Table of Contents


UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For quarterly period ended: June 30, 2009ORo
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the transition period from                            to





Commission File Number: 000-26887





Silicon Image, Inc.


(Exact name of registrant as specified in its charter)





Delaware

77-0396307(State or other jurisdiction of

(I.R.S. Employer I.D. Number)incorporation or organization)





1060 East Arques Avenue, Sunnyvale, California 94085


(Address of principal executive office)(Zip Code)





(408) 616-4000


(Registrant’s telephone number, including area code)





N/A


(Former name, former address and former fiscal year,


if changed since last report)





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 past 90 days.  YesxNoo





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files).  YesoNoo





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.





Large accelerated filer    x
Accelerated filer   oNon-accelerated filer   o
Smaller reporting company   o(Do not check if a smaller reporting company)





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YesoNox





CLASS

OUTSTANDING AT July  31, 2009Common Stock, $0.001 par value

74,870,030








Table of Contents





Silicon Image, Inc.


Form 10-Q for the quarter ended June 30, 2009











Part I Financial Information (Unaudited)
3It              Item 1 Financial Statements
3Condensed Consolidated
Balance Sheets as of June 30, 2009 and December 31, 2008
3Condensed
Consolidated Statements of Operations for the three  and six months ended June 30, 2009 and 2008
4Condensed
Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and 2008
5Notes
to Condensed Consolidated Financial Statements
6Item 2 Management’s Discussion and Analysis of Financial Condition and
Results of Operations
20Item 3 Quantitative and Qualitative Disclosures About Market Risk
29Item 4 Controls and Procedures
30Part II Other Information
30Item 1 Legal Proceedings
30Item 1A Risk Factors
30Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
45Item 3 Defaults Upon Senior Securities
45Item 4 Submission of Matters to a Vote of Security Holders
45Item 5 Other Information
45Item 6 Exhibits
46Signature
47


EXHIBIT 31.01


EXHIBIT 31.02


EXHIBIT 32.01


EXHIBIT 32.02

















2
 
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Part I. Financial Information





Item 1. Financial Statements (Unaudited)





Silicon Image, Inc.


Condensed Consolidated Balance Sheets


(in thousands)


(unaudited)








June 30, 2009


December 31, 2008AssetsCurrent Assets:Cash and cash equivalents

$
18,583


$
95,414Short-term investments


144,370



89,591Accounts receivable, net of allowances for doubtful accounts
$1,355 at June 30, 2009 and $1,778 at December 31, 2008


19,059



5,922Inventories


9,169



12,775Prepaid expenses and other current assets


19,096



15,275Deferred income taxes


6,445



6,665Total current assets


216,722



225,642Property and equipment, net


16,696



19,394Goodwill


-



19,210Intangible assets, net


29,975



32,921Deferred income taxes, non-current


21,101



28,193Other assets


794



1,181Total assets

$
285,288


$
326,541Liabilities and Stockholders’ EquityCurrent Liabilities:Accounts payable

$
10,351


$
7,278Accrued and other current liabilities


20,882



23,023Deferred license revenue


2,400



2,348Deferred margin on sales to distributors


1,884



6,881Total current liabilities


35,517



39,530Other long-term liabilities


8,831



8,064Total liabilities


44,348



47,594Commitments and contingencies (See Note9)Stockholders’ Equity:Common stock


92



92Treasury stock


(106,517
)


(106,276
)Additional paid-in capital


450,943



442,228Accumulated deficit


(103,688
)


(57,030
)Accumulated other comprehensive income (loss)


110



(67
)Total stockholders’ equity


240,940



278,947Total liabilities and stockholders’ equity

$
285,288


$
326,541

















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Silicon Image, Inc.


Condensed Consolidated Statements of Operations


(in thousands, except per share amounts)


(unaudited)




Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Revenue:Product

$
29,436


$
61,836


$
64,031


$
119,023Licensing


7,900



8,247



13,817



18,173Total revenue


37,336



70,083



77,848



137,196Cost of revenue and operating expenses:Cost of product revenue (1)


17,264



28,615



35,483



56,403Cost of licensing revenue


274



492



470



841Research and development (2)


17,619



22,298



35,353



43,840Selling, general and administrative (3)


12,678



19,067



26,393



37,385Restructuring expense (Note 5)


7,098



-



7,857



-Amortization of intangible assets


1,473



1,587



2,946



3,174Goodwill impairment (Note 15)


-



-



19,210



-Total cost of revenue and operating expenses


56,406



72,059



127,712



141,643Loss from operations


(19,070
)


(1,976
)


(49,864
)


(4,447
)Interest income and other, net


598



1,380



1,537



3,296Loss before provision for income taxes


(18,472
)


(596
)


(48,327
)


(1,151
)Income tax benefit


(5,143
)


(134
)


(1,669
)


(127
)Net loss

$
(13,329
)

$
(462
)

$
(46,658
)

$
(1,024
)Net loss per share – basic and diluted

$
(0.18
)

$
(0.01
)

$
(0.63
)

$
(0.01
)Weighted average shares – basic and diluted


74,806



73,399



74,618



77,257(1) Includes stock-based compensation expense

$
244


$
431


$
443


$
781(2) Includes stock-based compensation expense


1,617



2,213



2,991



3,447(3) Includes stock-based compensation expense


2,352



3,614



4,344



6,053


















See accompanying Notes to Condensed Consolidated Financial Statements.























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Silicon Image, Inc.


Condensed Consolidated Statements of Cash Flows


(in thousands)


(unaudited)


Six Months Ended June 30,2009


2008Cash flows from operating activities:Net loss

$
(46,658
)

$
(1,024
)Adjustments to reconcile net loss to cash provided by (used in) operating activities:Impairment of goodwill


19,210



-Stock-based compensation expense


7,778



10,281Deferred income taxes


7,312



(2,723
)Depreciation


4,592



5,257Amortization of intangible assets


2,946



3,174Amortization of investment premium


1,683



378Non-cash restructuring expense


200



-Loss on disposal and retirement of property and equipment


180



402Provision for doubtful accounts


154



534Realized loss/(gain) on sale of short-term investments


15



(52
)Tax deficiency from employee based compensation plans


(781
)


(501
)Excess tax benefits from employee stock transactions


(13
)


(304
)Changes in assets and liabilities:Accounts receivable


(13,256
)


(7,781
)Inventories


3,606



2,512Prepaid expenses and other current assets


(3,404
)


