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Edited Transcript of PXLW earnings conference call or presentation 27-Apr-17 9:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Pixelworks Inc Earnings Call

SAN JOSE May 9, 2017 (Thomson StreetEvents) -- Edited Transcript of Pixelworks Inc earnings conference call or presentation Thursday, April 27, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Steven L. Moore

Pixelworks, Inc. - CFO, VP, Treasurer and Secretary

* Todd A. DeBonis

Pixelworks, Inc. - CEO, President and Director

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Conference Call Participants

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* Brian Matthew Alger

Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst

* Richard Cutts Shannon

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Pixelworks Incorporated First Quarter 2017 Earnings Conference Call. I will be your operator for today's call. (Operator Instructions) This conference call is being recorded for replay purposes.

I would now like to turn the call over to Mr. Steve Moore.

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Steven L. Moore, Pixelworks, Inc. - CFO, VP, Treasurer and Secretary [2]

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Good afternoon, and thank you for joining us today.

With me on the call is Todd DeBonis, Pixelworks' President and CEO. The purpose of today's conference call is to supplement the information provided in our press release issued earlier today announcing the company's financial results for the first quarter of 2017.

Before we begin, I would like to remind you that various remarks we make on this call, including those about our projected future financial results, economic and market trends and our competitive position, constitute forward-looking statements. These forward-looking statements and all other statements made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. All forward-looking statements are based on the company's belief as of today, Thursday, April 27, 2017, and we undertake no 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, 2016, and subsequent SEC filings for a description of factors that would cause forward-looking statements to differ materially from actual results.

Additionally, the company's press release and management's statements during this conference call will include discussions of certain measures and financial information in GAAP and non-GAAP terms, including gross margin, operating expenses, net income loss, net income loss per share. These non-GAAP measures exclude stock-based compensation expense and certain charges related to the company's announced restructuring in the first half of 2016. We use these non-GAAP measures internally to assess our operating performance.

The company believes these non-GAAP measures provide a meaningful perspective on our core operating results and underlying cash flow dynamics, but we caution investors to consider these measures in addition to, not as a substitute for nor superior to, the company's consolidated financial results as presented in accordance with GAAP. Included in the company's press release are definitions and reconciliations of GAAP to non-GAAP net income loss and GAAP net income loss to adjusted EBITDA, which provide additional details.

With that said, I will now turn the call over to Todd for his opening remarks.

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [3]

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Thank you, Steve, and good afternoon to everyone on today's call. As reported in today's press release, we started off the year with very solid results in the first quarter. Revenue of $22.7 million was near the high end of our guidance, which included $9.2 million from expected end-of-life, or EOL, products. Excluding EOL contribution, revenue reflected typical seasonality in the first quarter, but grew 40% year-over-year. Gross margin in the first quarter was 54.8%, which was also at the upper end of guidance. And when combined with operating expenses being at the low-end, we achieved profitability for the second consecutive quarter.

Net income was $0.09 per diluted share on a GAAP basis and $0.12 on a non-GAAP basis. Notably, this enabled our cash balance to be unchanged from the last quarter, despite funding a significant amount of EOL orders during the quarter. Our continued top line growth and significant improvements made to our operating model and underlined financials last year are clearly evident in our bottom line results.

Our goal for the year continues to be delivering year-over-year annual revenue growth even when excluding EOLs, while also maintaining profitability.

In addition, we expect the contribution from EOL products to add over $8 million in nondiluted capital to our balance sheet between the first and second quarters.

Shifting to an update on our end markets of projector and mobile. First, in our projector business. As previously mentioned, revenue grew 42% year-over-year, excluding EOL. End market demand reflected typical seasonality and as we continue to see more normalized order patterns from customers following last year's inventory and supply channel disruptions.

Most notable during the quarter, we entered into an $8 million co-development agreement with a large projector customer for an SoC to be launched in the 2019 timeframe. This agreement demonstrates not only the strength of relationship with this market-leading customer, it also further solidifies and extends Pixelworks' leadership position in the broader projector market for the foreseeable future.

Although, the multiyear agreement will not contribute to near-term revenue, it does help offset a large portion of the development expenses associated with this custom chip. The chip itself will ultimately be exclusive to the customer, however, any intellectual property created during the development process can be used by Pixelworks in future chips for other customers.

