UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

For the transition period from                     to                     

Commission File Number: 000-30269

PIXELWORKS, INC.

(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 90 days.  Yes   ý    No   o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes   ý    No   o

Number of shares of Common Stock outstanding as of April 30, 2005: 46,496,945

PIXELWORKS, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

TABLE OF CONTENTS

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PART I – FINANCIAL INFORMATION

Item 1.            Financial Statements

PIXELWORKS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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PIXELWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

4

PIXELWORKS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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PIXELWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except per share data)

NOTE 1:                BASIS OF PRESENTATION

Nature of Business

Pixelworks, Inc. (“Pixelworks” or the “Company”) is a leading designer, developer and marketer of semiconductors and software for the advanced display industry, including advanced televisions, multimedia projectors and flat panel monitors.  Our system-on-chip semiconductors provide the ‘intelligence’ for these types of displays by processing and optimizing video and computer graphic signals to produce high-quality images.

Condensed Consolidated Financial Statements

These condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such regulations, although we believe that the disclosures provided are adequate to prevent the information presented from being misleading.

The financial information included herein for the three months ended March 31, 2005 and 2004 is unaudited; however, such information reflects all adjustments, consisting only of normal recurring adjustments, that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows of the Company for these interim periods.  The financial information as of December 31, 2004 is derived from our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2004, included in Item 8 of our Annual Report on Form 10-K, and should be read in conjunction with such consolidated financial statements.

The results of operations for the three months ended March 31, 2005 are not necessarily indicative of the results expected for the entire fiscal year ending December 31, 2005.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and judgments that affect the amounts reported in the financial statements and accompanying notes.  Our significant estimates and judgments include those related to product returns, warranty obligations, bad debts, inventory valuation, property and equipment, intangible assets and income taxes.  The actual results experienced by the Company could differ materially from our estimates.

Reclassifications

Certain reclassifications have been made to the 2004 condensed consolidated financial statements to conform to the 2005 presentation, including the reclassification of investments in auction rate securities from cash and cash equivalents to available-for-sale short-term marketable securities and the reclassification of tooling depreciation from research and development expense to cost of revenue.  Additionally, facilities and information technology expenses have been allocated between selling, general and administrative expense, research and development expense and cost of revenue based on employee headcount.

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NOTE 2:                STOCK PLANS

We have a 1997 Stock Incentive Plan and a 2001 Nonqualified Stock Option Plan under which employees, officers and directors may be granted stock options to purchase shares of the Company’s common stock.  We also have a 2000 Employee Stock Purchase Plan under which eligible employees may purchase shares of Pixelworks’ common stock at 85% of fair market value at specific, pre-determined dates.

As permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), and SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an Amendment of FASB Statement No. 123, we continue to apply the intrinsic value based method of accounting for stock compensation described in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“Opinion 25”).  As such, stock-based compensation cost is measured as the excess, if any, of the quoted market price of Pixelworks’ stock on the grant, or other measurement date, over the amount that an option holder must pay to acquire the stock.

Entities electing to continue to apply Opinion 25 must make prominent pro-forma disclosures of net income and earnings per share as if the fair value based method prescribed by SFAS 123 had been applied.  Had we accounted for our stock-based compensation plans in accordance with SFAS 123, our net income (loss) would have approximated the pro-forma amounts below:

The fair value of stock-based compensation costs reflected in the above pro-forma amounts were determined using the Black-Scholes option pricing model and the following weighted average assumptions:

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The effects of applying SFAS 123 in this pro-forma disclosure are not indicative of future amounts and additional awards are anticipated in future periods.

NOTE 3:                BALANCE SHEET COMPONENTS

Marketable Securities

At December 31, 2004, we classified all marketable securities as held-to-maturity in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”), with the exception of auction rate securities and our investment in Semiconductor Manufacturing International Corporation (“SMIC”), which we classified as available-for-sale.