1,508Accounts payable


2,722



(1,745
)Accrued and other current liabilities


(978
)


(361
)Deferred license revenue


52



435Deferred margin on sales to distributors


(4,997
)


1,543Cash provided by (used in) operating activities


(19,637
)


11,533Cash flows from investing activities:Purchases of short-term investments


(128,350
)


(111,937
)Proceeds from sales of short-term investments


71,952



144,681Purchases of property and equipment


(1,840
)


(4,622
)Proceeds from sale of property and equipment


120



-Cash provided by (used in) investing activities


(58,118
)


28,122Cash flows from financing activities:Proceeds from issuances of common stock, net


1,718



3,084Excess tax benefits from employee stock transactions


13



304Payments for vendor financed software and intangibles purchased


(625
)


(6,153
)Repurchase of restricted stock units for income tax withholding


(241
)


-Repurchase of common stock


-



(68,180
)Cash provided by (used in) financing activities


865



(70,945
)Effect of exchange rate changes on cash and cash equivalents


59



13Net decrease in cash and cash equivalents


(76,831
)


(31,277
)Cash and cash equivalents — beginning of period


95,414



137,822Cash and cash equivalents — end of period

$
18,583



106,545Supplemental cash flow information:Restricted stock units vested

$
667


$
-Net cash payment (refund) for income taxes

$
(5,574
)

$
1,215Unrealized net gain (loss) on short-term investments

$
79


$
(30
)Property and equipment purchased but not paid for

$
577


$
636








See accompanying Notes to Condensed Consolidated Financial Statements.






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Silicon Image, Inc.


Notes to Condensed Consolidated Financial Statements


June 30, 2009


(unaudited)





1. Basis of Presentation





In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Silicon Image, Inc. (the “Company”, “Silicon Image”, “we” or “our”) included herein have been prepared on a basis consistent with our December 31, 2008 audited financial statements and
include all adjustments, consisting of normal recurring adjustments, necessary to fairly state the condensed consolidated balance sheets of Silicon Image and our subsidiaries as of June 30, 2009 and December 31, 2008, the related consolidated statements of operations for the three and six months ended June 30, 2009 and 2008,  and the related consolidated statements of cash flows for the six months ended June 30, 2009 and 2008. All significant intercompany accounts and transactions have been eliminated.
These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.  The Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2009 are not necessarily indicative of future operating results to be expected for the fiscal year ending December 31, 2009.








2. Recent Accounting Pronouncements





In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 141 (revised 2007), “Business Combinations”
(SFAS 141(R)) and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin (“ARB") No. 51” (SFAS 160). SFAS 141(R) will significantly change current practices regarding business combinations. Among the more significant changes, SFAS 141(R) expands the definition of a business and a business combination; requires the acquirer to recognize the assets acquired, liabilities assumed and noncontrolling interests (including
goodwill), measured at fair value at the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination; and requires in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset. SFAS 160 will change the accounting and reporting for minority interests, reporting them as equity separate from the parent entity’s equity, as well as requiring expanded disclosures. SFAS 141(R) and SFAS 160
are effective for financial statements issued for fiscal years beginning after December 15, 2008. The adoption of SFAS 141(R)  and SFAS 160 is not expected to have a significant impact on the Company’s consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions the Company consummates after the effective date.





In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133," which requires additional
disclosures about the objectives of using derivative instruments, the method by which the derivative instruments and related hedged items are accounted for under FASB Statement No.133 and its related interpretations, and the effect of derivative instruments and related hedged items on financial position, financial performance, and cash flows. SFAS 161 also requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. SFAS 161 is effective for financial statements
issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged.  The Company adopted this standard effective January 1, 2009. The implementation of this standard did not have a material impact on the Company's consolidated financial statements.





In April 2009, the FASB issued FASB Staff Position (“FSP”) FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments." This FSP amends the other-than-temporary impairment guidance for debt securities
to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments in the financial statements. The most significant change the FSP brings is a revision to the amount of other-than-temporary loss of a debt security recorded in earnings. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted this FSP effective April 1, 2009 and the Company’s adoption did not have a material impact
on its consolidated financial statements.





In April 2009, the FASB issued FSP FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly." This
FSP provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. This FSP emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability
and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. FSP FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009, and is applied prospectively.  The
Company adopted this FSP effective April 1, 2009 and the Company’s adoption did not have a material impact on its consolidated financial statements.





In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments." This FSP amends FASB Statement No. 107, "Disclosures
about Fair Value of Financial Instruments," to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 and APB 28-1 is effective for interim and annual reporting periods
ending after June 15, 2009. The Company adopted this FSP effective April 1, 2009 and the Company’s adoption did not have a material impact on its consolidated financial statements.







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In April 2009, the FASB issued FSP FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP FAS 141(R)-1 amends and
clarifies SFAS 141(R) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The adoption of this FSP is not expected
to have a significant impact on the Company’s consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions the Company consummates after the effective date.





In May 2009, the FASB issued SFAS No. 165, "Subsequent Events." SFAS 165 should be applied to the accounting for and disclosure of subsequent events. This Statement does not apply to subsequent events or transactions that are within
the scope of other applicable GAAP that provide different guidance on the accounting treatment for subsequent events or transactions.  SFAS 165 would apply to both interim financial statements and annual financial statements. The objective of SFAS 165 is to establish general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this Statement sets forth: 1) The period after
the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; 2) The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and, 3) The disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS 165 is effective for interim or annual financial
periods ending after June 15, 2009. The Company adopted this standard effective April 1, 2009 and the Company’s adoption did not have a material impact on its consolidated financial statements. See Note 16.


In June 2009, the FASB issued SFAS 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No 162.” SFAS 168 established the effective date for use of the FASB codification for interim
and annual periods ending after September 15, 2009. Companies should account for the adoption of the guidance on a prospective basis. The Company does not anticipate that the adoption of SFAS 168 will have a material impact on its consolidated financial statements. The Company will update its disclosures for the appropriate FASB codification references in the third quarter of 2009.






3. Significant Accounting Policies





The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ materially from these estimates. Areas where significant judgment and estimates are applied include revenue recognition, stock based compensation, cash equivalents and short-term investments, allowance for doubtful accounts, inventory valuation, realization of long lived assets, including goodwill and intangibles, income taxes, deferred tax assets, accrued liabilities, guarantees, indemnifications and warranty liabilities, foreign currency, restructuring liability,
and legal matters. The condensed consolidated financial statements include the accounts of Silicon Image, Inc. and its subsidiaries after elimination of all inter-company balances and transactions.