Following our streamlining of the business and conversion of several customers to higher-value products, we are now beginning to realize favorable impacts to both ASPs and margins. We are expecting these benefits to remain over the intermediate- to longer-term, with projector material margins generally remaining around current levels.

Consistent with my comments last quarter, we see no reason to expect any meaningful deviations to typical revenue cycles and seasonality throughout the remainder of the year. When combined with now-normalized market demand, we anticipate our projector business to post solid year-over-year growth, excluding EOL, for the balance of 2017.

Shifting to our mobile business. Revenue in the first quarter was in line with our expectations, although the quarterly contribution from mobile is still relatively small, revenue grew nearly 300% compared to the year-ago quarter, as we continued to shift volume production in support of previously announced ASUS devices. During the quarter, there were several announcement and product launches that indicated the mobile market continues to move in our direction.

Beginning with the UHD Alliance's announcement of its Mobile HDR Premium specifications in February at Mobile World Congress. This video-quality standard represents a first of its kind for mobile devices, and it outlines specific performance criteria for resolution, dynamic range, color space and bit depth.

Pixelworks is a contributing member to the UHD Alliance, and this interindustry group's recognition is a meaningful event in the importance and potential adoption of superior video quality on mobile devices. Also notable during the quarter, multiple Tier 1 OEMs launched devices that highlighted the benefits and need for display processing. As part of the respective launches, these OEMs highlighted visual-centric attributes such as TV-like HDR playback as well as adaptive displays. These mark some of the first devices with this capability, which significantly turns up the pressure on many of the fast followers in China and other regions we are targeting to incorporate similar technology in their next-generation devices. The pressure is particularly acute for mobile OEMs in Asia, with aspirations of making inroads in capturing market share in developed markets, specifically in the U.S.

More specific to Pixelworks, we've now sampled our third-generation Iris processor with a meaningful number of perspective mobile OEM customers in Asia, and our engagements with these OEMs are progressing well. I believe we are largely on track for adoption in late 2017 and into early 2018. Although it's difficult to pinpoint the timing of any given customer product launches, the designs we are being considered for includes several flagship and mid-range smartphones and tablets that are looking to differentiate through a better visual experience.

Simultaneously, we continue to pursue our dual go-to-market strategy and see intermediate- to longer-term opportunities more broadly across the mobile ecosystem. There is no shortage of future potential customers and/or partners looking for ways to/deliver enhanced streaming video to its consumers on mobile devices.

We are talking to players across the ecosystem, from mobile SoC companies, DDI and panel manufacturers, creators of original video content as well as over-the-top streaming video providers. Although it's still early, I expect there will be more to discuss in this area as the year progresses.

In summary, our first quarter results reflect a strong start to the year as the underlying fundamentals of our business continue to show improvement following the actions taken last year. Our core projector business is performing well, and we continue to advance our mobile initiative with the market that is increasingly primed for broader adoption of Pixelworks' visual processing technology.

At the highest level, we are focused on executing to deliver year-on-year growth, improving margins and continued profitability. I look forward to reporting on our progress towards these goals and the incremental adoption of Pixelworks' best-in-class visual processing solutions as the year unfolds.

With that, I'll turn the call over to Steve to review our financial first quarter financials and guidance for the second quarter in more detail. Steve?

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Steven L. Moore, Pixelworks, Inc. - CFO, VP, Treasurer and Secretary [4]

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Thank you, Todd. Revenue for the first quarter of 2017 was $22.7 million, which included $9.2 million of EOL product revenue. This is compared to $16 million in the fourth quarter of 2016 and revenue of $11.2 million in the first quarter of 2016. Excluding EOL contribution, first quarter 2017 revenue in the digital projection market reflected typical seasonality and grew 42% year-on-year.

The breakdown of revenue during the first quarter was as follows: revenue from digital projection was approximately $18.3 million; mobile revenue was approximately $340,000; and revenue from legacy chips sold into the TV panel market was approximately $4.1 million.

Non-GAAP gross profit margin was 54.8% in the first quarter of 2017 compared to 53.6% in the fourth quarter of 2016. Gross margin was higher quarter-on-quarter due to a decrease in direct material cost as a percentage of revenue associated with a more favorable product mix and to higher absorption of operations cost.

