Pixelworks Inc (PXLW) 2006 Q2 法說會逐字稿

Good day, and welcome to the second quarter earnings announcement for Pixelworks Inc.

Today's call is being recorded.

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

Please go ahead.

Good afternoon, and thank you for joining us.

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

The main purpose of this conference call is to augment the information provided in our press release earlier today announcing the Company's financial results for the second quarter ending June 30, 2006.

The earnings press release and contents of this conference call contain comments about our business outlook, including forward-looking statements and are based on our second quarter financial results.

These forward-looking statements include expectations related to factors impacting revenue, gross margins, operating expenses, design wins, market performance and expectations for new product transition.

In addition, these forward-looking statements include operational expectations related to restructuring plans and investments made in electronic design tools benefiting future design performance.

Changes to our revenue are highly dependent on a number of factors, including but not limited to, consumer confidence in spending, electronics market seasonality, the Company's ability to secure design wins, timely customer transition to new product designs, new product introduction and ramp yields, growth rates in our key markets, levels of inventory at distributors and customers, and increased supply of products from the Company's third-party foundries.

Investors are cautioned that all forward-looking statements involve risks and uncertainties that could cause actual results to differ materially.

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.

Please refer to today's press release, our annual report on Form 10-K for the year ended December 31, 2005, and subsequent SEC filings for a description of factors that could cause forward-looking statements to differ materially from actual results.

During this conference call, we will also be making reference to non-GAAP gross margins, operating expenses, EBITDA, net loss and EPS, which excludes certain non-cash expenses for the amortization of acquired intangible assets, stock-based compensation, an impairment charge of goodwill, and restructuring charges required under generally accepted accounting principles.

The Company uses these non-GAAP measures internally to asset its operating performance.

The Company believes these non-GAAP measures provide a meaningful perspective on its underlying cash flow dynamics but cautions investors to consider these measures in addition to, not as a substitute for nor superior to, its consolidated financial results as presented in accordance with GAAP.

A complete reconciliation between GAAP and non-GAAP financial measures is included in the Company's quarterly earnings release and is also available in the Investor Relations section of the Company's website.

I will now turn the call over to Allen.

Before I get into the details of the status of our turnaround strategy and the rollout of our new products, let me summarize some key financial results from the second quarter.

Revenue was in line with our outlook for Q2 and came in and $30.9 million, down $5.7 million, or 16% from the first quarter of 2006.

As anticipated, most of the decline was in the television segment of the business, as customers worked through inventory of older product prior to transitioning to newer designs.

Revenue for the other market segments of our business came in at or above the high end of the outlook for the quarter.

We were especially pleased to see the strength in our orders this quarter.

During the second quarter, we saw growth in the order rates, led by strength in both the front projection and advanced television portions of our business.

Overall, run rate book-to-bill ratio, excluding end-of-life, last-time buys, was approximately 1.15:1.

We believe this is an indication that customers are preparing to ramp projects into production beginning in the third quarter.

We are referring to this ratio as our run rate book-to-bill because we had some unusually large last-time buy orders that we have excluded from the calculation.

The last-time orders amounted to approximately an additional $10 million that we'll be shipping over the next 18 months to 2 years as we clear the inventory and backlog of these end-of-life products.

Later in the call, as I walk through the market segment results, I will be making reference to their respective book-to-bill ratios.

All of these ratios will be run rate book-to-bill and support the overall 1.15 that I mentioned earlier.

Non-GAAP gross profit margin in the second quarter was 40% compared to 40.8% in the first quarter.

Included in cost of sales in the quarter were inventory-related write-offs and reserves totaling $2 million that were recorded primarily for excess and obsolete inventory and for parts containing lead.

These parts can no longer be sold due to regulations imposed by the European Union's restriction of hazardous substances directive.

We came in better than our outlook for non-GAAP operating expense at $20.4 million, down 11% from $23 million in the first quarter.

The decrease came primarily from lower compensation costs and discretionary spending as a result of the restructuring plan we announced in late April.

Turning to our balance sheet, we have an unusual, large non-cash charge this quarter.

As we mentioned in our last call, we have been monitoring the potential impairment of goodwill.

This quarter, because the Company's fair market value dropped below its book value, as part of the second quarter close, we performed an analysis of the recovery of goodwill.

As a result, the Company concluded that all of the goodwill on the balance sheet was impaired, and we recorded a $133.7 million non-cash charge to operating expense in the second quarter.

As of June 30, we have $11.1 million of acquired intangible assets and no goodwill remaining on our balance sheet.

Our non-GAAP earnings before interest, taxes, depreciation and amortization, or EBITDA, was a loss of $3.8 million in the second quarter.

So, even though we reported a large second quarter GAAP loss, a vast majority of the loss was due to non-cash charges.

You can see this on our balance sheet, where we remain in a strong cash position with $126.1 million.

While we've made improvements to stabilize the operating results of the Company, there's more work to be done, and we continue to remain focused on our strategy to get the Company back on a path of growth and profitability.

Sustainable profitability cannot be achieved by only reducing expenses.

We must also grow revenue and margins as well.

I'm pleased to announce we've hired an executive to lead this effort who possesses the skills, experience and passion to do this.

Jerry Artison has joined us as our Vice President of Worldwide Sales.

Jerry is a proven, successful semiconductor sales executive with over 22 years of experience.