Revenue recognition
 
 The Company’s revenue recognition policy complies with Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition(SAB No. 104). We recognize revenue when persuasive evidence of an arrangement exists, delivery or performance has occurred,
the sales price is fixed or determinable and collectability is reasonably assured.
 
 Revenue from products sold directly to end-users, or to distributors that do not receive price concessions and rights of return, is generally recognized when title and risk of loss has passed to the buyer which typically occurs upon shipment. Reserves for sales returns are estimated based primarily on historical experience
and are provided at the time of shipment. All shipping costs are charged to cost of product revenue.
 
 For products sold to distributors with agreements allowing for price concessions and stock rotation rights/product returns, the Company recognizes revenue based on when the distributor reports that it has sold  the product to its customer. The Company’s recognition of such distributor sell-through is
based on point of sales reports received from the distributor which establishes a customer, quantity and final price. Revenue is not recognized upon the Company’s shipment of product to the distributor, since, due to certain forms of price concessions, the sales price is not substantially fixed or determinable at the time of shipment. Price concessions are recorded when incurred, which is generally at the time the distributor sells the product to its customer. Additionally, these distributors have stock
rotation rights permitting them to return products to the Company, up to a specified amount for a given period of time. When the distributor reports that it has sold product to its customer, our sales price to the distributor is fixed. Once Silicon Image receives the point of sales reports from a distributor, it has satisfied all the requirements for revenue recognition and any product returns/stock rotation and price concession rights that the distributor has under its distributor agreement with Silicon
Image are exhausted. Pursuant to our distributor agreements, older, end-of-life and certain other products are generally sold with no right of return and are not eligible for price concessions. For these products, revenue is recognized upon shipment and title transfer assuming all other revenue recognition criteria are met.
 
 At the time of shipment to distributors, the Company records a trade receivable for the selling price since there is a legally enforceable right to payment, relieves inventory for the carrying value of goods shipped since legal title has passed to the distributor and records the gross margin in “deferred margin
on sale to distributors”, a component of current liabilities in its consolidated balance sheet. Deferred margin on the sale to distributor effectively represents the gross margin on the sale to the distributor. However, the amount of gross margin the Company recognizes in future periods will be less than the originally recorded deferred margin on sales to distributor as a result of negotiated price concessions. The Company sells each item in its product price book to all of its distributors worldwide at
a relatively uniform list price. However, distributors resell our products to end customers at a very broad range of individually negotiated price points based on customer, product, quantity, geography, competitive pricing and other factors. The majority of The Company’s distributors’ resale is priced at a discount from list price. Often, under these circumstances, the Company remits back to the distributor a portion of their original purchase price after the resale transaction is completed. Thus,
a portion of the “deferred margin on the sale to distributor” balance represents a portion of distributors’ original purchase price that will be remitted back to the distributor in the future. The wide range and variability of negotiated price concessions granted to distributors does not allow the Company to accurately estimate the portion of the balance in the deferred margin on the sale to distributors line item that will be remitted back to the distributors. The Company reduces deferred margin
by anticipated or determinable future price concessions.
 
 Revenue Arrangements with Multiple Deliverables


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The IP licensing agreements generally include a nonexclusive license for the underlying IP. Fees under these agreements generally include (a) license fees relating to our IP, (b) support, typically for one year; and (c) royalties payable following
the sale by our licensees of products incorporating the licensed technology. The license for the Company’s IP has standalone value and can be used by the licensee without support. Further, objective and reliable evidence of fair value exists for support. Accordingly, license and support fees are each treated as separate units of accounting.
  Certain licensing agreements provide for royalty payments based on agreed upon royalty rates. Such rates can be fixed or variable depending on the terms of the agreement. The amount of revenue the Company recognizes is determined based on a time period or on the
agreed-upon royalty rate, extended by the number of units shipped by the customer. To determine the number of units shipped, the Company relies upon actual royalty reports from its customers when available and rely upon estimates in lieu of actual royalty reports when the Company has a sufficient history of receiving royalties from a specific customer for us to make an estimate based on available information from the licensee such as quantities held, manufactured and other information. These estimates for royalties
necessarily involve the application of management judgment. As a result of the Company’s use of estimates, period-to-period numbers are “trued-up” in the following period to reflect actual units shipped. In cases where royalty reports and other information are not available to allow the Company to estimate royalty revenue, the Company recognizes revenue only when royalty reports are received.
  For contracts related to licenses of our technology that involve significant modification, customization or engineering services, the Company recognizes revenue in accordance the provisions of SOP 81-1 “Accounting
for Performance of Construction-Type and Certain Production-Type Contracts”. Revenues derived from such license contracts are accounted for using the percentage-of-completion method.
  The Company determines progress to completion based on input measures using labor-hours incurred by its engineers. The amount of revenue recognized is based on the total contract fees and the percentage of completion achieved. Estimates of total project requirements
are based on prior experience of customization, delivery and acceptance of the same or similar technology and are reviewed and updated regularly by management. If there is significant uncertainty about customer acceptance, or the time to complete the development or the deliverables by either party, the Company applies the completed contract method. If application of the percentage-of-completion method results in recognizable revenue prior to an invoicing event under a customer contract, the Company recognizes
the revenue and records an unbilled receivable assuming collectability is reasonably assured. Amounts invoiced to the Company’s customers in excess of recognizable revenues are recorded as deferred revenue.
  Stock-based compensation
 
 Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards, or SFAS, No. 123R, Share-Based Payment, (SFAS No. 123R),
requiring it to recognize expense related to the fair value of our stock-based compensation awards. The Company elected to use the modified prospective transition method as permitted by SFAS No. 123R. Under this transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with
the original provisions of SFAS No. 123, as adjusted for estimated forfeitures. Stock-based compensation expense for all stock-based compensation awards granted subsequent to December 31, 2005 was based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. Under SFAS No. 123R, our ESPP is considered a compensatory plan and we are required to recognize compensation cost for grants made under the ESPP. The Company recognizes stock-based compensation
expense on a straight-line basis for all share-based payment awards, consisting primarily of employee stock options, employee stock purchase plan and employee restricted stock units (RSUs), over the respective requisite service period of the awards. For purposes of calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R), the Company followed the alternative transition method discussed in FASB Staff Position No. 123(R)-3 “Transition
Election to Accounting for the Tax Effects of Share-Based Payment Awards.”
 