Non-GAAP operating expenses were $8.3 million in the first quarter of 2017 compared to $7.3 million in the fourth quarter of 2016. Adjusted EBITDA was $5 million in the first quarter of 2017 compared to $2.1 million in the fourth quarter of 2016.

A reconciliation of adjusted EBITDA to GAAP net income loss may be found in today's press release. On a non-GAAP basis, the company reported a net profit of $3.8 million or $0.12 per diluted share in the first quarter of 2017 as compared to a net profit of $1.2 million or $0.04 per diluted share in the prior quarter.

Moving to the balance sheet. We ended the first quarter with cash and cash equivalents of approximately $19.6 million, just slightly above the end of the fourth quarter. Other balance sheet metrics include days sales outstanding of 38 days at quarter end compared to 18 days at the end of the fourth quarter. The increase is primarily due to a large portion of our EOL orders shipping in the month of March. Inventory turns during the first quarter increased to 15.6x compared to 10.1x in the prior quarter.

Turning now to guidance. For the second quarter of 2017, we expect revenue to be in the range of between $20 million and $21 million for Q2. We anticipate EOL revenues in excess of what would otherwise be normalized quarterly revenue to be approximately $5 million consistent with previous expectations. Note we currently do not expect any meaningful EOL revenue after Q2 2017.

We expect gross profit margin for the second quarter to be in the range of between 53% and 55% on both a GAAP and a non-GAAP basis. In terms of operating expenses, we expect the second quarter to range between $8.5 million and $9.5 million on a GAAP basis and $7.5 million and $8.5 million on a non-GAAP basis. As a result, we expect second quarter GAAP net income to be in a range of between $0.01 and $0.08 per diluted share, and we expect non-GAAP net income to be in a range of between $0.04 and $0.11 per diluted share.

With that now, we will now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Brian Alger from Roth Capital Partners.

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Brian Matthew Alger, Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst [2]

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It seems as this little projector business is certainly stabilized and can be generating some profits for the years to come. I want to flesh out a little bit, if we might, Todd. Your comments -- and I know it's early days, but your comments with regards to the engagements that you're having today on the mobile side, I've seen a number of the handsets over in Asia that have the HDR capability and certainly there is a number introduced at Mobile World Congress in Spain back in February. What can we be thinking of? What should be thinking of in terms of the near-term interests of a progression here?

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [3]

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Well, I mean, so -- so I think that -- we don't only deliver HDR compatibility. In fact, we still - we're in this delicate position because I haven't done a full product announcement, a public product announcement of our third-generation chip, which is coming. And so I don't want to get really in front of that announcement and talk about all the features and functionality. But I will say is that some of the elements that these handsets are highlighting as advantages of their new phones, we support, but there are many that they haven't announced that we also support. So our display processing engine, Iris, has many features, and we'll elaborate them when we do the product announcement. But in general, what I think you're seeing here is there's a big move to more vibrant, more colorful displays on the mobile devices, whether there'd be tablets or handsets. And I would suggest to you that -- the 2 leaders in the field, this is one of the key differentiators of their flagship handsets for 2017, both what has been announced and what could be announced. The display itself allows that wide-color gamut in higher density and more vibrant display, but there is an entire display processing pipeline and know-how behind it to truly demonstrate it. Large device OEMs that have been spending a lot of time innovating in this display pipeline area may be able to bring this know-how to you. I am suggesting that even if Qualcomm delivered it for their customers or MediaTek delivered it for their customers, they're probably not at the level that these handset manufactures are demonstrating. And even -- I would actually suggest to you that only their newest and most advanced processors would entail some of these capabilities and the older processors would not. So if you look at the rest of the market that wants to try to keep up with advanced display technology, maybe use high-resolution screens, brighter resolution screens have access to OLED capacity somewhere or even advanced LCD screens, they need help. That's where we come in. We offer help. Beyond that, I don't know what specifically you're asking me.

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Brian Matthew Alger, Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst [4]

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Well, I guess -- and that is helpful to put it in context. I appreciate it. I guess, 2 follow ups. First, I think I heard that you are display technology agnostic, we mean OLED or advanced LCD, that's really what we're talking about, it's more about the capabilities of the display. One, I want to clarify that. And two, I guess, it sounds as though these are pretty mainstream devices in the fast follower category and not so much niche, small one-offs, if you will, but rather the mainstream type of products for the fast followers that are so prevalent in the emerging -- in frankly, the Chinese market.