The majority of his experience was with Motorola and ARM, where he served as Executive Vice President of Worldwide Sales and President of USA Operations.

Jerry brings the professionalism of Motorola and the entrepreneurial zeal and winning spirit of ARM to Pixelworks.

I'm extremely pleased to have him on the Pixelworks' team.

I'll now turn to a more detailed overview of our operations in the second quarter.

Advanced television revenue was $8.4 million in the second quarter.

This was down more than we had anticipated from the first quarter revenue of $13.8 million.

Average sale prices in the quarter were down 9% due almost entirely to a shift if product mix.

We continued to see some weakness in Europe and China, combined with slower than anticipated product transitions from our older YEM and PESTO products to the new Opal 2 image processor.

World Cup sales were generally below expectations for Europe, and we believe the lack of sell through delayed the ramp of some of our customers' new products.

Geographically, our shipments in the second quarter to China were 32% of total TV revenue, followed by Taiwan at 30%, Korea at 15%, Europe at 10% and Japan representing approximately 7%.

The technology split of our revenue was 73% direct view LCD, 14% progressive scan CRT, 9% plasma and 4% rear projection.

As we look to the third quarter, we are expecting to see growth once again in our television business.

We are getting the new Opal 2 based designs into production and expect them to ramp during the third quarter.

We believe we could more than double our Opal 2 TV shipments from approximately 60,000 units shipped in Q2.

This ramp is further supported by our run rate book-to-bill ratio for the advanced television segment of our business, coming in at approximately 1.3:1.

We have several new television designs ramping with Opal.

Today, we announced one of them, a design win with Syntax-Brillian for their new Mainstream Olevia 3 series LCD televisions.

The design is for five models, from 23 inches to 42 inches.

We're especially pleased with the outstanding price performance we've been able to deliver with Opal for these mainstream Syntax-Brillian models.

The new Olevia 3 series models are in early production and will be reaching the market during the next quarter.

Forecasting the overall LCD television market for the next couple of quarters is going to be interesting.

In recent months, analysts and the media have been widely reporting the buildup of LCD panel inventory.

This has been due to several factors, including lower than expected European demand in Q2, especially for Tier 2 brands, as well as World Cup sales fell short of expectations.

Reports also have new LCD fabs continuing to run at near full capacity, although there have been some recent announcements that some manufacturers are beginning to slow production.

The result is that the over supply situation has reduced panel prices dramatically.

We use DisplaySearch, as well as our own intelligence, to analyze market trends.

Focusing on the 32-inch WXGA LCD as a proxy for the overall market, DisplaySearch shows a 16% drop in ASPs in Q2.

They're forecasting a further 10% drop in Q3 with a resulting ASP of $410.

However, we believe panel prices are dropping even faster.

According to our sources in Asia, ASPs in Taiwan have already dropped to below $400 and we believe will continue to drop further into the mid $300 range or even lower in Q3.

We believe that although the dramatic price drop makes for a chaotic market, it is ultimately good for us and will drive lower price points and broaden demand.

Taking all of these factors and trends into account, we anticipate revenue growth from the advanced television segment to rebound and be up 20% to 30% in the third quarter from the second quarter.

Longer term, we believe our market opportunities are among the most exciting in the semiconductor industry.

The latest example came last week, where Sharp was reported to be eyeing a tenth generation LCD production facility with substrates of 9'4" by 10' that would be capable of building 8 57-inch panels or 6 65-inch panels on a single piece of glass.

This means that the $1,000 57-inch television is not a dream.

This type of tenth generation fab could be coming on line in mid to late 2008 and be ramped up for the 2009 Christmas season.

Projectors continue to be a bright spot for us.

Revenue for the projector market in the second quarter beat the high end of our outlook.

Revenue was approximately $14.6 million, up 5% compared to $13.9 million in the first quarter.

ASPs were actually up 3% compared to the first quarter, again primarily due to product mix.

Most of the increase in revenue for the second quarter came from our largest Japanese customers, Seiko, Epson and Hitachi, and one of our Taiwanese customers, [BenQ], who is manufacturing for a large Japanese projector brand.

Over 78% of projector revenue came from our top five customers.

By geography, 86% came from Japan, 11% from Taiwan, 2% from China and 1% from other.

Pacific Media Associates, or PMA, a leading projector industry analyst, is estimating 1.2 million units were shipped in the second quarter, which is about flat from the first quarter with about a 50/50 split between DLP and polysilicon display based products.

PMA is forecasting projector unit volumes to grow 27% from 4.1 million units in 2005 to 5.2 million units in 2006, with most of the growth coming in the second half of the year.

This is up from their previous 2006 market estimate of 5 million units.

We continued to have several of our largest projector customers launch new products incorporating Pixelworks' chips during the quarter.

The second quarter marked the first quarter where Opal-based products became the largest unit and revenue contributor to the projector business.

We expect this trend to continue as our customers make the transition to Opal and Pearl-based product platforms in the back half of 2006.

We're also seeing some other positive market trends, the most significant of which is we believe our largest customers are beginning to take market share.

We're also seeing a renewed interest in polysilicon-based projectors coming from Taiwanese ODMs that have been predominantly DLP-based manufacturers, and we're seeing a pickup in the growth of polysilicon-based consumer projectors.

As we exit the second quarter, we saw our run rate book-to-bill ratio for the projector segment grow to 1.1:1.

