would run AMP as a stand-alone group and then integrate them over the next year.

As I mentioned, the acceleration of digital video distributed via the Internet has been dramatic.

Customers are asking for Internet connectivity for televisions and their set-top box and videoconferencing customers are asking for improved image quality and enhancement.

As a result, we have begun the process of creating a unified roadmap, and we have already integrated the engineering and marketing teams.

The other significant change in our organization has been in our sales force.

While we have been strong in Taiwan, China, and Europe, lately we have not been as successful with the tier 1 television customers in Korea and Japan.

We have hired two new senior sales executives to lead our efforts in Korea and Japan.

Both of these executives have excellent industry experience and significantly raise our presence and profile in these key geographies.

They are both chartered with expanding our footprint in these key tier 1 accounts.

Now let me give you a quick update on the new product introductions in the third quarter.

We were pleased to release to production four new products during the third quarter including Copper, a new and improved version of our Photopia image processor that is used in both televisions and projectors; and improved version of Feta, the successor to the Cheddar front-end chip that integrates our latest-generation video decoder and, most importantly, the tandem of the PWM 2000 MPEG 2 decoding chip and Opal.

Opal is our most highly integrated chip to date that essentially integrates into a single chip the functions of a Feta front-end chip with a Copper image-processing chip.

We shipped tens of thousands of both the PWM 2000 and Opal in Q3.

We are also very pleased to release to production our first digital TV solution to our lead customer, Dell, late in third quarter.

Dell recently introduced a 50-inch plasma TV and a 30-inch LCD TV and will soon be introducing a new 32-inch LCD TV that are capable of receiving ATSC broadcasts in the United States.

All of these TVs use multiple chips from Pixelworks including the PWM 2000.

This was a huge milestone for us as the software development effort was enormous.

It has not been easy, but we now believe we are beginning to ship the most complete, fully integrated ATSC compliant solution available in the industry.

We are excited to now be able to leverage the initial software development to get additional TV -- digital TV customers quickly into production.

I'll now turn to review the markets for our various products starting with projectors.

The projector business in the third quarter was again a bright spot coming in better than expected.

Projector revenue was $14.5 million, up from a little over $14 million in the second quarter and $12 million in the first quarter.

We continued to see stabilization in DLP and polysilicon market share with each representing roughly half the projector market.

There have been some interesting new products introduced in the projector business.

One of the innovations that we have promoted and pioneered is the integration of a progressive scan DVD player and a high fidelity audio system into a projector to create a theater in a box.

One of the most innovative and highest quality introductions of this theater in a box is the Epson Movie Mate 25.

The Movie Mate 25 is a 1,200 lumen, 16x9 wide screen projector that also includes a progressive scan DVD player integrated self-amplified JVC stereo speakers and an external subwoofer.

Epson has even included a portable, 80-inch 16x9 format floor-standing screen.

The estimated street price of the Movie Mate 25 is $1,199.

Looking at the overall market, what was split between polysilicon and DLP has stabilized at about 50-50.

The overall worldwide market forecast continues to be soft.

Entering the year, industry analysts believed this would be an extremely strong year with as much as 50% year-over-year growth.

According to Pacific Media Associates, a leading industry analyst, the market for business and consumer projectors is now expected to grow approximately 18% to 4.2 million units in 2005.

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

Looking forward to Q4, we are faced with some conflicting data.

On one hand, our book-to-bill in the third quarter was greater than one-to-one, and inventory at our distributor in Japan, our largest market, shrunk.

At the same time, the overall market is softening especially in Europe.

We believe we could see softness in demand as we move into the second half of the quarter.

Therefore, we believe Q4 could be down about 5% from Q3.

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

Order rates continue to be strong in Q3, the competitive landscape has settled down, and market share between DLP and polysilicon projectors appears 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'll now turn to monitors and panel products.

LCD monitor revenue in the third quarter was approximately $3 million, which was flat from the second quarter and was better than our expectations.

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 about $500,000 in the fourth quarter.

We continue to make progress on our programmable timing controller product, code-named "Peanut," but have yet to ship any meaningful volume.

During the quarter, we agreed to make some revisions to the chip based on feedback from our lead customer, Samsung.

This will delay the prospects for any significant production until the first half of 2006.

We are pleased with the level of commitment by Samsung on this program.

It is the nature of the business that we are getting into that getting into production is not easy.

We are developing new technology with new features and new benefits.

The good news is that once in production, the level of resources and support required are minimal.

We will then work to expand our design into a broader range of panels and applications.

I'll now turn to our advanced media processor business.

The former Equator technologies, or Advanced Media Processor, we call AMP business, came in in line with our expectations at $8.9 million.

The revenue was split pretty evenly between videoconferencing, set-top box, and other miscellaneous applications, which include broadcasting, coding, and imaging.

We had significant customer concentration with two customers -- one in videoconferencing and one in set-top box representing about 50% of this revenue.

New market introductions of new technology can often be unpredictable.