On March 31, 2005, we determined that we no longer had the intent to hold any of our securities to maturity based on the potential for future acquisitions, and we reclassified all of our held-to-maturity securities to available-for-sale.  The amortized cost of the securities transferred from held-to-maturity to available-for-sale was $159,632 on the March 31, 2005 transfer date.

Short-term marketable securities were classified as follows:

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Long-term marketable securities were classified as follows:

Unrealized holding losses on short-term available-for-sale marketable securities, net of tax, were $571 at March 31, 2005.  Unrealized holding losses on long-term available-for-sale marketable securities, net of tax, were $531 at March 31, 2005.  These unrealized holding losses are recorded in accumulated other comprehensive loss, a component of shareholders’ equity, at March 31, 2005.

There were no unrealized holding gains or losses on available-for-sale auction rate securities at December 31, 2004, and the unrealized holding gain on our investment in SMIC at December 31, 2004, net of tax, was $531.  This unrealized holding gain was recorded in accumulated other comprehensive income at December 31, 2004.

Gross unrealized holding losses on short-term held-to-maturity marketable securities were $48 at December 31, 2004, and gross unrealized losses on long-term held-to-maturity marketable securities were $68 at December 31, 2004.

Accounts Receivable, Net

Accounts receivable are recorded at invoiced amount and do not bear interest when recorded or accrue interest when past due.  We do not have any off balance sheet exposure risk related to customers.  Accounts receivable are stated net of an allowance for doubtful accounts, which is maintained for estimated losses that may result from the inability of our customers to make required payments.  Accounts receivable, net consisted of the following:

Inventories, Net

Inventories consist of finished goods and work-in-process, and are stated at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market (net realizable value), net of a reserve for slow moving and obsolete items.  Inventories, net consisted of the following:

The following is a summary of the change in our reserve for slow moving and obsolete items:

While we do not currently expect to be able to sell or otherwise use the reserved inventory we have on hand at March 31, 2005 based upon our forecast and backlog, it is possible that a customer will decide in the future to purchase a portion of the reserved inventory.  It is not currently possible to predict if or when this will happen, or how much we may sell.  We do not expect that if such sales occur, they will have a material impact on gross profit margin.

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Property and Equipment, Net

Property and equipment, net consisted of the following:

Acquired Intangible Assets, Net

Acquired intangible assets, net consisted of the following:

Accrued Liabilities and Current Portion of Long-Term Liabilities

Accrued liabilities and current portion of long-term liabilities consisted of the following:

The following is a summary of the change in our reserve for sales returns and allowances for the three months ended March 31, 2005 and 2004:

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The following is a summary of the change in our reserve for warranty returns for the three months ended March 31, 2005 and 2004:

Long-Term Debt

On May 18, 2004, we issued $125,000 of convertible subordinated debentures (the “debentures”) due 2024 in a private offering pursuant to Rule 144A under the Securities Act of 1933 and outside of the United States in accordance with Regulation S under the Securities Act.  On June 4, 2004, we issued an additional $25,000 of debentures pursuant to the exercise of an option granted to the initial purchasers.

The debentures bear interest at a rate of 1.75% per annum and interest is payable on May 15 and November 15 of each year, beginning November 15, 2004.  The debentures are convertible, under certain circumstances, into our common stock at a conversion rate of 41.0627 shares of common stock per $1,000 principal amount of debentures for a total of 6,159 shares.  This is equivalent to a conversion price of approximately $24.35 per share.  The debentures are convertible if (a) during any calendar quarter, the market price of our common stock exceeds 130% of the conversion price per share for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the previous calendar quarter, (b) the trading price of the debentures declines to less than 98% of the product of the closing sale price of our common stock and the number of shares issuable upon conversion of $1,000 principal amount of the debentures for five consecutive trading days, (c) a call for redemption occurs, or (d) in the event of certain other corporate transactions.  We may redeem some or all of the debentures for cash on or after May 15, 2011 at a price equal to 100% of the principal amount of the debentures plus accrued and unpaid interest.  The holders of the debentures have the right to require us to purchase all or a portion of their debentures on May 15, 2011, May 15, 2014 and May 15, 2019 at a price equal to 100% of the principal amount plus accrued and unpaid interest.