This book-to-bill supports that the third quarter should be stronger than the second quarter, as projector manufacturers begin to ramp production to get ready for the holiday buying season in Q4.

Taking these factors into account, we anticipate third quarter revenue growth from the projector portion of the business to be up again approximately 10% to 15% from the second quarter.

Revenue for the advanced media processor market in the second quarter was approximately $4.8 million, down 9% compared to $5.3 million in revenue for the first quarter.

Looking out to the third quarter, we do not see any dramatic changes to this business.

However, as we wind down further development of non-IPTV-related products as part of our restructuring plan, we expect revenues from those existing customers to come down over time.

Accordingly, we anticipate third quarter revenue from the advanced media processor segment to come down approximately 10% to 15% from the second quarter.

LCD monitor revenue in the second quarter came in above the high end of our outlook for the quarter at $2.4 million, an increase of 10% over the first quarter.

We expect the monitor revenue in the third quarter to remain basically flat with the second quarter.

We also grew shipments of our existing timing controller product, code-named Peanut, to approximately 100,000 units with Samsung in the second quarter.

Shipments to date for this product have now exceeded 200,000 units.

While we made good progress proving our technology during the quarter, this still represents a fairly small level of production volume potential for timing controllers, and we continue to experience lower than acceptable yields for the product.

So far the results from our timing controller efforts have not met our expectations.

We are continuing our developments in this area for several reasons.

Strategically, we believe that integrating our solutions onto the panel itself will be important over the long term.

We believe that staying close to the requirements and the dynamics of the panel business is also in our best interest.

Our timing controllers provide a platform for the developments technologies that directly improve panel performance and cost.

An example of this is the development of our motion estimation motion compensation algorithms have been developed by the requirements of our timing controller lead customer.

Ultimately, there is a large market opportunity for these advanced timing controller products, and our continued investment in this area allows us to participate in a development partnership with the largest LCD manufacturer in the world.

Tactically, looking forward to the next couple of quarters, we're implementing changes to improve performance, yield, and to broaden the suitability of our timing controller products to a larger range of panel types and applications.

Q3 will be a transition quarter.

We will not ship meaningful volume of our old generation timing controller, but we do expect to begin shipping samples of our improved version to Samsung.

We expect to begin production shipments of the new version in the Q4 or Q1 time frame.

Let me give you an update on our restructuring.

Our turnaround strategy consists of three primary elements centered around focus and execution.

First, focus our revenue growth strategy around key Tier 1 and ODM customers.

Second, invest in state of the art design tools and processes to create a new product development execution engine.

And, third, focus on reducing our operating expense run rate.

While we recognize that getting our product expenses in line is important, we also realize that we are still at the beginning of an extraordinary market opportunity, and we cannot cut our way to market leadership.

We must prudently invest in core competencies, design tools, and development partnerships to bring innovative products to market.

Let me give you an update of where we stand with each of these elements.

In addition to taking out costs and improving our product development execution, strategically, we are also looking for ways to take our existing competencies in video performance and pixel processing into new market applications for television projectors.

We are streamlining our product roadmap to focus our resources and energy on the delivery of products to support our revenue growth in the near term while positioning us to deliver on new innovative products for the future.

In early June, we participated in the Computex trade show in Taipei, which was a great opportunity for us to meet with customers and demonstrate the latest results of our development efforts and technology offerings.

Computex is an important checkpoint during the year, where we can interact with many of our customers, show them our current line up, and discuss product roadmap opportunities.

The show was one of the most successful in our Company's history in terms of customer meetings, with more than 100 of them in our private suite.

We did not announce any new products at the show.

We did demonstrate the latest versions of many products announced at CES.

Our Opal 2 and Pearl image processors, PDN2020 and 2030 media processors, Songbird audio processor and innovative pixel processing technologies were on display.

Based on the positive reaction we received from our existing and potential new customers, it gives us confidence that we are on the right track with our current product development efforts.

The latest products are making good progress along their development paths.

The most mature of these new product offerings is our Opal 2 image processor.

We announced Opal 2 at CES in January, and it is already available in off-the-shelf TVs.

We have shipped more than 100,000 parts to more than 20 companies for a wide variety of end products, including LCD, PDP, DLP and [inaudible] based advanced televisions, polysilicon and DLP front projectors, and even multimedia monitors.

It is still early in the product ramp for Opal 2, but overall we're pleased with the adoption of Opal 2 by the marketplace.

In the second quarter, the Opal products were the single largest contributor in the growth of our overall run rate book-to-bill ratio as a Company.

Our Pearl image processor is the main product we are using to regain our position in top tier television customers.

Winning designs with these companies is not a quick process, but we believe we are making progress and are demonstrating the ability to deliver outstanding image quality at a compelling price point.

Pearl also forms the foundation for our next-generation premium performance projector products.

Our lead customer, Sony, is expected to begin production with Pearl-based projector products in Q4.

Spanning all applications and market segments, we have shipped technical samples of Pearl to more than two dozen customers.

In the digital television market, our most recent offerings are the PWM2020 media processor, targeting DTVs in Europe, and PWM2030 media processor for ATSC-based designs in North America.

We are currently engaged in advanced television designs with lead customers no both products and are expecting to begin shipping them by the end of the year.

Our PW60 image processor, also known as Pixel-GX, is designed for the digital CRT market.