After two steady quarters of shipments, we are currently seeing some softness in set-top box demand.

We are now anticipating that new orders to support the continued rollout from our major customers will push out beyond the fourth quarter.

We believe Q4 revenue for our AMP products will be $6 million to $7.5 million.

The next logical and technological step in the evolution of the television signal path is a transitioning content delivery from a broadcast television model where you watch what is available at the time 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 when you want, just like with a digital video recorder.

The move to using the Internet to distribute video continues and is, in fact, picking up momentum.

The introduction of the video iPod is a leading indicator of this trend.

ESPN is now offering streaming college football games through their Game Plan website.

Games are live, and a selection of games are archived for time-shifted viewing.

We expect to see additional content and products introduced every year.

As I mentioned earlier, our customers are driving us to integrate our AMP business with our image processor business faster than we originally thought.

Television customers are asking for the ability to view digital video content delivered via the Internet and our set-top box and videoconferencing customers are interested in our video enhancement products.

We have recognized this and are taking steps to integrate our roadmaps and the development teams.

We believe this will enable us to, with reasonable development cost, bring Internet connectivity to our television customers and dramatically improved image performance to our set-top box and videoconferencing customers.

I will now turn to the advanced television business.

As I mentioned earlier in the call, we are pleased that we were able to begin shipment of our new television products in the quarter.

Unit sales of our newest television products including Feta, Photopia Copper, PWM 2000, and Opal increased over 45% sequentially, and revenue increased to more than $8 million.

Unfortunately, the ramp of these products did not occur until late in the quarter resulting in approximately 45% of our television revenue coming in the final month of the quarter.

Therefore, overall advanced television business was down about 13% to approximately $20 million.

During the third quarter, we had a very broad set of advanced television customers with the top 10 representing a little more than 16% of our business and only one being larger than 10% of advanced television revenue.

We continued to see a growth in our customer base to more than 80.

While we do see this broad customer base as a benefit and an endorsement of our total strategy, we believe we are now saturating the potential customer space and do not expect this number to continue to rise.

We believe, with the continued ramp of our new products, revenue in the advanced television business should grow 10 to 15% sequentially in the fourth quarter.

Success in the television business depends on optimizing two often-conflicting performance parameters continuously lowering cost and continuously improving performance.

We are lowering costs by building our team in Shanghai to design solutions for the extremely cost-focused digital CRT market.

We then plan to take these products and re-purpose them for flat panel displays.

By effectively competing in the CRT market, we drive the discipline to settle for nothing less than lowest cost in our other lines of business.

On the other hand, success in the tier 1 accounts requires both low cost but also great video quality.

In fact, you have to be able to win awards and direct shootout comparisons.

Recently Dell commissioned a comparison between a Dell 42-inch plasma TV, W4200HD, and a premium plasma TV from a top-tier Japanese television company.

The results were overwhelmingly in favor of the Dell, which is powered by Pixelworks Photopia image processor and was the first television to receive our DNX video certification. "Without knowing who makes either TV, following viewings on each TV and approximate prices for each model, more than two-thirds of all respondents preferred the Dell model."

Looking to the balance of 2005 and entering 2006, the ramp of our new digital television products is the key to our success.

We have made a huge investment in the IC system and software platforms necessary to complete these designs.

Our lead customer, Dell, and our integration partners in Taiwan and Korea have worked closely with us to bring these products into production.

The Dell program is a platform for the North American digital television market that covers 50-inch plasma TV and a 37-inch LCD TV and will soon include a new 32-inch LCD TV.

The experience that we gain developing what we believe is the most highly integrated, fully ATSC compatible system will be critically important to us as we roll out our new products at the Consumer Electronics Show, or CES, in early January 2006.

This is the last opportunity I will have to talk to you before CES, so I want to give you a preview of what we are working on and what we will be showing at CES.

CES 2006 will be the largest demonstration of new products in our company's history.

We are very focused on winning share in the digital CRT business during 2006.

We expect to demonstrate several new chips at CES.

The first is an entry-level digital CRT product that we believe will set new performance standards while providing extremely low total system cost.

For the mid-range, we expect to bring the power of our Opal family to a line of products specifically tailored to CRT televisions.

For the flat-panel television business, we also expect to introduce a complete new family of offerings from top to bottom.

The first is a very cost-effective chip that brings many of the features of Opal to the baseline flat-panel segment.

The second is the next generation of our mainstream Opal platform and, finally, for the premium segment, we expect to introduce a chip that will set new video performance standards for Pixelworks.

For the digital television segment, we expect to introduce our newest generation of low cost MPEG decoder chips for both the North American and European markets.

These chips are a second generation of MPEG decoder chips that both improve performance and lower cost.

We have made the investment in developing our new software platforms this year.

All of the new flat-panel television chips including those anticipated for introduction at CES leverage our new Cobalt and Indigo software.

We believe this will give our customers the lowest risk and fastest path to market.

In addition to the main platform products, we hope to have a few surprises at CES, including demonstration of some innovative video enhancement techniques and other new products that incorporate parts of the signal path that, up to this time, we have not included in our offerings.