 Financial Instruments
 
 The Company accounts for its investments in debt securities under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and FASB Staff Position, or FSP No. 115-1/124-1, The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments. Management determines the appropriate classification of such securities at the time of purchase and reevaluates such classification as of each balance sheet date. The investments are adjusted for amortization of premiums and discounts to maturity and such amortization is included in interest income. We follow the guidance provided by FSP 115-1/124-1 and Emerging Issues Task Force ("EITF") No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,
to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in the consolidated statements of income. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee,
and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.
 
 Effective April 1,
2009, the Company adopted FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments.” The Company’s adoption of this standard did not have any significant impact on its consolidated financial statements.  The Company evaluates other-than-temporary impairment of debt securities for appropriate recognition and presentation in the consolidated financial statements in accordance with the FSP.
  The classification of our investments into cash equivalents and short term investments is in accordance with SFAS No. 95 ("SFAS No. 95") Statement of Cash Flows. Cash equivalents have
maturities of three months or less from the date of purchase. Short-term investments consist of commercial paper, United States government agency obligations, corporate/municipal notes and bonds. These securities have maturities greater than three months from the date of purchase.
  Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157 ("SFAS 157") “Fair Value Measurements”, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required
under other accounting pronouncements. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. SFAS 157 also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a
pricing model) and/or the risks inherent in the inputs to the model. SFAS 157 is effective for the current fiscal year. The adoption of SFAS 157 did not have a significant impact on our financial statements.
   8
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   SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets
for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:
  Level 1   Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
  Level 2   Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly;
  Level 3   Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
  A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
  In February 2008, the Financial Accounting Standards Board ("FASB") issued Staff Position No. 157-2 ("FSP 157-2") that delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed
at fair value in the financial statements on a recurring basis (at least annually). The delay is intended to allow the FASB and constituents additional time to consider the effect of various implementation issues that have arisen, or that may arise, from the application of SFAS 157.
 
 Effective April 1, 2009, the Company adopted FSP FAS 157-4,Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. The Company’s adoption of this standard did not have any significant impact on its consolidated financial statements. The Company evaluates the fair value of its investments using the guidance as specified in this FSP when the Company determines the
volume of activity for the asset or liability has significantly decreased and transactions that are not orderly.
  Effective April 1, 2009, the Company adopted FSP FAS 107-1 and APB 28-1,Interim
Disclosures about Fair Value of Financial Instruments.The Company’s adoption of this standard did not have any significant impact on its consolidated financial statements. The Company has disclosed the fair value of its financial instruments in its interim reporting period as required by this standard.
  Further information about the Company financial instruments can be found in Note 13 below.
  Derivative Instruments
  The Company recognizes derivative instruments as either assets or liabilities and measures those instruments at fair value. The accounting for changes in
the fair value of a derivative depends on the intended use of the derivative and the resulting designation. The Company accounts for derivative instruments in accordance with authoritative accounting standards, including Statement of Financial Accounting Standards (SFAS) 133 - Accounting for Derivative Instruments and Hedging Activitiesand SFAS 52 - Foreign
Currency Translation. For a derivative instrument designated as a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. As of December 31, 2008 the Company had no outstanding derivative instruments.
  Effective January 1, 2009, the Company adopted the provisions of SFAS 161,Disclosures
about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.The Company’s adoption of this standard did not have any significant impact on its consolidated financial statements. The Company has disclosed the objectives of using derivative instruments, the method by which the derivatives instruments and the related hedged items are accounted for under FASB Statement
No.133 and its related interpretations, and the effect of derivative instruments and related hedged items on the consolidated financial statements as required by SFAS 161.
  Allowance for Doubtful Accounts
 
 The Company reviews collectability of accounts receivable on an on-going basis and provides an allowance for amounts it estimates will not be collectible. During the Company’s review, it considers its historical experience, the age of
the receivable balance, the credit-worthiness of the customer and the reason for the delinquency. Delinquent account balances are written-off after the Company has determined that the likelihood of collection is remote. Write-offs to date have not been material.
 
 Inventories
 
 The Company records inventories at the lower of actual cost, determined on a first-in first-out (FIFO) basis, or market. Actual cost approximates standard cost, adjusted for variances between standard and actual. Standard costs are determined based on the Company’s estimate of material
costs, manufacturing yields, costs to assemble, test and package its products and allocable indirect costs. The Company records differences between standard costs and actual costs as variances. These variances are analyzed and are either included on the consolidated balance sheet or the consolidated statement of income in order to state the inventories at actual costs on a FIFO basis. Standard costs are evaluated at least annually.
  Provisions are recorded for excess and obsolete inventory and are estimated based on a comparison of the quantity and cost of
inventory on hand to the Company’s forecast of customer demand. Customer demand is dependent on many factors and requires the Company to use significant judgment in its forecasting process. The Company must also make assumptions regarding the rate at which new products will be accepted in the marketplace and at which customers will transition from older products to newer products. Generally, inventories in excess of six months forecasted demand are written down to zero and the related provision is recorded
as a cost of revenue. Once a provision is established, it is maintained until the product to which it relates is sold or otherwise disposed of, even if in subsequent periods we forecast demand for the product.
  