We have design wins with several major China-based CRT manufacturers and expect to begin shipping Pixel-GX-based products in the fourth quarter.

We have also received significant interest in Pixel-GX with worldwide top tier television brands.

Our Pixel GX development efforts are providing the foundation for our new CRT products and also help influence the architecture and feature set of our entry-level LCD products.

We continued to make critical infrastructure investments in people, processes, and state of the art EDA design and flow tools to improve our time to market execution on new product designs.

During the second quarter, we invested in the creation of and training in each of, our global design centers on our new product development architecture and new product development process.

As we look out to 2007, 2008, and beyond, the level of complexity of the solutions demanded by top tier customers continues to rise dramatically.

Our goal is to introduce disruptive products into the marketplace.

The complexity of these products requires an extremely sophisticated system-on-silicon architecture, deep sub-micron semiconductor processes, and a modular software platform.

In addition to a new architecture and management methodology, these system-on-silicon solutions require the development of many technology blocks in order to meet all of the requirements of the most demanding Tier 1 customers.

We cannot develop all of them ourselves.

As a result, we are creating a strategy to focus our development resources where we can differentiate and license or acquire other commonly available technology components.

Analog technology is also becoming increasingly important as we capture the entire signal path of a television.

Here, we are both licensing key analog technology, such as HDMI, and are also significantly investing in our own in-house analog design capabilities where we feel we can differentiate.

As I mentioned earlier, we have been making good progress on our restructuring efforts announced late in April.

Accordingly, we are well on our way to significantly reducing our operating expenses and have already surpassed our goal of achieving an annualized savings of $9 million off of our Q1 2006 operating expense run rate.

The next element of the restructuring plan calls for space consolidation in several locations.

We are planning to move out of most of the identified space by the end of the third quarter.

Therefore, we expect to record a restructuring charge, primarily for space-related costs of $2 million to $2.3 million in the third quarter.

I'll now turn the call back over to Mike, and he will walk you through the details of the second quarter financial results.

Revenue in the second quarter was $30.9 million, a decrease of $5.7 million, or 16%, from the first quarter of 2006.

However, as a result of the growth in our book-to-bill ratio as a Company, we are anticipating sequential revenue growth in the third quarter with overall Company revenue expected to be between $33 million and $35 million.

GAAP gross profit margin was 37.5% in the second quarter compared to 35.1% in the first quarter, which excluded the write-off of the developed technology in Q1.

Also included in cost of sales during the second quarter was approximately $750,000 of non-cash expense for the amortization of acquired intangible assets and stock-based compensation.

Excluding the amortization of acquired intangible assets and stock-based compensation, our non-GAAP gross profit margin was 40% in the second quarter compared to 40.8% in the first quarter.

In addition, included in both GAAP and non-GAAP cost of sales was $2 million for inventory-related write-offs and reserves that were recorded primarily for excess and obsolete inventory and parts containing lead that can no longer be sold due to compliance requirements with the European Union's restriction of hazardous substance directive.

We expect GAAP gross profit margin in the third quarter to be between 40% to 42% and non-GAAP gross profit margin to be between 42% to 44%, which excludes an estimated $800,000 in non-cash expenses for the amortization of acquired intangible assets and stock-based compensation.

As Allen mentioned earlier, we performed an analysis on the recoverability of our goodwill in accordance with SFAS-142, goodwill and other intangible assets.

As a result, the Company concluded that all of the goodwill on the balance sheet was impaired and recorded a $133.7 million non-cash charge to operating expense in the second quarter.

Accordingly, our GAAP operating expenses were $157.5 million in the second quarter compared to $27.8 million in the first quarter.

Excluding the non-cash expense for the impairment of goodwill, amortization of acquired intangible assets and stock-based compensation and the Q2 restructuring charge, our non-GAAP operating expense in the second quarter was $20.4 million, down 11% from $23 million in the first quarter, primarily due to lower compensation costs and discretionary spending as a result of the restructuring plan.

For the third quarter, we expect GAAP operating expenses of $24.5 to $26.5 million and non-GAAP operating expenses of $20 million to $21 million.

Excluded in non-GAAP operating expenses are an estimated $2.5 to $3 million in non-cash expenses for stock-based compensation and amortization of acquired intangible assets and $2 to $2.3 million in anticipated restructuring charges.

The non-GAAP EBITDA loss, which excludes the Q2 restructuring charge of $900,000, was a loss of $3.8 million for the second quarter.

Interest and other income was $600,000 in the second quarter compared to $3.5 million in the first quarter.

The decrease in other income was due to a net realized gain of $3 million in the first quarter on the repurchase and retirement of $10 million of the Company's convertible bonds at a discount to their face value.

The provision for income taxes in the second quarter was $201,000 compared to $252,000 in the first quarter and relates to miscellaneous foreign taxes.

We expect income tax expense to be approximately $100,000 per quarter for the duration of 2006.

The second quarter GAAP net loss of $145.6 million, or $3.02 per diluted share, included non-cash expenses totaling $137 million for the impairment of goodwill, stock-based compensation, and the amortization of acquired intangible assets, plus a $900,000 restructuring charge.

This compares to a net loss of $33.1 million, or a loss of $0.69 per diluted share, in the first quarter, which included non-cash expenses totaling $28.2 million for the impairment loss on certain acquired intangible assets, stock-based compensation expense, and the amortization of acquired intangibles.