We will be hosting an Investor Day at CES similar to what we did last year.

Watch our website for announcements regarding registration, time, and location.

We expect that live attendance will be limited due to space constraints, but we will also be offering a webcast.

I'll now turn the call over to 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 non-GAAP numbers.

Please refer to the financial statements and notes in the earnings release for reconciliation of the differences between financial results on a GAAP and non-GAAP basis.

Revenue in the third quarter of $46.8 million increased 13% over $41.3 million in the second quarter.

Approximately $8.9 million of the total revenue came from the inclusion of Equator.

As expected, revenue was back-end loaded in the quarter with approximately 45% of total revenue shipping in September.

The back-end loaded nature of the quarter was mainly a function of delays in getting new products into production.

Our customer base continued to be broad with our largest customer representing only 12% of revenue in the quarter.

All other customers were less than 10% of total revenue with the top 10 customers totaling approximately 55% of revenue.

Gross profit margin on a GAAP basis in the third quarter was 31.3%, which was slightly above the high end of our outlook.

Included in costs of sales thereby negatively impacting GAAP gross profit margins was approximately $5.8 million of noncash acquisition-related expenses representing 12.5% of revenue.

Excluding these expenses, non-GAAP gross profit margins were 43.8%, which was up 320 basis points from 40.6% in the second quarter.

The increase in margins resulted largely from improved product margins and advanced TV products resulting from new product introductions as well as the more favorable overall mix of revenue.

R&D and SG&A expenses combined increased $5.3 million to $23.8 million in the third quarter from $18.5 million in the second quarter.

Approximately $4 million of the increase came from having a full quarter of Equator expenses.

The remaining $1 million or so resulted primarily from increased compensation expenses.

The effective tax rates, both on a GAAP and non-GAAP basis came in as expected.

The effective tax rate on a GAAP basis in the fourth quarter was 47.3% versus an outlook of 40% to 50%.

On a non-GAAP basis, the effective tax rate was 80.9% versus an outlook of 75% to 85%.

On the bottom line, the GAAP net loss was $5.3 million or $0.11 per share, which was on the better end of our outlook for a $0.10 to $0.13 loss.

On a non-GAAP basis, the net loss was $592,000, or $0.01 per share.

This was also within our outlook for a $0.01 to $0.02 loss.

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 $147 million at the end of the third quarter, which was down from $163 million in the second quarter.

The primary uses of cash were a $9.3 million increase in accounts receivable and $2.8 million increase in inventory.

Accounts receivable of $27.4 million represented 53 day sales outstanding compared to 40 days in the second quarter.

The increase in accounts receivable in day sales outstanding resulted primarily from the back-end loaded nature of the quarter.

Inventory of $27.8 million in the third quarter was up $2.8 million from the second quarter.

Currently, inventory levels are at about 12 weeks, so we will be working on bringing that down in the coming quarters.

Goodwill increased $13.4 million to $134 million in the third quarter primarily as a result of an increase in valuation allowance placed against deferred tax assets coming from the Equator acquisition.

I'll now provide a few details behind the Q4 outlook provided in the earnings release issued earlier today.

We expect revenue in the fourth quarter to be approximately $45 million to $48 million, which is roughly flat with the third quarter plus or minus $1.5 million.

The gross profit margins in the fourth quarter are projected to increase to 34% to 36% from 31.3% in the third quarter.

The increase is mainly related to having less noncash acquisition-related expenses in the fourth quarter compared to the third quarter.

Within comps sales we expect noncash acquisition-related expenses to be approximately $3.8 million in the fourth quarter, which is down from $5.8 million in the third quarter.

The projected decrease in noncash acquisition-related expenses is due primarily to lower expenses from the amortization of acquired inventory markup from the Equator acquisition.

These expenses alone represented $3.2 million in the third quarter and are expected to decline to about $1.8 million in the fourth quarter.

Non-GAAP gross profit margins, which exclude the estimated $3.8 million in noncash acquisition-related expenses are expected to be 42.5% to 44.5% in the fourth quarter.

This is roughly flat with the third quarter plus or minus 1%.

Non-GAAP R&D and SG&A expenses combined are expected to be $22.5 million to $23.5 million in the fourth quarter, which is down from $23.8 million in the third quarter, in large part due to savings from the recent headcount reductions.

Severance-related expenses in the fourth quarter are expected to be approximately $1 million.

This will be excluded when reporting non-GAAP financial results in the fourth quarter.

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

Our best estimate is then on a GAAP basis, the effective rate will be 35% to 45% in the fourth quarter, which is down from 47.3% in the third quarter.

On a non-GAAP basis, the effective rate is expected to decrease to 50% to 60% in the fourth quarter from 80.9% in the third quarter.

On the bottom line, we expect a loss per share of $0.10 to $0.11 on a GAAP basis and $0.02 to $0.03 on a non-GAAP basis.