 9
 Table of Contents
   Goodwill, intangible and long-lived assets
 
 Consideration paid in connection with acquisitions is required to be allocated to the assets, including identifiable intangible assets and liabilities acquired. Acquired assets and liabilities are recorded based on the Company’s
estimate of fair value, which requires significant judgment with respect to future cash flows and discount rates.
  For certain long-lived assets, primarily fixed assets and identifiable intangible assets, for example the Company’s IP acquired from Sunplus (refer to Note 12 below), the Company is required to estimate the useful life of its asset and recognize the cost
as an expense over the useful life. The Company uses the straight-line method to depreciate long-lived assets. The Company evaluates the recoverability of our long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.Whenever events or circumstances indicate that the carrying amount of long-lived
assets may not be recoverable, the Company compares the carrying amount of long-lived assets to its projection of future undiscounted cash flows, attributable to such assets. In the event that the carrying amount exceeds the future undiscounted cash flows, the Company records an impairment charge against income equal to the excess of the carrying amount over the asset’s fair value. Predicting future cash flows attributable to a particular asset is difficult and requires the use of significant judgment.
  The Company assigns the following useful lives to its fixed assets — three years for computers and software, one to five years for equipment and five to seven years for furniture and fixtures. Leasehold improvements and assets held under capital leases
are amortized on a straight-line basis over the shorter of the lease term or the estimated useful life, which ranges from two to five years. Depreciation expense was $4.6 million and $5.3 million for the six months ended June 30, 2009 and 2008.
  The Company periodically reviews the carrying value of intangible assets not subject to amortization, including goodwill, to determine whether impairment may exist. SFAS No. 142, Goodwill
and Other Intangible Assets, requires that goodwill and certain intangible assets be assessed annually for impairment using fair value measurement techniques. Specifically, goodwill impairment is determined using a two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. The Company has determined based on the criteria of SFAS 142 that we have one reporting
unit for this purpose. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds
the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined by comparing the fair value of the Company’s equity as of the date of the impairment testing to the carrying amount of stockholders equity. The impairment charge for other intangible assets not subject to amortization, for which impairment indicators exists, consists of a comparison of the fair value of the intangible asset with its carrying value.
If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. Furthermore, SFAS 142 requires purchased other intangible assets to be amortized over their useful lives unless these lives are determined to be indefinite. Significant assumptions are inherent and highly subjective in this process. During the six months ended June, 30, 2009,
the Company recognized an impairment loss on goodwill as a result of the periodic review due to the presence of impairment indicators. Refer to Note 15 below for further information.
  Income Taxes
  The Company must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, tax benefits and deductions and in the calculation of certain tax assets and liabilities,
which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Significant changes to these estimates may result in an increase or decrease to our tax provision in the subsequent period when such a change in estimate occurs.
  Deferred tax assets
 
 We account for deferred tax assets in accordance with the Statement of Financial Accounting Standard No. 109 (SFAS No. 109), Accounting for Income Taxes. In the first quarter of 2007, we adopted
the Financial Accounting Standards Board (FASB) FIN No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109. FIN No. 48 requires that the Company determines whether a tax position is more likely than not to be sustained upon examination, including resolution of any related appeals
or litigation processes, based on the technical merits of the position. For income taxes the Company uses an asset and liability approach, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in its financial statements, but have not been reflected in its taxable income. In general, a valuation allowance is established to reduce deferred tax assets to their estimated realizable value, if based on the weight of available
evidence, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. The Company evaluates the realizability of the deferred tax assets quarterly and will continue to assess the need for valuation allowances.
  Guarantees, Indemnifications and Warranty Liabilities
 
 Certain of the Company’s licensing agreements indemnify its customers for expenses or liabilities resulting from claimed infringements of patent, trademark or copyright by third parties related to the intellectual property content of our
products. Certain of these indemnification provisions are perpetual from execution of the agreement and, in some instances; the maximum amount of potential future indemnification is not limited. To date, the Company has not paid any such claims or been required to defend any lawsuits with respect to a claim.
  At the time of revenue recognition, the Company provides an accrual for estimated costs (included in accrued liabilities in the accompanying consolidated balance sheets) to be incurred pursuant to its warranty obligation. The Company’s estimate is based primarily
on historical experience.
  Restructuring Expenses
 
 The Company records provisions for workforce reduction costs and exit costs when they are probable and estimable. Severance paid under ongoing benefit arrangements is recorded in accordance with SFAS No. 112, Employers’
Accounting for Postemployment Benefits. One-time termination benefits and contract settlement and lease costs are recorded in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. At each reporting date, the Company evaluates its accruals related to workforce reduction charges, contract settlement and lease costs and plant and equipment write downs to ensure that these accruals are still
appropriate. As of June 30, 2009, we had $7.2 million in accruals related to workforce reduction charges and $0.1 million in accruals related to lease costs, which included estimates, primarily related to sublease income over the lease terms and other costs for vacated properties. Increases or decreases to the accruals for changes in estimates are classified as restructuring expenses in the consolidated statement of income.
 
 Foreign Currency translation
 
 The Company accounts for foreign currency transactions in accordance with the Statement of Financial Accounting Standard No. 52 (SFAS No. 52), Foreign Currency Translation.The
Company determines the functional currency for its foreign subsidiaries by reviewing the currencies in which their respective operating activities occur. The functional currency for the Company’s foreign subsidiaries is the local currency. Transaction gains and losses arising from activities in other than the applicable functional currency are calculated using average exchange rates for the applicable period and reported in  the Company’s consolidated statement of income as a non-operating
item in each year. Monetary balance sheet items of the Company’s subsidiaries denominated in foreign currency are translated using the exchange rate in effect on the balance sheet date and any adjustments arising from remeasurements are included in other comprehensive income.
 
 Research and Development
 
 Research and development costs are expensed as incurred. It is the Company’s policy to record a reduction to research and development expense for funding received from outside parties for research and development projects.
   10
 Table of Contents
   4. Stock-Based Compensation
 
 The Company has a share-based compensation program that provides its Board of Directors with broad discretion in creating equity incentives for employees, officers and non-employee board members. This program includes incentive and non-statutory
stock option grants, restricted stock units (RSU’s) and an automatic grant program for non-employee board members pursuant to which such individuals will receive option grants at designated intervals over their period of board service. These awards are granted under various plans, all of which are stockholder approved. Grants under the discretionary grant program generally vest as follows: 25% of the shares vest on the first anniversary of the vesting commencement date and the remaining 75% vest proportionately
each month over the next 36 months of continued service. Stock option grants to members of our Board of Directors vest monthly, over periods not to exceed four years. Some options provide for accelerated vesting if certain identified milestones are achieved, upon a termination of employment or upon a change in control of the Company. RSU grants generally vest over a one to four-year period and certain of the RSU grants also have performance based vesting criteria. Additionally, we have an Employee Stock Purchase
Plan (ESPP) that allows employees to purchase shares of common stock at the lower of 85% of the fair market value on the commencement date of the six-month offering period or on the last day of the six-month offering period.




Valuation and Expense Information Under SFAS 123(R)





Share-based compensation expense recognized under Statement of Financial Accounting Standards No. 123 (revised 2004) “Share-Based Payment”, (SFAS 123(R)) consists primarily of expenses for the share-based awards discussed above.