Excluding the non-cash expenses and restructuring charge, the net loss on a non-GAAP basis in the second quarter was $7.7 million, or a loss of $0.16 per diluted share, compared to a net loss of $7.8 million, or a loss of $0.16 per diluted share, in the first quarter.

Cash and marketable securities consisting of cash and cash equivalents, short term marketable securities, and long term marketable securities were $126.1 million, a decrease of $4.5 million from a balance of $130.6 million at the end of the first quarter.

The decrease in cash during the quarter came primarily from the loss from operations, the use of cash from a decrease in accounts payable and long term liabilities, offset by cash provided from lower accounts receivable and inventory.

Accounts receivable of $15.4 million came down $1.6 million from a balance of $17 million in the first quarter, primarily as a function of lower revenue in the second quarter.

Day sales outstanding was 45 days compared to 42 days in the first quarter.

The decrease-- or the increase in the day sales outstanding of 3 days is primarily related to the timing of cash receipts relative to revenue earned in the last month of the quarter.

Inventory of $20.2 million came down $3.4 million, or 14%, from a balance of $23.6 million in the first quarter, primarily from our proactively managing inventories to lower levels, coupled with scrapping certain excess and older products.

During the quarter, we either wrote off the scrap or recorded reserves for excess and slow-moving inventory totaling $2 million compared to $1.8 million in the first quarter, as we transition out of previous generations of products to new chip designs and migrate to lead-free parts in compliance with RoHS requirements effective in June of 2006.

Inventory turns remained fairly constant at approximately 3.5 turns compared to the first quarter.

We will continue to focus on improving inventory turns over the course of the year to enhance cash flow from working capital sources.

Goodwill at $0, decreased $133.7 million as a result of the non-cash impairment write-off recorded in the second quarter.

As Allen mentioned earlier in the call, we are continuing our efforts to optimize internal operations.

Accordingly, we announced our restructuring plan in late April to significantly improve our break-even point by reducing manufacturing overhead costs and operating expenses and focusing operationally on our core markets.

As a result, the Company incurred a restructuring charge of $900,000 in the second quarter, primarily for severance-related costs.

The Company expects to incur approximately $2 million to $2.3 million of restructuring charges in the third quarter, primarily for space cost as office space is vacated.

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

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

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

Before we wrap up, I have some information on upcoming investor relations events.

On August 7 and 8, we will be attending the Pacific Crest 8th Annual Technology Forum in Colorado.

We will be presenting on Monday, August 7, at 3:30 p.m. mountain time; and this event will be webcast.

On Wednesday, August 9, we will be hosting the Oregon Technology Investor Tour at our offices in Tualatin, Oregon at 10:30 a.m. pacific time; and this event will also be webcast.

As we enter the second half of 2006, we remain squarely focused on three primary initiatives - to grow revenue through new design wins with key Tier 1 and ODM customers in television, front projections and panel market segments; to improve the execution of our new global product development process; and to reduce operating expenses and improve operational cash flow efficiency.

We've made good progress towards these initiatives during the second quarter.

We improved the Company's book-to-bill run rate-- ratio-- to 1.15:1.

We continue to make end roads on our long term revenue growth initiatives by focusing development efforts for design wins with key Tier 1 and ODM customers, and by entering new television market applications that improve the performance of CRT TVs and timing controllers for panels.

We make good additional progress on the creation of our new global product development execution process, and we improved our break-even point as a Company by reducing our operating expenses by over 11%.

In summary, in the second quarter, we have begun to lay the groundwork for what we believe to be the beginning of a turnaround in the third quarter.

Holding our costs in line as we continue to focus on new product development and market execution will be critical to rebuilding and sustaining our momentum.

Thank you.

We can now open the call for questions.

Thank you. [OPERATOR INSTRUCTIONS].

Your first question is from Craig Berger with Wedbush Morgan.

Craig, are you there?

Craig Berger, your line is open.

Hearing no response on that line, we'll go to Richard Pogaro with Kennedy Capital.

Can you talk about your market potential on the TV side for 2007?

Do you think your TV revenues will be up in '07?

And, talk about your market share potential.

Rich, we're not [outlooking] all the way to 2007 in this call.

Obviously short term with book-to-bill being 1.3:1 in the television business, it bodes well for Q3.

I think we've got pretty good visibility on Q3 and then decent visibility going into Q4, certainly from a design win-- From the design wins-- they're all in place.

It's really more a matter for Q3 and getting into Q4 of, I'd say, macro market conditions in the television business.

Do we see panel prices continue to drop?

I think everybody recognizes that our strength has been in some of the Tier 2 accounts, and they seem to be more affected by some of the dynamics in Europe than some of the Tier 1 guys.

But, I'd say cautious optimism for Q4 at this point in time.

But excluding Q4, the design wins for 2007-- how do you feel about that?

Yes.

The design win season is-- we're right in the middle of it now.

Tier 1 customers tend to make decision win decisions earlier, and they'll be making their design win decisions probably within the next quarter.

The Tier 2 customers, some of our ODMs, will make their design win commitments later on in the year.

As I've said before, it can even, for the Tier 2 guys, extend out into next year.

If we use Opal as an example, we introduced that product at CES, and we're in production with it already with some TV customers as well.

So, the Tier 1 guys are going down within the next quarter or so; the Tier 2 guys near the end of the year, and then some of our existing customers - it could even be out to CES before we get that completely nailed down.