The projected increase in non-GAAP loss per share in the fourth quarter compared to the third quarter is a function of the effective tax rate decreasing.

That concludes the review of third quarter financial results and the fourth 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 third quarter financial results.

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

Thank you, Jeff.

We have taken the steps to reorganize our engineering organization to lower our costs and improve efficiencies.

We've added strength in our sales organization specifically to penetrate the tier 1 accounts in Japan and Korea.

We are now in a position where we can continue to make the investments necessary to stay at the forefront of our business and markets.

We are completing the rollout of a broad line of products that extends our penetration of the signal path.

Most importantly, we have released to production our PWM 2000 MPEG media processor and the ATSC compliant software stack for the North American digital televisions.

At CES in January, we expect to introduce an even more expansive series of new television solutions that will continue to leverage our Cobalt and Indigo software.

The projector business has stabilized with the split between polysilicon LCD projectors and DLP projectors remaining at around 50-50.

Our design wins for 2006 are in place, and our customers are introducing new and innovative products.

In 2005 we took on a huge task to deliver an unprecedented level of complex software and systems for the television market.

Since then we have made extensive organizational and process changes.

We are now a leaner, more focused organization.

We are making the investments to continue the rapid pace of product development required to stay at the forefront of our industry.

We will now open the call for questions.

[OPERATOR INSTRUCTIONS] Tore Svanberg of Piper Jaffray.

Yes, good afternoon.

Just looking at your outlook per segment and especially looking at TV, what's going to be driving the growth there?

Is it Dell or are there any other design wins that's going to be driving that?

Obviously, Dell will have something to do with that -- success of Dell in the market will have something to do with that.

In fact, if you go to the Dell website, I think you'll see that there is -- they have the TVs listed now, and the delivery dates are in the next few weeks, something like that, Jeff?

Yeah, I think as long as a month, in the past now.

So that's a key.

There are several other customers that I don't think we've announced yet that are ramping into production as well.

So it's a combination of all of those things.

I guess I'm still a little bit confused about your comment about Japan and Korea.

I think you talked about adding some sales efforts there, but I think you also just mentioned you had penetrated Japan and Korea.

Shall we assume you already have some design wins with some of the majors in those regions?

Yes, that's something that we've actually addressed in previous calls.

We have design wins with many of the top brands.

It's just not as broad as some of our other competitors.

What we've said is that we needed to focus on Japan and Korea.

We've specifically hired two executives that are now either they're in Japan and Korea now, or they are moving to Japan and Korea.

I know the one guy in Japan is there.

I think the Korean guy is commuting right now.

These are people that are experienced in our business; that know the customers; that have ramped multimillion-dollar businesses in those regions, and we are very, very confident that they're going to have a direct impact on our sales, specifically selling into the top-tier accounts in Japan and Korea.

Jeff might have some numbers for you to back some of this up.

Yes, Tore, to give you a sense, if you looked at our advanced TV revenue in the third quarter, and these are shipments directly into these regions that I will go over here.

About 15% of our TV shipments went directly into Korea, and then about 10% or so -- 10% to 12% of our TV revenue come directly from shipments into Japan.

And then we also have relationships through ODMs, for example, in Taiwan that ship for -- certainly, for some of the brands in Japan.

But those are just kind of to give you a sample or a feel for what we ship directly to customers in those regions.

Okay, very well.

On the digital TV side, I think you mentioned you were going to be something in low-cost decoded chip.

Are you also working on maybe a fully integrated chipset at this point and when should we expect that?

I only gave a brief preview of CES.

Obviously, higher and higher levels of integration are things that everybody is working towards.

That would be something that would be in our roadmap, but I really don't want to talk anymore about the CES rollout other than what I've said in the call.

That's fair, and just a final question -- looking at projector, other than DLP polysilicon now at 50-50, have you seen any other dynamics to suggest that that business has stabilized?

You know, maybe pricing, some of your customer activity -- just trying to get some more flavor other than just the 50-50 comment.

You know, pretty much, the design wins are in place for 2006, and we pretty much know where we're solid there.

And I think the biggest factor for us now, going into 2006, would be shift in polysilicon versus DLP.

If it went more towards DLP, that would hurt us.

If it went more towards polysilicon, that would help us.

At this point in time, we're not anticipating much of a shift at all either way.

Craig Berger of Wedbush Morgan Securities.

Just getting started on the TV, to follow-up on some of Tore's questions -- are you able to tell us who maybe your top five revenue customers are in TV?

We haven't generally done that.

Yeah, we haven't generally done that.

I think, obviously, Dell was the lead customer on the digital TV products.

We've talked about penetration of top-tier accounts before.

I think that's definitely something -- broadening our focus on those top-tier accounts is definitely something that we're planning on doing specifically in Japan and Korea.

But outside of that, we haven't really talked about the top customers in TV.

Okay, you noted in projector that you've got a lot of the 2006 design wins kind of locked.

With respect to the TV segment, what type of visibility do you have into ramping wins at customers there, and how shall we compare the number of wins you've got lined up for '06 versus where we were a year ago, for '05?