The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach with the following weighted-average assumptions:




Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Employee stock option plans:Expected life in years


4.7



4.8



4.7



4.8Expected volatility


64.5
%


62.3
%


64.5
%


64.8
%Risk-free interest rate


2.3
%


3.3
%


2.3
%


2.7
%Expected dividends

none


none


none


noneWeighted average fair value

$
1.34


$
3.70


$
1.37


$
2.80Employee Stock Purchase Plan:Expected life in years


0.5



0.5



0.5



0.5Expected volatility


96.3
%


78.1
%


96.3
%


78.1
%Risk-free interest rate


1.2
%


3.5
%


1.2
%


3.5
%Expected dividends

none


none


none


noneWeighted average fair value

$
1.31


$
1.63


$
1.31


$
1.63
 
 As required by SFAS No. 123(R), management made an estimate of expected forfeitures and is recognizing stock-based compensation expense only for those equity awards expected to vest. For the three months ended June 30, 2009 and 2008 no shares were purchased under the ESPP program. For the six months ended June 30, 2009 and 2008,
the Company’s employees purchased 544,629 and 449,997 shares of common stock under the ESPP program, respectively. At June 30, 2009, the Company had $170,000 of total unrecognized compensation expense, net of estimated forfeitures under the ESPP program. The unamortized compensation expense will be amortized on a straight-line basis over a period of approximately 0.1 year.


.


Stock Options Activity





The following is a summary of activity under the Company’s stock option plans during the six months ended June 30, 2009, excluding RSUs (in thousands, except weighted average exercise price):




Number of Shares


Weighted Average Exercise Price


Weighted Average Remaining Contractual Term in Years


Aggregate Intrinsic ValueOutstanding at January 1, 2009


13,849


$
8.65



6.09


$
2,396Granted


111



2.52Exercised


(95
)


1.04Forfeitures and cancellations


(974
)


8.25Outstanding at June 30, 2009


12,891


$
8.68



5.41


$
506Ending vested and expected to vest at June 30, 2009


12,425


$
8.74



5.32


$
506Exercisable at June 30, 2009


10,344


$
8.95



4.88


$
506





At June 30, 2009, the total unrecognized compensation expense related to options granted to employees under our share-based compensation plans was approximately $14.3 million, net of estimated forfeitures. The unamortized compensation expense will be amortized on a straight-line basis over a weighted average period
of approximately 2.07 years.







11
  Table of Contents







Restricted Stock Units





The RSUs that the Company grants to its employees typically vest ratably over a certain period of time, subject to the employee’s continuing service to the Company over that period. RSUs granted to non-executive employees typically vest over a four-year period. RSUs granted to executives
typically vest over a period of between one and  four years or upon the achievement of certain performance milestones.





RSUs are converted into shares of the Company’s common stock upon vesting on a one-for-one basis. The cost of the RSUs is determined using the fair value of the Company’s common stock on the date of the grant. Compensation is recognized on a straight-line basis over the requisite service
period of each grant adjusted for estimated forfeitures.





A summary of activity with respect to the Company’s RSUs during the six months ended June 30, 2009 is as follows: (in thousands):





Number of shares


Weighted Average Remaining Contractual Term in Years


Aggregate Intrinsic ValueOutstanding at January 1, 2009


3,712



1.24


$
15,591Granted


1,788Vested


(216
)Forfeitures and cancellations


(2,152
)Outstanding at June 30, 2009


3,132



1.77


$
7,172Ending vested and expected to vest at June 30, 2009


2,245



1.70


$
5,141
  As of June 30, 2009, the Company had $6.2 million of total unrecognized compensation expense, net of estimated forfeitures, related to RSUs. The unamortized compensation expense will be recognized on a straight-line basis, and the weighted average estimated remaining life is 2.46 years.





Purchases of Equity Securities





During the six months ended June 30, 2009, the Company repurchased shares of stock from employees upon the vesting of the RSUs that were granted under the Company’s equity incentive plan to satisfy the employees’ minimum statutory tax withholding
requirement as follows: (in thousands, except for the total number of shares repurchased and price per share):




Period

Total Number of Shares Repurchased


Weighted Price Per Share


Total ValueThree months ended March 31, 2009


71,045


$
3.15


$
224Three months ended June 30, 2009


7,050



2.45


$
17Six months ended June 30, 2009


78,095






$
241





12


Table of Contents







Stock-based Compensation Expense





The table below shows total stock-based compensation expense included in the Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2009 and 2008 (in thousands):




Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Cost of sales

$
244



431


$
443



781Research and development


1,617



2,213



2,991



3,447Selling, general and administrative


2,352



3,614



4,344



6,053Income tax benefit


(459
)


(1,274
)


(932
)


(2,032
)$
3,754


$
4,984


$
6,846


$
8,249








5. Restructuring and Asset Impairment Charges





Ongoing Restructuring Activities





At December 31, 2008, the Company’s accrued restructuring balance was $3.5 million. In connection with its ongoing restructuring activities, the Company recorded restructuring costs of approximately $7.9 million, which includes approximately $0.2 million of operating lease expense in excess of related accruals which was expensed
as incurred, during the six months ended June 30, 2009.
  In the three months ended June 30, 2009, the Company recorded restructuring charges of approximately $7.1 million primarily as a result of the management-approved restructuring plan announced in June 2009 to realign and focus the Company’s resources on its core competencies and in order to better align its revenues and expenses.  The
restructuring charges associated with the aforementioned reduction in force were comprised of approximately $6.5 million in employee severance costs and approximately $0.2 million in charges related to the impairing of certain equipment as a result of the restructuring plan. The other $0.4 million restructuring charges during the three months ended June 30, 2009 were related to additional severance, operating lease expense and legal costs incurred for reduction in forces that took place during fiscal year 2008.
  During the three months ended March 31, 2009, the Company incurred $0.8 million in restructuring charges mainly relating to employee severance and benefit arrangements due to terminations in connection with the restructuring plan announced in fiscal year 2008.


The following table summarizes the Company’s restructuring activities for the six months ended June 30, 2009 (in thousands):


Employee Severance and Benefits


Operating Lease Termination


Impaired Fixed Assets


TotalAccrued restructuring balance as of December 31, 2008

$
3,252


$
200


$
-


$
3,452Additional accruals


7,527



22



197



7,746Cash payments


(3,529
)


(134
)


-



(3,663
)Non-cash charges and adjustments


-



(3
)


(197
)


(200
)Accrued restructuring balance as of June 30, 2009

$
7,250


$
85


$
-


$
7,335


The operating lease accruals have been reflected as restructuring expense in the consolidated statements of operations. The remaining accrual as of June 30, 2009 relates to severance benefits, the majority of which, the Company expects to payout by the end of fiscal year 2009 and operating lease termination costs over the remaining lease terms
of approximately 3 years.