Mike, did you have a comment?

Yes.

I'd also add that, in addition, we've also got design wins happening on the CRT front in the television market with our Pixel-GX portfolio of products, a product called PixelAmp as well.

And then, as Allen mentioned, the timing controllers.

I think all three of those areas represent potential upside for us in 2007 relative to the other image processor, media processor, projector portions of the business.

Can you guys talk about the plans for the equator business?

Where are you going to take that business?

What are you focusing on now?

Your thoughts on 2007.

It goes into kind of two pieces.

One is the run rate equator business and sort of some of the set-top box areas that they've got, some of the video conferencing areas and that sort of thing.

We're servicing those customers and working with them on maintaining that business.

But I don't think that business is going to-- We're not outlooking that that business is going to increase.

In fact, we expect that that business will decrease over time and into 2007.

The rest of the equator business is trying to roll the equator technology into our product roadmap and introduce equator-like products in our product roadmap during 2007 and even going out into 2008 and rolling that equator IPTV type capability into our offerings that we offer to the television customers.

Today, the equator products aren't suitable for use in the televisions that we've looked at, so far at least.

And, we really need to roll that technology into our roadmap for 2007 and 2008.

So, overall, I expect that the equator business-- what you've come to recognize as the equator business of about $4.5 to $5 million a quarter will probably tail off over this year.

Then we expect to see the tail off continuing into 2007.

Yes.

Can you guys talk about on the shares outstanding - why they increased?

Most of the options should be out of the money now, yet your shares outstanding increased quarter to quarter?

Did I miss something?

It can't be more than a couple hundred thousand.

Off the top of my head, I don't know.

We might have had a few with some of the people-- When we made the restructuring announcement, there were some people who had been here for many, many, many years that may have even had pre-IPO type priced options that were still on the money when they left.

They may have exercised some, but I don't believe it was very many.

The reason why I'm asking - it looks like you guys have like 9 million options, and about 8 million of those should be out of the money.

So, I would have expected shares outstanding to drop pretty dramatically into this quarter, given the methodology.

Yes.

We have about 8.7 million outstanding, and you're right.

Most of those are underwater.

But we do have a few people who still have some really early-on options in the money.

Okay.

We can talk about it after the call, Mike.

Mike, one, I think you're doing a good job.

I wanted to give you a compliment on the improvements you've made there.

Our concern as a shareholder is that your guys' peak profits were $20 million, whenever you guys hit it in '04.

The burn rate is still way too high.

It still appears to me that you're spending more than many of your competitors on a lower level of revenues.

Where else can you guys bring down expenses without hurting your future potential? $48 million in R&D run rate-- plus, actually.

So, talk to us about where all that R&D is coming and where we're going to get the big $40 million back, and when does that happen?

I think, Rich, there's-- We talked about it a little bit in the call.

The complexity of the products is growing pretty dramatically, and what we've done is shift a lot of our expenses from people to the tools necessary in order to design the next generation of products.

I think you've seen that probably over the past three or four quarters here.

We continually look at areas for efficiency and areas where we're not getting the leverage and constantly work that, and we are working that.

I don't think operating expenses are going to come down dramatically over the next several quarters.

There may be some shifting in where those expenses occur as we continue to have some investments in the CRT side of the business.

We're not going to invest heavily in the timing controller side of the business until we see the whites of their eyes in terms of a product ramp there.

But we're going to maintain the investment that we're doing.

We've got another turn on the product with Samsung that's coming up here, and we're interested to see how that turns out.

A big effort in the next generation of chips that unify the equator architecture with our other image processors, and that's where bulk of the investment is occurring.

But we're looking at areas where we can find economies and take money out of the model wherever we can.

Mike, did you have some--?

I think probably the best thing to look at is that OpEx-- Our goal is to get OpEx down to $20 million and to hold it at that level.

That's what we'd announced as part of the restructuring plan in late April.

As Allen mentioned, the nature of those expenditures might shift a little bit as we go out of the Q3 and Q4 into Q1.

The next big opportunity in the near term is in the space consolidation arena, which is where we're focusing our efforts right now.

We have offices, particularly here on the west coast in North America, where we think we can consolidate space and save some money there.

As you can imagine, in a turnaround scenario like we're in, one of the things that we also have to focus on as a management team is the health and welfare of our employee base around the world.

So, one of the things that we're looking at is how do we better do that?

It results in increased communication, maybe some things that we're doing in terms of training and developing competencies in our work force that we currently don't have or may have had in other offices that we're now moving to new offices.

So, those types of things we will be incurring, and our goal is to get it down to $20 million and to hold it at that level through next year while we grow the top line going into next year.

How do we get confidence in the management team?

Allen, this is to you direct; how do we get confidence that that R&D that you guys have sat down and ran a model - that you're going to get us a return back on that R&D that is going to be substantial?

It's not just we're going to come out with a product, and we think this-- How does the--?

How are you presenting this to the board, and how is the board receiving this presentation, because, from our standpoint, it still seems like a lot of money being spent without justification of the financial model.

We believe that the market potential supports this level of expense.

That's kind of the first tier, Rich.

The second thing is the details of the products that we're rolling out and then the backup materials that go with that in terms of headcount by project, by product; a new product life cycle process, where we've got gates in place, where we're monitoring the progress of each of these programs, reporting that to the board.