Yeah, that's -- I'd say, generally speaking, we're right in the middle of those things firming up at this point in time, and what we're doing is we're now going out and pre-disclosing to customers the roadmap that will be hopefully embodied in silicon at CES in January.

Several of the customers make decisions based on FPGA demos of some of these things, and some of them make decisions based on prototypes of other sorts.

Some of them make preliminary decisions and then firm up the decision at CES based on seeing the actual product demonstrated.

So I think, at least for us, a lot of that is in flux right now as we enter the fourth quarter and going into the first part of the first quarter.

So projector design wins typically lock earlier than TV design wins?

Not necessarily.

I think what you're seeing there, Craig, is we had such a long relationship with the customers on the projector side, and that many of these are just the next generation with our next-generation chip with a customer where we've had a six- or seven-year relationship.

It's a little more predictable than the television business, where maybe we're displacing somebody else or it's a hotly competed-for slot.

That's helpful, thank you.

And then just my last question -- it seems like you have a lot of interesting product development efforts underway.

Just getting back to a financial perspective, do you guys have a plan to get to material profitability, you know, earnings power of, say, $0.40 to $0.50 a year and any timeline to get there?

And then just as related to that, you know, what these restructuring efforts do you think 37 hits is enough given your operating results.

Thank you.

The goal for profitability is absolutely what we're all focused on here, and I think you've seen, both in our history and when you look at some of our competitors that a reasonable movement on the top line drives an awful lot of cash to the bottom line.

So, yes, profitability is absolutely in our focus.

The headcount changes that we made were really focused on re-prioritizing some things and efficiency to drive us forward and to allow us a little bit of headroom to reinvest some of those dollars.

We're not in a situation where just cutting expenses is going to turn us to profitability and make us an extremely attractive company.

We think making the investments and moving the top line is what's going to make us an extremely attractive company and an extremely attractive stock to own, and we're still focused on making the investments to do that.

I'm going to sneak one last question in, and that's -- I know you're not providing guidance for Q1, but are you able to provide us any type of directionally -- up, down, flat -- on the TV business, and should we expect seasonality there or do you think design-win growth should offset that?

Thanks.

We're not providing an outlook for Q1 at this time.

It will get clearer as we go through Q4, get through CES, and right after CES we'll be doing the next call, and we'll be able to give you some more visibility at that time.

Jennifer West of Merriman.

Good afternoon.

If you have rolled out your new products, the ones that introduce those to your customers for CES, are customers still integrating the current Opal product and the PWM now or are they waiting for the next-generation products?

It's a combination of both, Jennifer.

We have several customers that are finishing up the integration of PWM 2000 and Opal.

We have several other customers that we're now engaged with the discussions on and preparing them for the integration of the new products.

The nice thing is that most of the software is -- a huge part of the software is carryover between the two.

So somebody can make an investment in a PWM 2000 and an Opal today, and it carries over into the next generation.

The next generation, architecturally, is very similar, lowers cost points, and improves performance.

Okay, and then going to operating centers, maybe you can talk to your long-term plans.

It seems like they're coming down in the near term, but you're going to reinvest.

So are they going to come back up and does any of this digital TV investment in R&D trail off at some point?

Yeah, I expect that they will come up somewhat in the future, but I'm not going to try to outlook the full year of 2006 yet.

I think we are already getting leverage from our digital TV investments that we've been making.

Largely, those are rolling over into investments in other areas.

I mentioned that we've got a pretty big thrust into reinvigorating that digital CRT business.

So we're not short of opportunities to invest in right now.

I think we're still at the very early stages of our markets, and we have plenty of opportunities to invest in.

We're going to continue doing that.

Daniel Gelbtuch of CIBC.

This is actually Dan Morris talking for Daniel Gelbtuch.

You tended to decline in the past to talk about any ASPs or specific contribution for Peanut.

I was wondering if you might -- if you wanted to update us a little bit on what we might be able to expect in 2006 from Peanut?

Sure, when you talk about ASPs, you're specifically talking about ASPs for Peanut?

Yes.

The ASPs for Peanut are kind of mid-single-digit ASPs, and in terms of outlook in terms of number of units and that sort of thing, I haven't put a specific number on it.

We've talked that there's multiple design win possibilities with something like Peanut, and when they go, they go across a large number of products.

That's what really makes it so attractive to us.

The latest turn of the chip for Samsung, we think is going get us into a position to get into production at least with a subset of the total number of products that we can be in production with.

And then as we roll forward, we'll be able to give you some visibility on breadth and depth of those design wins.

But the ASPs are in the mid-single-digits.

Okay, thank you, and also you noted that market expectations for DTV, I think you cited $22 million for this year, and going to $60 million in 2008.

I just wonder if you could give us maybe what your own expectations are for market growth in 2006?

You know, I haven't focused specifically on 2006.

I'm very, very bullish on the market growth and projections overall.

The newest generation of LCD fabs, they're going to be coming online.