13


Table of Contents







6. Comprehensive loss





The components of comprehensive loss, net of related taxes, were as follows (in thousands):


Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Net loss

$
(13,329
)

$
(462
)

$
(46,658
)

$
(1,024
)Change in unrealized value of investments


(90
)


(87
)


79



(30
)Foreign currency translation adjustments


330



(10
)


68



133Effective portion of cashflow hedges


(16
)


-



30



-Total comprehensive loss

$
(13,105
)

$
(559
)

$
(46,481
)

$
(921
)
 
 7. Net Loss Per Share





Basic and diluted net loss per share is computed using the weighted-average number of common shares outstanding during the period, excluding shares subject to repurchase. The following table sets forth the computation of basic and diluted net loss per
share (in thousands, except per share amounts):




Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Numerator:Net loss

$
(13,329
)

$
(462
)

$
(46,658
)

$
(1,024
)Denominator:Weighted average shares – basic and diluted


74,806



73,399



74,618



77,257Net loss per share – basic and diluted

$
(0.18
)

$
(0.01
)

$
(0.63
)

$
(0.01
)





The securities that were anti-dilutive and excluded from the net loss per share calculations were approximately 14.8 million and  13.8 million for the three and six months ended June 30, 2009, respectively and 12.6  million and 13.3 million for the three and six months ended June 30, 2008, respectively.








8. Balance Sheet Components




June 30, 2009


December 31, 2008(in thousands)Inventories:Raw materials

$
3,434


$
4,962Work in process


1,849



545Finished goods


3,886



7,268Total inventories

$
9,169


$
12,775Property and equipmentComputers and software

$
24,809


$
24,250Equipment


25,674



25,059Furniture and fixtures


2,704



2,70153,187



52,010Less: accumulated depreciation


(36,491
)


(32,616
)Total property and equipment, net

$
16,696


$
19,394Accrued and other current liabilities:Accrued payroll and related expenses

$
4,107


$
5,359Accrued restructuring


7,335



3,452Software and IP liability


625



2,500Amounts due to customers


1,105



1,966Bonus accrual


-



1,556Accrued and other liabilities


7,710



8,190Total accrued liabilities

$
20,882


$
23,023





14
 
 Table of Contents





9. Commitments and Contingencies





Legal Proceedings





On December 7, 2001, the Company and certain of its officers and directors were named as defendants, along with the underwriters of the Company’s initial public offering, in a securities class action lawsuit. The lawsuit alleges that the defendants participated in a scheme to inflate the
price of the Company’s stock in its initial public offering and in the aftermarket through a series of misstatements and omissions associated with the offering. The lawsuit is one of several hundred similar cases pending in the Southern District of New York that have been consolidated by the court. In February 2003, the District Court issued an order denying a motion to dismiss by all defendants on common issues of law. In July 2003, the Company, along with over 300 other issuers named as defendants, agreed
to a settlement of this litigation with plaintiffs. While the parties’ request for court approval of the settlement was pending, in December 2006 the United States Court of Appeals for the Second Circuit reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Second Circuit denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference,
the Court terminated the proposed settlement as stipulated among the parties. Plaintiffs filed an amended complaint on August 14, 2007. On September 27, 2007, plaintiffs filed a motion for class certification in the six focus cases, which was withdrawn on October 10, 2008. On November 13, 2007 defendants in the six focus cases filed a motion to dismiss the complaint for failure to state a claim, which the district court denied in March 2008.  Plaintiffs, the issuer defendants (including the Company),
the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations.  The parties have reached a settlement agreement, which was submitted to the District Court for preliminary approval on April 2, 2009.  As part of this settlement, the Company’s insurance carrier has agreed to assume the Company’s entire payment obligation under the terms of the settlement.  On June 10, 2009, the District Court granted preliminary
approval of the proposed settlement agreement.  A hearing is scheduled for September 10, 2009 to determine whether the proposed settlement agreement should be granted final approval.  Although the District Court has granted preliminary approval of the proposed settlement agreement, there can be no guarantee that it will receive final approval from the District Court.  The Company believes that it has meritorious defenses to these claims.  If the settlement is not approved
by the District Court and the litigation continues against the Company, the Company would continue to defend against this action vigorously.





On July 31, 2007, the Company received a demand on behalf of alleged shareholder Vanessa Simmonds that its board of directors prosecute a claim against the underwriters of its initial public offering, in addition to certain unidentified officers, directors and principal shareholders as identified
in our IPO prospectus, for violations of sections 16(a) and 16(b) of the Securities Exchange Act of 1934. In October 2007, a lawsuit was filed in the United States District Court for the Western District of Washington by Ms. Simmonds against certain of the underwriters of the Company’s initial public offering. The plaintiff alleges that the underwriters engaged in short-swing trades and seeks disgorgement of profits in amounts to be proven at trial from the underwriters. On February 25, 2008, Ms. Simmonds
filed an amended complaint. The suit names the Company as a nominal defendant, contains no claims against the Company and seeks no relief from it.  This lawsuit is one of more than fifty similar actions filed in the same court.  On July 25, 2008, the underwriter defendants in the various actions filed a joint motion to dismiss the complaints for failure to state a claim.  In addition, certain issuer defendants in the various actions filed a joint motion to dismiss the complaints
for failure to state a claim.  The parties entered into a stipulation, entered as an order by the court that the Company is not required to answer or otherwise respond to the amended complaint.  Accordingly, the Company did not join the motion to dismiss filed by certain issuers.    On March 12, 2009, the court dismissed the complaint in this lawsuit with prejudice.  On April 10, 2009, the plaintiff filed a notice of appeal of the District Court’s order,
and thereafter the underwriter defendants’ filed a cross appeal to a portion of the District Court’s order that dismissed thirty (30) of the cases without prejudice following the moving issuers’ motion to dismiss.  On May 27, 2009, the Ninth Circuit issued an order stating that the cases were not selected for inclusion in the mediation program, and on May 22, 2009 issued an order granting the parties’ joint motion filed on May 22, 2009 to consolidate the 54 appeals and 30 cross-appeals.  Under
the current briefing schedule, the parties’ appellate briefs are due as follows: plaintiff’s initial brief is due August 26, 2009; defendants’ opposing briefs, including the underwriter defendants’ cross-appeal arguments, are due October 2, 2009; plaintiff’s reply brief, including opposition to the cross-appeal, is due November 2, 2009; and the underwriter defendants’ cross-appeal reply brief is due November 17, 2009.