We have filed a shelf registration statement with the Securities and Exchange Commission covering resales of the debentures and the common stock issuable upon conversion of the debentures.  The registration statement was declared effective August 24, 2004.  The debentures are unsecured obligations and are subordinated in right of payment to all our existing and future senior debt.

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NOTE 4:                COMPREHENSIVE (LOSS) INCOME

Total comprehensive (loss) income for the three months ended March 31, 2005 and 2004 was as follows:

NOTE 5:                EARNINGS PER SHARE

We calculate earnings per share in accordance with SFAS No. 128, Earnings per Share.  Basic earnings per share amounts are computed based on the weighted average number of common shares outstanding, and includes exchangeable shares.  These exchangeable shares, which were issued on September 6, 2002 by Jaldi, our Canadian subsidiary, to its shareholders in connection with the Jaldi asset acquisition, have characteristics essentially equivalent to Pixelworks’ common stock.

Diluted weighted average shares outstanding includes the increased number of common shares that would be outstanding assuming the exercise of certain stock options and the vesting of certain restricted stock, when such exercise or vesting would have the effect of reducing earnings per share.  In the fourth quarter of 2004, we adopted Emerging Issues Task Force Issue No. 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share.  As a result, diluted weighted average shares outstanding also includes the increased number of common shares that would be outstanding assuming the conversion of our convertible debentures, using the if-converted method, when such conversion would have the effect of reducing earnings per share.  The common shares issuable upon conversion of the debentures have been excluded from weighted average dilutive common shares outstanding for the three months ended March 31, 2005, as their inclusion would have the effect of increasing earnings per share.

The following schedule reconciles basic and diluted weighted average shares outstanding:

For the three months ended March 31, 2005 and 2004, respectively, approximately 4,551 and 1,271 weighted average shares related to stock options were also excluded from the calculation of diluted weighted average shares outstanding because the exercise prices of these options were equal to or greater than the average market price of Pixelworks common stock during these periods, and as a result, their inclusion would have been anti-dilutive.

NOTE 6:                SEGMENT INFORMATION

In accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, we have identified a single operating segment: the design and development of integrated circuits for electronic display devices.  Substantially all of our assets are located in the United States.

Geographic Information

Revenue by geographic region, attributed to countries based on the domicile of the customer, was as follows:

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Significant Customers

Sales to distributors represented 54% and 71% of total revenue for the three months ended March 31, 2005 and 2004, respectively.  The following distributors accounted for 10% or more of total revenue for certain of the periods presented:

Sales to our top five end customers represented 36% and 37% of total revenue for the three months ended March 31, 2005 and 2004, respectively.

The following end customers accounted for 10% or more of total revenue for certain of the periods presented:

End customers include customers who purchase directly from us, as well as customers who purchase our products indirectly through distributors and contract manufacturers.

The following accounts represented 10% or more of gross accounts receivable:

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NOTE 7:                                                RISKS AND UNCERTAINTIES

Concentration of Suppliers

We do not own or operate a semiconductor fabrication facility and do not have the resources to manufacture our products internally.  We rely on four third-party foundries to produce all of our products and we do not have any long-term agreements with any of these suppliers.  In light of these dependencies, it is reasonably possible that failure to perform by one of these suppliers could have a severe impact on our growth and results of operations.

Risk of Technological Change

The markets in which we compete or seek to compete are subject to rapid technological change, frequent new product introductions, changing customer requirements for new products and features and evolving industry standards.  The introduction of new technologies and the emergence of new industry standards could render our products less desirable or obsolete, which could harm our business.