They're going to start pushing up into 60-inch, 70-inch, and maybe even 80-inch LCDs, which means 40-inch becomes that much more affordable.

So I don't see any end in sight in terms of being able to push up to larger sizes and aggressively drive costs down.

We are flirting with $1,000 30-inch and 32-inch LCD TV with the new LCD fabs that are going to be coming out with some of the new equipment, we'll push that down to 40 inches, and I think those are extremely compelling price points.

But we'll be looking at 2006 a little bit more through this quarter and probably give you a little bit better idea in the next call.

Richard Todaro of Kennedy Capital Management.

Hi, Allen, we think you're making the right moves, but I do have some questions.

We're still hearing that the '06 design wins for new TVs are already completed.

Would you say that's the case or not?

Where do you feel that you're at?

Our view is that you certainly get design-win indications during the fourth quarter, and if this is a product, if this is a chip, that isn't in silicon yet, you have until about CES to show it in silicon.

If you show it in silicon at CES, then you lock in those design wins during Q1, do the integration in Q2, and start ramping in Q3 and Q4.

So certainly some of them have firmed up, but I would say there's probably somewhere around half that are still up for grabs.

How do you feel if we hear a Broadcom, MediaTek, Zoran, everybody is coming into the space, Trident's moving down after you guys.

How do you feel that you can continue to compete?

You have Dell as your signature customer, they're small volumes, you know, next year should be kind of the sweet spot of the market.

How does this play out for the company ultimately -- all this money that we're investing?

Sure, I think there is plenty of competition coming into the space.

I think if you ask people as far as completely integrated ATSC solution with all the software stack that you need, we're probably at the forefront of this business.

Most of the designs that are out there today are really a set-top box sort of grafted onto or stuck into a television set.

We've really done a design where they are completely integrated.

It's really important for that because as the chips become more integrated, you're going to have to do that on the software side and actually the software integration is more difficult than the chip integration.

We certainly have competition coming in.

We think we've created some great partnerships and great relationships to leverage those partnerships and relationships.

We think, frankly, the thing that has been missing in our equation is relationships with some of those top-tiered customers.

We went broad.

I think I mentioned in the call we've got something in excess of 80 television customers.

So there's an awful lot of people out there that are counting on Pixelworks and have leveraged our software platform to get to market quickly.

Now what we're doing is turning our attention to some of those rifle shots at some of those top-tier customers.

We've put the sales folks in place to do it, and we think we have the products in place to do it.

With all the competition coming, why not look at being a consolidated AT or putting the company for sale and offering your resources to another company that can leverage it that already have the sales force in place and the design wins.

My philosophy is that the moment that you turn to sell a company, you will probably make decisions that ultimately make the company less valuable.

Coming out of the venture business, when we had companies in our portfolio, what you do is you put your head down, and you go like crazy to be number one in your space, you go like crazy to get to the public offering as a venture company.

Along the way, if you create enough value, and it's attractive for you and your shareholders to pursue another course, you always entertain those things.

I think from our standpoint is building core value is the most important thing, and then whether that's manifested as an extraordinary position in the market where we have a stock price where we can be the consolidator where somebody comes along and recognizes that value as well.

The bottom line is we just have to build that value.

Two last questions on the Equator acquisition.

It's cost the company over $100 million in cash.

You own over 2 million shares that's cost you $10 million, probably, in personal value in the company, probably $250 million in market cap.

You talked about revenues being down next quarter.

Can you talk about why you spent the money and where you see this going?

SFA is talking about IPTV set-top boxes next year with Southwestern Bell.

Where are you guys in this design cycle?

When can you get a big design?

Where will it be, and where is this division going?

I think, obviously, we talked about in the call distribution of digital video via the Internet is going to happen.

It is happening now.

In order to effectively do that, there's two things -- you have to be able to decode it.

We think a fixed-function decoder is right for certain applications.

We think a programmable decoder is right for other applications.

We think we bought the company that's got arguably the best software decoder and portfolio software decoders on the market.

So this is a macro trend to digital video and digital video being distributed by the Internet.

We have a couple of great customer relationships in the IPTV set-top box arena.

We are very concentrated in two or three customers there.

I mentioned in the call that one of those customers in particular is pushing out their rollout.

They bought enough product for the fourth quarter, they're probably going to be pushing into the first quarter before we see a reorder there.

But we see it as a pushout more than a situation where we lost that customer.

But when do we really see the growth in this division?

I mean, and was it worth $10 million to you personally to do the acquisition?

Give us a -- you know, next year we think we'll have some design wins in some company, or we will see some growth from something.

Or what's the story?

I think we already have significant design wins with significant customers that could move tonnage for us in this business.

Obviously, we have to expand those design wins not just in IPTV, but another area that we're seeing where some of the unique characteristics of what bought are in videoconferencing, videophones, that sort of thing.

We haven't done an outlook for 2006, and I don't want to extemporaneously do an outlook for 2006.

I think -- I'm happy with what I've got right now.