It's a completely new, much more rigorous process than we've ever used before, and I think it's an increased awareness of exactly what you're saying.

We have to get the bang for the buck for these R&D efforts that we're putting in.

We're doing it in conjunction with our global management team and with the board of directors.

I guess, just as a final thought, we still, hearing what we're hearing, still think you guys would be better off being part of another company.

Since you're going through all the restructuring and going through all the R&D, you might as well let another company come in and handle those.

Whether they need to move you to another office, we think it would be more dramatic to your employees to do multiple moves and to go through this whole transition again.

So, our vote is still that the board needs to step in and do their job here and look at what the options are.

Maybe we're missing something, but, in our opinion, we think you need to do a better job of talking about '07 and '08 and where the profit potential is, because, right now, one to two quarters out, you're asking a lot.

Your shareholders have suffered from $20 to $2.

If the board's hearing something that's making them believe that, boy, 2008 is going to be a great year and everything's going to be fine, I believe you owe it to the shareholders to communicate that to them.

Otherwise, if you don't really have that and you don't have that to back up, in our opinion, is there should be a book out being shopped on the firm.

So, that's where we stand.

Thank you.

Okay.

Thanks, Rich.

The next question is from Adam Benjamin with Jefferies & Company.

Can you give us any more detail on the direction of gross margins by your product segments?

I know you're not going to break them out specifically but sort of directionally, if they either went up or down.

You're right; we don't break them out by segment.

One of the things that we're looking at is for them to go up overall into that 42% to 44% range.

If you take out the effects of the inventory adjustments that we booked for some reserves and scrap this quarter, that would suggest that we should be able to do that fairly readily as we go forward.

We look at each of the segments.

I would tell you that the primary segment to drive the business model for the Company in the advanced TV and projector segment continue to be strong.

We're very excited about the new product, Opal 2-based products that are coming out, as Allen mentioned, for Q3 and Q4.

The book-to-bill ratio is supporting those growing.

So, from a mix perspective, we expect gross margins to continue to be in that 42% to 44% range overall for the Company.

We don't break it out by segment.

All right.

Thank you.

We have a question from Eric Reubel with Miller Tabak Roberts.

Congratulations on getting the cost reductions working in the right direction.

Mike, a couple of quick questions on working capital.

It looks like you did a pretty good job this quarter.

What's your outlook for Q3, and can you also talk about the state of the inventory?

A couple of write downs over the past two quarters.

What are you expecting for Q3?

How much is in the inventory that we can turn to cash?

When you're in a cycle like we've been for the last couple quarters with revenues coming down, you end up in a position where previous estimates and forecasts that we use for making judgmental calls on reserves end up changing.

Now, as we look forward and we see the low water marks here in Q2 and revenue starting to come back up in Q3-- I believe we've got most of the significant issues around inventory-related reserve items covered.

So, I'm not anticipating anything of any size here as we go into Q3 and Q4 from an inventory reserve perspective.

In terms of working capital cash flow, as I mentioned in the prepared remarks, I believe that inventory continues to represent a potential area for us to improve.

We've got inventory turns of about 3.5.

Our management goal internally here is to get that up to 6 as soon as we can.

That's kind of tough to do when you have revenues coming down.

But, then again, with revenues starting to turn sequentially north again in Q3, we believe we'll make some progress on that front here in Q3; and we'll continue to look at driving that going out into Q4 as well to get as much cash there as we can.

On the receivable side, we probably can manage it in that 42- to 43-day DSO range.

It slipped up to 45 here this last quarter, primarily because of the timing of orders coming in.

But, again, when you have a strong book-to-bill like we had, that will allow us to see order rates throughout the quarter, probably more evenly distributed then they've been in the last couple.

So, that should help DSO.

And on the payable side, I think we may end up seeing payables slip up a little bit here because if you've got slow inventory turns, that means you've paid for the inventory, and you already have it on your balance sheet.

As you improve inventory turns, which we expect to do in the back half of the year, payables will come up a little bit and help improve cash flow from that side.

So, if I'm hearing you right, the end of life sales that were conducted have worked their way through and not too much more to come from that and not too much more to write down.

Yes.

Okay.

What was CapEx in the quarter, and what's your outlook for Q3 and the full year?

Well, capital expenditures for the quarter were about $2.7 million, and most of that was dollars that were committed some time ago for some space-associated lease improvements that we made.

I think for the duration of the year-- the back half of the year, we're probably looking at about $4 to $6 million.

Depreciation in the quarter was a little bit over $4 million.

So, when I take into consideration the operating improvements that we expect to see going into Q3 and we watch closely the capital expenditures in Q3, we ought to be able to significantly improve our EBITDA performance in the third quarter.

Okay.

And, a question for [Alvin].

You've talked about looking into 2007 and 2008 on the advanced television side.

And you describe these new products as disruptive.

If you can help me understand what that is.

Do you have an idea in your mind what is going to be disruptive?

Are you getting active input from Tier 1 customers here on where they see the market going?

And when you talk about unifying the equator product, does that mean that it's a component of the SOC that's going to do this job - it's an equator-integrated single chip that you're looking to get this done in '07 and '08.

Yes; those are both great questions.

On disruptive products, often times just listening to the customers doesn't get you there because many, many times our customers will tell us what's wrong with our existing products and what they'd like to see to sort of fix the existing products.