Concentrations of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist of cash equivalents, short and long-term marketable securities and accounts receivable.  We limit our exposure to credit risk associated with cash equivalent and marketable security balances by placing our funds in various high quality securities and limiting concentrations of issuers and maturity dates.  We limit our exposure to credit risk associated with accounts receivable by carefully evaluating creditworthiness before offering terms to customers.

NOTE 8:                                                COMMITMENTS AND CONTINGENCIES

Indemnifications

Certain of our software license agreements include limited indemnification provisions for claims from third-parties relating to our intellectual property.  Such indemnification provisions are accounted for in accordance with SFAS No. 5, Accounting for Contingencies.  The indemnification is limited to the amount paid by the customer.  As of March 31, 2005, we have not incurred any material liabilities arising from these indemnification obligations, however in the future, such obligations could impact our immediate results of operations but would not materially affect our business.

NOTE 9:                                                SUBSEQUENT EVENT

On April 28, 2005, we entered into an Agreement and Plan of Merger with Equator Technologies, Inc. (“Equator”).  Equator is a leading provider of programmable digital video and audio encoding and decoding solutions with a family of Broadband Signal Processor integrated circuits.  Under the terms of the merger agreement, we will purchase all outstanding shares of Equator for approximately $109 million in cash.  Additionally, all outstanding Equator stock options will be converted into options to acquire Pixelworks common stock.  The transaction is expected to close in the second quarter of 2005 and is subject to regulatory approval and customary closing conditions.  The transaction will be accounted for by the purchase method of accounting, and accordingly, the results of operations of Equator will be included in our financial statements beginning on the date of closing.

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Item 2.           Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Report contain “forward-looking statements” within the meaning of the Securities Litigation Reform Act of 1995 that are based on current expectations, estimates, beliefs, assumptions and projections about our business.  Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and variations of such words and similar expressions are intended to identify such forward-looking statements.  These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict.  Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements due to numerous factors.   Such factors include, but are not limited to, increased competition, continued adverse economic conditions in the U.S. and internationally, including adverse economic conditions in the specific markets for our products, adverse business conditions, failure to design, develop and manufacture new products, lack of success in technological advancements, lack of acceptance of new products, unexpected changes in the demand for our products and services, the inability to successfully manage inventory pricing pressures, failure to reduce costs or improve operating efficiencies, changes to and compliance with international laws and regulations, currency fluctuations and our ability to attract, hire and retain key and qualified employees.  These forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q.  If we do update or correct one or more forward-looking statements, you should not conclude that we will make additional updates or corrections with respect thereto or with respect to other forward-looking statements.

(Dollars in thousands)

Overview

We are a leading designer, developer and marketer of semiconductors and software for the advanced display industry, including advanced televisions, multimedia projectors and flat panel monitors.  Our system-on-chip semiconductors provide the ‘intelligence’ for these new types of displays by processing and optimizing video and computer graphic signals to produce high-quality and realistic images.  Many of the world’s leading manufacturers of consumer electronics and computer display products utilize our technology to enhance image quality and ease of use of their products.  Our goal is to provide all of the electronics necessary to process the entire signal path in order to provide a turnkey solution for our customers.

On April 28, 2005, we entered into an Agreement and Plan of Merger with Equator Technologies, Inc. (“Equator”).  Equator is a leading provider of programmable digital video and audio encoding and decoding solutions with a family of Broadband Signal Processor integrated circuits.  Under the terms of the merger agreement, we will purchase all outstanding shares of Equator for approximately $109 million in cash.  Additionally, all outstanding options to purchase Equator stock will be converted into options to acquire Pixelworks common stock.  The transaction is expected to close in the second quarter of 2005 and is subject to regulatory approval and customary closing conditions.  The transaction will be accounted for by the purchase method of accounting.  The results of operations of Equator will be included in our financial statements beginning on the date of closing.  Accordingly, the discussion of our results of operations below for the quarter ended March 31, 2005 does not include the effects of the Equator transaction.