Sure, I'd love the revenue to be higher in the fourth quarter, we all would, but I think we've got good customer relationships in place.

We're merging the two divisions, what we call AMP and video and image processors together, unifying the roadmaps there and unifying the development resources so that, in fact, we can accelerate development of some of our other things.

But well give you an update at the next conference call for looking out for 2006.

And my last comment/suggestion -- you did the convert up higher.

There's going to be shares in the dilution there plus we feel the company has too many shares outstanding relative to revenues.

We feel 50 million shares outstanding relative to 200 million in revenues is too many.

It doesn't give you enough earnings leverage with $4 a share in revenues, and we would like to see about a $20 million stock buyback.

We know that that makes you net cash, but we feel you took on the convert for a reason.

The interest rate flow enough, and we feel reducing the shares outstanding -- to reduce the 7 million potential options outstanding, we think are -- which we also believe are too many options for a company your size with the number of employees you have, we would think would be a nice signal to the Street also is that the company, you believe in the company.

What's your opinion on that?

We always evaluate those things, Rich -- stock buybacks and evaluating all the ways that we can capitalize the company and take advantage of it.

Obviously, you mentioned earlier, I personally own 2 million shares of the company, so all of these things are very near and dear to my heart.

We evaluated on a quarterly basis, we evaluated at every board meeting.

That's why we did a convert at the time that we did it.

We thought that was a prudent time to do it.

By the same token, any kind of action, like a stock buyback or anything like that, we entertain doing that on a quarter-to-quarter basis.

Well, we would like, you know, as a 15% shareholder, we would like for you to put it front and center on the next board meeting, and we would like to hear on the next call why it was not chosen, if you choose not to do it.

That's all I had, thanks.

Brian Alger of Pacific Growth Equities.

Well, I don't carry as much weight as Richard does here, but I'll ask a couple of questions, anyway.

You guys talked about the business at Equator being concentrated with a couple of key customers.

Obviously, we know Polycom is one of them on the videoconferencing side of things.

Can you maybe tell us on the IPTV front and the set-top box front who your customer wins are with?

Well, I can give you some color.

There are three primary customers there -- Japan, Korea, and then one that sells pretty much all over the world, and then we have, from time to time, quarter to quarter, we've had other customers in that space.

One of them is one of these broad infrastructure plays where there's a lot of infrastructure associated with rolling out the set-top boxes.

One of them I'm not quite sure of, and the third one is an application where we call it an "over the top" application, where it's a set-top box that just uses existing Internet infrastructure to deliver the video to it.

Okay, well, I'll ask it another way.

Earlier this quarter we had a pre-announcement come out of the UTSI citing a delay in a pushout within Japan's [unintelligible] broadband.

Are you guys in the UTSI set-top boxes?

We haven't said anything other than Polycom so far.

Okay.

Of the 36 employees that had their positions eliminated, how many of those came from within the former Equator organization?

We didn't break it out.

I can tell you that approximately 30 of them came from Oregon, and about six were from the Silicon Valley, but the Silicon Valley location is broader than just Equator.

Right, because we had the old ASP down there, okay.

And looking at the TV business, you talked about the growth coming in Q4, 10 to 15%, I think, is what you said.

Is that just simply the business that you had hoped to see in Q3 rolling into Q4 because of the delays that we talked about?

Or is that end-market growth you see being 10 to 15% sequential?

I'd say part of it is a Q3 business that we would have expected to see in Q3.

But I think the majority of it would be driven by some of the new designs ramping into production that were just late in Q3.

The one we talked about was Dell, but there were others.

So you could either say that's business that you thought you were going to get into Q3, or it's just run rate business in Q4, depending upon how you want to look at it.

Okay, and hoping to get some color on the Dell designs.

You talked about there being both LCD and plasma.

I'm wondering if both those designs are coming through one ODM or is that multiple ODMs that you're working with to support Dell?

In the call we said that we worked with integrators in Taiwan and in Korea on the Dell program.

Jason Pflaum of Thomas Weisel Partners.

This is Alex Kim actually covering for Jason Pflaum today -- just a question on the linearity of the December quarter.

I think you had noted that 45% of the Q3 revenues actually fell in the month of September.

I'm wondering how that affects the linearity of December and, more importantly, where we are with respect to backlog.

I think it won't be that back-end loaded in the fourth quarter.

I mean, typically, that was an unusual quarter for us as a result of the product introductions.

Typically, in any one month we're between 30 and 40% of the quarter's revenue in any one month.

And I think that will probably follow that pattern in the fourth quarter.

Okay, that's fair.

And then just a question on your inventory makeup.

I know that it gets a little bit confusing with Equator in there, and I'm really trying to get a sense of what the inventory is ex Equator, but I'm wondering if you could break down your inventory by product segment, if that's possible.

I do not have the information with me.

I guess I would assume it's roughly in proportion to what the revenue streams look like, but I don't have that information with me.