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [5]

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Well, so you have to look at it this way, Brian. Initially, you have -- okay, in order for this to be a marketable differentiated feature for the handset manufacturer, whether they put it on a mainstream or a niche product, it depends what their customer base demands. I would suggest to you that some markets are more mature in consuming and having readily available, high-resolution mobile HDR or even HDR content available to be consumed. If a market doesn't have it available and a phone manufacturer is targeting only that market that is not available, they may see it coming, but are they willing to take a risk to go out and get in front of the content itself and say, "Okay, I need to spend money, spend R&D, spend power budget on my phone, et cetera." Even though there's not a lot of content available. Maybe that's something I'll address next year. Where some markets it's becoming a necessity to compete in that market, because the services are there, the content is there, and that's how the phone manufactures and device manufacturers are differentiated. So if you go look at -- at certain markets around the world, some markets are more mature with this advanced content than others, I would suggest to you that we're probably targeting the markets where the demand is first, but that doesn't mean the rest of the markets won't follow. And maybe I can give you some color. So today, Amazon offers HDR content, and I think it's in 100-and-something countries around the world, right, and they are trying to qualify devices for mobile HDR content. They -- one of countries they don't offer HDR content is China, one of the few countries they don't offer, okay? Netflix just cut a deal with Baidu to deliver -- their original programming with the content. It's not clear to me whether it will be UHD, HDR content or not. Most of their original content is available in that format in this country. I don't know yet whether it's in China. Clearly, in North America, this is a hot topic. The service providers are trying to deliver you this content, the content originators are trying to create this content and then the device manufacturers are trying to respond so you have devices to consume this content. Other countries will respond, it's how quickly they will respond. So go look at the markets where the content is, go look at the phone, the tablet manufacturers that are catering to those markets, and that's probably where we're focused. Does that give you clarity?

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Brian Matthew Alger, Roth Capital Partners, LLC, Research Division - Head of Technology Research and Senior Research Analyst [6]

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It helps. I don't know if it's clear, but it helps.

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [7]

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Thanks, Brian. I'm trying to help you without actually getting in front of my customers, which are -- and my design wins, which I keep telling you guys, I'm not going to do, so...

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Operator [8]

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(Operator Instructions) And I do have a question from the line of Richard Shannon from Craig-Hallum.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [9]

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Todd, I'll note that, that the last discussion was very interesting and helpful. So thanks for giving us those pointers. Maybe I'll take us off the topic of mobile here, at least on the mobile chip side here and discuss the other side of licensing. I know you briefly touched on it as part of your broad go-to-market strategy here, and I don't think we've talked about this is an open forum in a couple of quarters. So I just want to get your latest sense here of discussions on the licensing side, when and -- if and when that could come to fruition. Either some sort of specific time frame or relative to the uptake in the device side.

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [10]

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So, I've talked about it in context probably more than it's part of our mobile initiative that shorter to midterm, this is really a chip play, this is how we bring our know-how and our value to those customers that I say -- that I just suggested to you that need help. But longer term, they want cost reductions and they want power advantages and they want to have some say and how they integrated into their display pipeline. And the best way to deliver that know-how and supports them maybe through IP licensing into the display pipeline arena, which is either on the SoC side or the DDI side. That still is active, we're discussing throughout that ecosystem. It's a broad ecosystem, and it has been somewhat up-ended by a rapid change to technologies for the device side. There's a big move towards OLED technology or OLED technology. There is limitations on readily available capacity there. And so I would say the demand in the world is -- far outstrips the supply and probably over the next 24 to 36 months. That doesn't mean people won't ship phones, that means they're going to be very creative in how to respond without access to technology that they think the market requires. And so with all those changes going on, it's an interesting environment right now, to say the least, engaging in that ecosystem. But that's still -- there's a lot of discussion, it's very healthy. I've always presented it as a mid to longer term part of our offering for the mobile initiative. But with that said, we also have technology. We were more or less out of the TV monitor business. But we have incredible technology that's applicable to the TV monitor market. We also have incredible technology that's applicable to the projector space. We have engagements of discussions for IP licensing in this arena as well, people that want to apply this technology to newer markets. So I would say, it was very healthy thing for us to do. We are limiting on how many engagements we could do. We have to pick and choose those engagements. But it's going to continue to be an active part of the way we market our intellectual property, our know-how and our support and services.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [11]

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Okay. That is helpful, I appreciate that. Maybe a question, I guess, perhaps for either of you. You made some statements about how your projector business may trend after the end of the year or throughout the rest of the year after the second quarter. And you made it sound like we should see some only guys has some good visibility into projectors growing sequentially in the remaining quarters of the year, outside of EOL, of course. Is that -- did I capture your intent there or would -- is there -- somewhat you would correct that impression?