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We sell our products worldwide through a direct sales force and indirectly through distributors and manufacturers’ representatives.  Manufacturers’ representatives support some of our European and Asian sales.  We sell to distributors in Japan, Taiwan, China and Europe.  Sales to distributors represented 54% and 71% of total revenue for the three months ended March 31, 2005 and 2004, respectively.  Effective February 4, 2005, we terminated our distributor relationship with Neoview, one of our Taiwanese distributors.  We now sell our products directly to Taiwanese customers previously served by Neoview, as well as through our other Taiwanese distributors.  The termination of this relationship led to the decrease in sales to distributors during the three months ended March 31, 2005 compared to the three months ended December 31, 2004.

Historically, significant portions of our revenue have been generated by sales to a relatively small number of end customers and distributors.  Sales to our top five end customers represented 36% and 37% of total revenue for the three months ended March 31, 2005 and 2004, respectively.  End customers include customers who purchase directly from us, as well as customers who purchase our products indirectly through distributors and contract manufacturers.

Significant portions of our products are sold overseas.  Sales outside the U.S. accounted for approximately 99% of total revenue for the three months ended March 31, 2005 and 2004.  Our integrators, branded manufacturers and branded suppliers incorporate our products into systems that are sold worldwide.  All revenue to date has been denominated in U.S. dollars.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).  The preparation of financial statements in conformity with GAAP requires us to make estimates and judgments that affect the amounts reported in the financial statements and accompanying notes.  On an ongoing basis, we evaluate our estimates, including those related to product returns, warranty obligations, inventories, property and equipment, intangible assets and income taxes.  We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances.  Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue Recognition.  We recognize revenue in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition.  Accordingly, revenue is recognized when an authorized purchase order has been received, the sales price is fixed and determinable, title and risk of loss have transferred, collection of the resulting receivable is probable and product returns are reasonably estimable.  This generally occurs upon shipment of the underlying merchandise.

Sales Returns and Allowances.  Our customers do not have a stated right to return product other than under our warranty policy discussed below.  As such, customer returns are accepted on a case-by-case basis as customer accommodations only.  However, certain of our distributors have stock rotation provisions in their distributor agreements, which allow them to return 5-10% of the products purchased in the prior six months in exchange for products of equal value.  Certain distributors also have price protection provisions in their agreements with us.

We record estimated reductions to gross profit for these sales returns and allowances in our reserve for sales returns and allowances.  We update the balance in this reserve at each reporting period based on

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historical experience.  If actual returns and allowances increase, we may be required to recognize additional reductions to gross profit.

Product Warranties.  We warrant that our products will be free from defects in materials and workmanship for a period of twelve months from delivery.  Warranty repairs are guaranteed for the remainder of the original warranty period.  Our warranty is limited to repairing or replacing products, or refunding the purchase price.

We provide for the estimated cost of product warranties in our warranty reserve.  We update the balance in this reserve based on historical experience at each reporting period.  While we engage in extensive product quality programs and processes, which include actively monitoring and evaluating the quality of our suppliers, should actual product failure rates or product replacement costs differ from our estimates, revisions to the estimated warranty liability may be required.

Allowance for Doubtful Accounts.  We offer credit to customers after careful examination of their creditworthiness.  We maintain an allowance for doubtful accounts for estimated losses that may result from the inability of our customers to make required payments.  We evaluate the balance in the allowance based on historical experience and the age of outstanding receivables at each reporting period.  If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventory Valuation.  We record a reserve against our inventory for estimated obsolete, unmarketable, and otherwise impaired products by calculating the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.  We review our inventory at the end of each reporting period for valuation issues.  If actual market conditions are less favorable than those we projected at the time the reserve was recorded, additional inventory write-downs may be required.