Okay, and just finally in gross margin, obviously, we saw a nice surprise there in gross margins, and I'm wondering if that just realigns your outlook on where gross margin targets should be and how should we look at gross margins, going forward, essentially, and, in particular, do you have a gross margin target today?

Yeah, I think the gross margins will be determined by a couple of things.

Obviously, the competitive landscape as well as our ability to introduce new products on a more timely basis.

So the faster that we can get these new products to market, the higher gross margins, on average, that we'll have.

So it will be determined by those things, and we'll have to watch that as we go forward.

So we haven't set, necessarily, a gross margin target as we move forward.

We felt that certainly in this TV business, it is going to be a competitive business, I think in general for all of us.

I would expect to see gross margins, perhaps, even come down over the longer term, the much longer term, as the unit volumes go up significantly, and there is perhaps more competition.

But I do think in the near term we have an opportunity to get products out on a more timely basis and get a larger percentage of our product revenue from new products and the prospect exists for gross margins to potentially go up.

But I'm not going to go out on a limb and try to predict what that might be.

On an operating margin basis, we obviously need to improve in that area.

So our ongoing model for operating margins is to be certainly in the teens, you know, ideally around 15% operating margins, and we've got a long ways to go, at this point, to get there.

But we were there just a year ago, so we know it's possible.

So operating margins in the mid-teens would be a good model for us in delivering kind of near-term profitability and yet making sure we're investing as much as we can in the future.

Alex Woodward of Mazama Capital Management.

Hey, Jeff, a quick question for you -- normally you give the metric of what point you are either shipped or in backlog as far as the midpoint of your guidance.

It's somewhere between 65 and 70 % right now.

Thank you.

And then just a comment that the gentleman from Kennedy Capital -- tomorrow is probably going to be the best time in the next -- in the last couple of years to do a buyback.

Okay.

Tore Svanberg of Piper Jaffray.

Yes, I just had a quick follow-up -- I think you mentioned you were going to be saving about a million a quarter in operating expenses.

I'm just trying to understand the split between R&D and SG&A.

There's a little bit in the cost of sales area.

It's probably about a 70%, roughly, R&D; 20% SG&A; and the balance would be, actually, within cost of sales in the operations area.

Okay, and just another quick follow-up -- I think you mentioned 65 to 70% booked so far.

How does that compare to last quarter?

I think it's pretty close.

From memory, I think it was about 70% last quarter.

Your last question is from Tayyib Shah of Longbow Research.

I was wondering if you can provide more color on how Equator's videoconferencing business did during the quarter and what's the outlook for it?

You may be able to infer that from some of the numbers that we gave you.

Let me just at a top level -- there weren't any surprises in the videoconferencing business.

It came in about where we thought it was going to come out.

We don't do a specific outlook, but I mentioned softness in the set-top box business for next quarter.

I didn't mention anything about the videoconferencing business.

Jeff, did you want to --?

It's run fairly consistently about 25% or so -- 25, 30% of the quarterly revenue amount for the last two quarters.

It's fairly stable.

That's probably the most -- one of the more stable revenue streams in that part of the business because it's a more mature market.

Okay, and on the set-top business, what is a typical design cycle in that business?

Is it something very similar to the TV business where you rent the lines now and first quarter for production in the third and fourth quarter or is it something different?

Well, that's a great question, and it really depends.

If it's a set-top box that goes into one of these big, mega rollouts where you have infrastructure that has to go into place, it could be very long, more than a year.

If it's a set-top box where they're basically taking our reference design and doing what we call an "over the top" application, where you just design the box, set up a website and start distributing video via that mechanism, it's much more like a TV business where you could generate revenue within a year from that.

So it really depends.

So about your set-top box business, what would be the composition of design wins in that there?

Well, we have both and, like I said, of the three accounts that were the top accounts in that business for us, one of them is a part of one of these broad system rollout, one of them is an over-the-top application and, frankly, I don't know about the third one.

I don't know enough about that deal to know whether it's a broad system rollout or it's an over-the-top application.

Okay, and what kind of timeline should we be looking at in terms of broadening the set-top box customer beyond the major three customers?

Well, we're working on that.

That's on ongoing process.

I don't think there is anything that's going to be happening in the fourth quarter, and we'll be looking at that for 2006 and hopefully giving you an update at the next call.

Okay, and just a follow-on some of earlier questions -- can you just clarify what is the share buyback program right now?

How much money you have allocated for it?

We don't have a share buyback program right now.

We have about $147 million in what I would say total cash, which is cash and cash equivalents, short-term marketable securities, and long term.

But we don't have a cash or a stock repurchase program in place.

Okay, and one final question -- on the cost side, question for Jeff, how are fab prices moving?

Do you see a substantial movement in this quarter or next quarter?

No, I don't expect to see a substantial movement.

And with there being no further questions, I'd like to turn the call back to Mr. Alley for closing remarks.

The only thing before signing off, I'll mention that we will be participating in the upcoming ADA Classic on November 7th and 8th in San Diego.

We look forward to seeing you there.

Thank you for joining us today.