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [12]

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The normal seasonality that we see would be that our lowest quarter would be the first quarter in projectors, and there's a number of reasons for that, most of which revolve around the fact that the Japanese report their earnings once a year and that's their end of their fiscal year. It then grows usually in the second quarter and then again usually into third quarter. Fourth quarter can be flat or down. Last year, it actually went up, but that was because our third quarter was negatively affected by the supply chain disruption from the earthquake that kept a panel -- an LCD panel factory offline that was supplying half of our Japanese customers. So the progression is one - lowest, third - highest and fourth - generally headed more back down to the first quarter.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [13]

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Okay. And it sounds like that's a fair way to think about your second half of the year as you see right now, then?

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Steven L. Moore, Pixelworks, Inc. - CFO, VP, Treasurer and Secretary [14]

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Currently, we believe that we're on that kind of normal track. As I mentioned last year was an abnormal. So looking at last year doesn't give you any real insight into this year. But if you would take a 10-year average, I think you'd see that progression as an average.

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [15]

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But if you're going to comp us off of last year, let's revisit real quick what happened last year. We had an inventory correction going into Q1 and Q2. So both our Q1 and Q2 were lower than probably what the full year would normally demand. We probably shipped some of the units in Q3 and Q4 because the customers thought they needed them, they thought it was going to continue to grow. They burned some of that inventory off in Q1 and Q2. So you're -- what you saw this quarter, you use the numbers we gave, I think I said 42%. You strip out the EOL, we had 42% growth year-over-year in Q1. That's a very high growth, right? We're going to have a good growth for the year. I wouldn't peg as 40% growth every quarter, okay, because what you're doing is you're backfilling those, those first 2 quarters that had a little bit of that inventory correction from last year. Then Q3, which was -- is normally our largest quarter last year is when we felt the brunt of the earthquake and Sony's 3LCD a shortfall in shipments to the projector manufacturers. This is probably caused the shortfall of between of $2.5 million and $3 million to the quarter. We saw some of it come back in Q4 and probably some of it come back in the quarter we just announced, right? I think everything sort of stabilized since then, and so, yes, we're seeing -- and then remember, we're still seeing some market share gains that we have. It -- the overall projector market is fairly flat, but we are gaining because we are gaining footprint at our largest customer throughout the year, among a couple of other things, all right? We also have better ASPs. We've merged more towards our higher end of our products, and that's -- so even on flat unit growth for the other part of the market, we'll see growth on a revenue basis because of the improved ASPs. So you -- it's a complex model. But the front end, bottom line, the front end you'll see more higher growth because your comp is against that inventory correction. Q3, you'll see reasonable growth, you're comping against that earthquake event. And then Q4 remains to be seen, but we had a very strong Q4. So be careful with that one.

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Richard Cutts Shannon, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [16]

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Right, right. Okay, makes sense. Last quick question for me. Todd, when you -- do you have a kind of a target date for announcing the third-gen Iris device? And just to be clear, the designs you hope to be ramping by late this year, those are all -- those are expected to be the third-gen ones, right?

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [17]

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It will -- as you know, we've announced in Analyst Day, we will release -- we will do product a release -- a product announcement before the Analyst Day, so that I can talk in detail about all the benefits of that solution.

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Operator [18]

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And that concludes our question-and-answer session for today. I would like to turn the conference back over to management for any closing remarks.

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Todd A. DeBonis, Pixelworks, Inc. - CEO, President and Director [19]

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Thanks. I know it wasn't the information everybody's really looking for. But we're executing, we're healthy. It's a -- Pixelworks is a very fun place to be at right now. I guess I'll leave on that note. Thank you.

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Operator [20]

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Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.