Useful Lives and Recoverability of Equipment and Other Long-Lived Assets.  In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we evaluate the remaining useful life and recoverability of equipment and other assets, including identifiable intangible assets with definite lives, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.  If there is an indicator of impairment, we prepare an estimate of future, undiscounted cash flows expected to result from the use of each asset and its eventual disposition.  If these cash flows are less than the carrying value of the asset, we adjust the carrying amount of the asset to its estimated fair value.

Goodwill.  Goodwill is not amortized.  Instead we test goodwill, which represents the excess cost over the fair value of net assets acquired in business combinations, annually for impairment, and more frequently if events and circumstances indicate that it might be impaired.  The impairment tests are performed in accordance with SFAS No. 142, Goodwill and Other Intangible Assets.  Accordingly, an impairment loss is recognized to the extent that the carrying amount of goodwill exceeds its implied fair value.  This determination is made at the reporting unit level.  We have assigned all goodwill to a single, enterprise-level reporting unit.  The impairment test consists of two steps.  First, we determine the fair value of the reporting unit.  The fair value is then compared to its carrying amount.  Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill.  The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation in accordance with SFAS No. 141, Business Combinations.  The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.  We perform our annual

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impairment test in the first quarter of each year.  We did not record any impairment losses against goodwill when we performed the test in the first quarter of 2005 or 2004.

Income Taxes.  Deferred income taxes are provided for temporary differences between the amount of assets and liabilities for financial and tax reporting purposes.  We establish a valuation allowance in accordance with SFAS No. 109, Accounting for Income Taxes, to reduce our deferred tax assets to the amount that is more likely than not to be realized.  Should we determine that we will not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset may be charged to income in the period such determination was made.

Tax contingencies are recorded to address potential exposures involving tax positions we have taken that could be challenged by taxing authorities.  These potential exposures result from the varying applications of statutes, rules, regulations and interpretations.  Our tax contingencies contain assumptions based on past experiences and judgments about potential actions by taxing jurisdictions.  The ultimate resolution of these matters may be greater or less than the amount that we have accrued.

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Results of Operations

The following table sets forth certain financial data for the periods indicated:

Percentages may not add due to rounding.

Revenue

Revenue for the three months ended March 31, 2005 was 11% lower than revenue for the three months ended March 31, 2004.  Changes in units shipped and average selling prices were as follows:

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Revenue by market as a percentage of gross revenue was as follows:

Advanced Televisions

Total revenue from advanced television sales increased 36% to $23,378 in the first quarter of 2005 from $17,217 in the first quarter of 2004.  Units shipped increased 34%, while average selling prices increased 1%.  The advanced television market includes products sold into liquid crystal display (“LCD”) televisions, digital cathode ray tube (“CRT”) televisions, plasma displays, and digital rear projection televisions.  Revenue from products sold into the LCD market comprised the majority of our advanced television revenue during the quarters ended March 31, 2005 and March 31, 2004.  Our advanced television revenue is generated on sales to customers located in China, Taiwan, Europe, Korea and Japan.

In the second quarter of 2005, we expect that advanced television revenue will increase 5% to 10% over the first quarter of 2005.

Multimedia Projectors

Total revenue from multimedia projector sales decreased 47% to $11,954 in the first quarter of 2005 from $22,392 in the first quarter of 2004.  Units shipped decreased 31%, while average selling prices decreased 23%.  The decrease in revenue in the multimedia projector market is partially attributable to a general weakening of the overall market and partially to excess channel inventory.  Consistent with the first quarter of 2004, the majority of our sales to multimedia projector manufacturers during the three months ended March 31, 2005 were to customers located in Japan.  Japanese customers accounted for 87% and 64% of total projector revenue for the three months ended March 31, 2005 and 2004, respectively.

We believe that multimedia projector revenue in the second quarter of 2005 will be within 5% of first quarter 2005 multimedia projector revenue.