But they don't really give us insight into what we would call disruptive or revolutionary product.

In the history of Pixelworks, we've done this a couple of times.

The first product that we did with embedded memory, I would say, was disruptive.

And the first product that we did with outstanding scaling that allowed $500 projector was disruptive.

So, along those lines, we have ideas about architectures that we think could be disruptive - about how to design next-generation or the generation after that chips with much smaller die size and higher performance.

Taking into account that now these chips have ten times the number of functions that our original chips had on them, how do we combine some of those functions intelligently together to dramatically reduce die size and increase performance?

Those are just some general ideas about where we see the ability to create disruptive products.

It's really being driven out of our digital signal processing group under the leadership of one of our folks there - one of our Vice Presidents there.

On unifying equator, it is taking the concept of what equator had, which was a programmable codex, and integrating that into our image processors to allow us to have multiple codex and then also the ability to encode as well as decode.

And, the assets from equator come in the chip architecture and then also in the software - the digital rights management work that they've done.

And, we're looking at using both pieces, but I actually think the biggest asset for us going forward in terms of using pieces of equator is using the software that was created and the software ideas that were created about partitioning the design between software and hardware on a go-forward basis.

Thanks for clarifying that.

If you could-- you're seeing, I guess, pretty good pricing trends here into the third-- at least into the third quarter, with gross margins going up; it's also a function of mix.

Can you give a little more color around current pricing, your mix and what you expect through the second half of the year?

Yes.

I don't think you can infer too much from the fact that ASPs actually went up in several segments.

We're not seeing a situation-- that doesn't reflect the competitive situation we're seeing.

That was really based on mix.

Competitively, we think we have good architectures, especially with Opal, to deliver some really outstanding price performance there.

But, we are seeing price competition, especially when you're trying to win new design slots.

So, I'd say the ASP trends are down.

Maybe, Mike, when I'm done with that, you can give us a flavor on what you see here.

And, I think in the television business, it's based on other competition that we're seeing.

In the projector business, we probably will see some ASPs come down from two reasons.

One is the new projector parts are much more highly integrated than the old projector parts.

And, they're naturally less costly.

So, the new parts tend to have ASPs that are lower than the older parts.

And, the other thing there is that we are seeing some terrific strength in the projector business.

Some of our biggest customers we believe are taking share in the projector business.

Their volumes are going up, and we're responding by giving them lower prices as their volumes go up to keep them right at the peak of competition and allow them to continue that trend.

Mike, did you have any--?

Yes.

Other than just maybe quantifying it a bit, it's probably a couple-- 2% to 3% in the TV overall as a company.

And then it varies a little bit from segment to segment as to are they 0% or are they 4%?

But, overall, for this next quarter, I'd say somewhere in the 2% to 3% would be a reasonable estimation.

Okay.

Thank you.

[OPERATOR INSTRUCTIONS].

The next question comes from Kevin O'Shea with Radcliff Group.

It looks like you've made some progress on the cost headings side in Q2 with OpEx down from Q1.

Mike, as you know, we're a large holder of your convertible bonds; and as a large investor, we're happy with that progress.

However, we have spoken with many of the other convertible holders, and we think, as do they, that it might be the best interest of all investors if the Company proactively explore its strategic alternatives in parallel with the current turnaround plan.

We appreciate, Allen, your comments you've made on this call, as well as in your previous call, where you were more explicit on the subject.

But, we think it is in the best interest of all investors of the Company to not simply focus on its restructuring plan without considering alternative ways to enhance value.

We just wanted to get that out there.

We wanted to hear if you had any response.

Sure.

I've said before the bottom line here is we need to focus on operational things, getting the Company back on an operational square footing and getting those costs under control, getting the revenue headed in the right direction.

Once you have that platform established, I think the Company becomes more valuable.

It becomes more valuable in the public markets.

It becomes more valuable in the private markets.

That's the trick is to increase shareholder value.

We have some very tactical operational things that we had to jump on right away and go kill.

We've made some progress there, and that's nice.

We are far from complete, both on focusing on the operational efficiencies that we have to do and focus on growing that top line.

I think, certainly in the market, the big merger that was announced earlier this week with ATI and AMD-- that has a halo effect on us.

ATI is a pretty decent competitor in this space.

I think people are recognizing that the kind of things that we bring to the table in terms of pixel processing, software in the TV business, relationships in the TV business and then our projector business-- there are certainly things of value.

We needed to chip some of the corrosion of the pieces of value, I think, in order to really have people see what Pixelworks is all about.

Hopefully, people are beginning to see that now.

Okay; that's great.

And, we're pleased with the progress you've made in Q2, and it looks like things are picking up here in the second half.

I understand, obviously, that you're trying to develop new, disruptive products maybe out for 12 or 18 months.

We just want simply you to execute on that plan but also not to preclude other means of enhancing shareholder value if they come along.

Sure.

We hear you, Kevin.

Thank you for the comment.

Okay.

Thanks, Allen.

At this time, there are no further questions.

I will turn the conference back over to you.

Thank you very much.

I'd just like to remind you that we'll be out in August, both at the Pacific Crest Technology Forum in Colorado, and that will be on August 7.

And, then, please come and visit us here in Tualatin.

If you're in town, we'll have some demonstrations that we can show you, and both of those will also be webcast for those who can't attend.

Thank you for joining us today.

That concludes today's conference.

Thank you for your participation.