LCD Monitors

Total revenue from LCD monitor sales decreased 33% to $3,184 in the first quarter of 2005 from $4,752 in the first quarter of 2004.  Units shipped decreased 60% but average selling prices increased 67%.  The overall decrease in LCD monitor revenue is primarily attributable to our strategy to stop developing mainstream products for this market.  The increase in average selling prices resulted from an increase in the percentage of chips sold into Ultra Extended Graphics Array (“UXGA”) monitors, which carry higher average selling prices than chips sold into Super Extended Graphics Array (“SXGA”) or Extended Graphics Array (“XGA”) monitors.  The majority of our monitor revenue is generated on sales to customers located in Taiwan.

In the second quarter of 2005, we expect that our LCD monitor revenue will be within 5% of our first quarter 2005 LCD monitor revenue.

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Other

Other revenue includes sales of evaluation kits as well as the impact of changes in our reserve for sales returns and allowances.  It also includes sales into small, niche markets that are unrelated to the three primary markets for our products.  We do not expect other revenue to be significant in the near future.

Cost of revenue and gross profit

Cost of revenue includes purchased materials, assembly, test, labor and overhead, warranty expense, royalties, amortization of purchased developed technology, provisions for slow moving and obsolete inventory and information technology and facilities allocations.

Gross profit decreased to 42.0% for the three months ended March 31, 2005 from 51.7% for the three months ended March 31, 2004.  The decrease is primarily driven by a change in the mix of products sold.  The decrease in sales to multimedia projector manufacturers as a percentage of total revenue contributed significantly to the overall decrease in gross profit, as our multimedia projector sales generally have the highest gross profit margins.

We expect our gross profit margin to be flat at approximately 42%, plus or minus 1%, for the second quarter of 2005.  This consistency is attributable to the fact that we do not expect any significant changes in the mix of products sold from the first quarter to the second quarter of 2005.

Research and development

Research and development expense includes compensation and related costs for personnel, depreciation and amortization, fees for outside services and expensed equipment and software.  Research and development expense, inclusive of stock-based compensation expense, was as follows:

Research and development expense, inclusive of stock-based compensation expense, increased $1,669, or 21%, from the three months ended March 31, 2004 to the three months ended March 31, 2005 due to the following offsetting factors:

•                  Depreciation and amortization expense increased $1,259 due to increased licensed technology and software asset purchases.

•                  Compensation expense increased $502 due to higher headcount in research and development departments during the three months ended March 31, 2005 as compared to the three months ended March 31, 2004.  The lower headcount for the three months ended March 31, 2004 was partially attributable to the restructuring that we initiated in the third quarter of 2003 to better position the Company to compete in the advanced television market.

•                  Facilities and information technology expenses allocated to research and development departments increased $456 from the three months ended March 31, 2004 to the three months ended March 31,

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2005.  The increase was driven by higher headcount in information technology, higher rent expense, higher depreciation expense and increased communication charges.

•                  Expensed equipment and software decreased $287.

•                  We recorded a $163 loss on the disposal of licensed technology during the three months ended March 31, 2004, as we were no longer utilizing the licensed technology and we had no alternate uses for it.  There were no such losses recorded during the three months ended March 31, 2005.

We expect our research and development expense to continue to increase in future periods to support our ongoing investment in new product development programs.

Selling, general and administrative

Selling, general and administrative expense includes compensation and related costs for personnel, travel, outside services, sales commissions and overhead incurred in our sales, marketing, customer support, management, legal and other professional and administrative support functions.  Selling, general and administrative expense, inclusive of stock-based compensation expense, was as follows:

Selling, general and administrative expense, inclusive of stock-based compensation expense, increased $1,514, or 27%, from the three months ended March 31, 2004 to the three months ended March 31, 2005 due to the following factors:

•                  Compensation expense increased $887 due to an increase in headcount in administrative and sales and marketing personnel required to support future revenue growth and new regulatory requirements.

•                  The facilities and information technology expenses allocated to selling, general and administrative expense increased $283.  The increase was driven by higher headcount in information technology, higher rent expense, higher depreciation expense and increased communication charges.