In January 2005, the Company and certain of its officers were named as defendants in a securities class action captioned “Curry v. Silicon Image, Inc., Steve Tirado and Robert Gargus.” Plaintiffs filed the action on behalf of a putative class of stockholders who purchased Silicon Image
stock between October 19, 2004 and January 24, 2005. The lawsuit alleged that the Company and certain of its officers and directors made alleged misstatements of material facts and violated certain provisions of Sections 20(a) and 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Final judgment was entered in favor of defendants on September 25, 2007. On October 19, 2007, plaintiffs filed notice of appeal of the court’s final judgment to the United States Court of Appeals
for the Ninth Circuit. Appellants’ opening brief was filed February 28, 2008 and the Company’s responsive pleading was filed April 14, 2008. Appellants filed a reply brief on May 16, 2008.  Oral argument was held on April 14, 2009.  On May 1, 2009, the Ninth Circuit issued an order affirming the lower court’s final judgment, which dismissed the action with prejudice.  The deadline for the plaintiffs to have filed a petition for rehearing or rehearing en banc was
May 15, 2009; no such petitions were filed.





In addition, the Company has been named as defendants in a number of judicial and administrative proceedings incidental to its business and may be named again from time to time.





The Company intends to defend the above matters vigorously and although adverse decisions or settlements may occur in one or more of such cases, the final resolution of these matters, individually or in the aggregate, is not expected to have a material adverse effect on the Company’s results
of operations, financial position or cash flows.





15


Table of Contents








Guarantees





Certain of the Company’s licensing agreements indemnify it’s customers for any expenses or liabilities resulting from claimed infringements of third party patents, trademarks or copyrights by its products. Certain of these indemnification provisions are perpetual from execution of the
agreement and, in some instances; the maximum amount of potential future indemnification is not limited. To date, the Company has not paid any such claims or been required to defend any lawsuits with respect to any claim.





Contractual Obligations and Off-Balance Sheet Arrangements





The table below represents the future minimum payments under the Company’s operating leases outstanding at June 30, 2009 (in thousands):




Contractual obligations

Total


Less than 1 year


1-3 years


3-5 years


More than 5 yearsOperating lease obligations

$
8,186


$
4,298


$
3,849


$
39


$
-





The amounts above exclude liabilities under FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”, as the Company is unable to reasonably estimate the ultimate amount or timing of settlement.







10. Customer and Geographic Information





The Company operates in one reportable operating segment, semiconductors and IP solutions for the secure storage, distribution and presentation of high-definition content. The Company’s Chief Executive Officer, who is considered to be the Company’s chief operating decision maker, reviews
financial information presented on one operating segment basis for purposes of making operating decisions and assessing financial performance.





Revenue





Revenue by geographic area was as follows (in thousands):


Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Japan

$
9,714


$
20,895


$
19,825


$
40,181Taiwan


9,501



13,690



20,219



25,837United States


9,074



11,671



16,262



24,982Europe


3,579



8,735



9,241



16,897Korea


1,899



3,138



2,126



7,007Hong Kong


1,672



7,509



4,917



12,976Other


1,897



4,445



5,258



9,316Total revenue

$
37,336


$
70,083


$
77,848


$
137,196


Revenue by product line was as follows (in thousands):




Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Consumer Electronics (1)

$
33,261


$
50,310


$
66,737


$
99,845Personal Computer (1)


1,785



11,758



4,992



22,927Storage (1)


2,290



8,015



6,119



14,424Total revenue

$
37,336


$
70,083


$
77,848


$
137,196(1) Includes development, licensing and royalty revenue (collectively "licensing revenue")




Three months ended June 30,


Six months ended June 30,2009


2008


2009


2008Consumer Electronics

$
25,686


$
44,613


$
53,262


$
87,065Personal Computer


1,700



10,970



5,168



20,977Storage


2,050



6,253



5,601



10,981Licensing revenue


7,900



8,247



13,817



18,173Total revenue

$
37,336


$
70,083


$
77,848


$
137,196
 For the three months ended June 30, 2009, one customer represented 12.6% of the Company’s revenue. For the six months ended June 30, 2009, two customers each represented 11.1% and 10.9% of the Company’s revenue. At June 30, 2009, three customers each represented 20.2%, 16.0% and 10.8% of gross accounts receivable, respectively.








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Property and Equipment





The majority of the Company’s property and equipment are located in the US.








11. Provision (Benefit) for Income Taxes





For the three and six months ended June 30, 2009, the Company recorded an income tax benefit of ($5.1) million and ($1.7) million, respectively. The effective tax rate for the three and six months ended June 30, 2009 were 27.9% and 3.5%, respectively, and were based
on our projected taxable income for 2009, plus certain discrete items recorded during the quarter. The difference between the provision for income taxes and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to various forecasted items including tax exempt income, SFAS 123(R) expense, tax credits and foreign taxes, adjusted for certain discrete items recorded during the quarter.
 
 During the three months ended March 31, 2009, the State of California legislature enacted significant California tax law changes.  As a result of the enacted legislation, the Company expects that in years 2011 and beyond, the Company’s  income subject to tax in California will be less than
under prior tax law and accordingly its California deferred tax assets are less likely to be realized.  The Company recorded a net discrete tax charge of $9.4 million for the three months ended March 31, 2009 related to the re-measurement of the Company’s California deferred tax assets to account for this change in tax law, as well as an increase in the valuation allowance for the Company’s California deferred tax assets that existed as of December 31, 2008.  The Company will continue
to assess its valuation allowance on its California deferred tax assets in future periods.
 
 For the three and six months ended June 30, 2008, the Company recorded a benefit for income taxes of ($134,000) and ($127,000), respectively. The effective tax rate for the three and six months ended June 30, 2008 were 22.5% and 11.0%, respectively, and were based on the Company’s projected
taxable income for 2008, plus certain discrete items recorded during the quarter.
  The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the provision for income taxes. The Company had interest and penalties of $88,000 and $173,000 for the three and six months ended June 30, 2009, respectively, and approximately $106,000 and $198,000 for the three and six months ended
June 30, 2008, respectively.  The Company conducts business globally and, as a result, the Company and its subsidiaries file income tax returns in various jurisdictions throughout the world including with the U.S. federal and various U.S. state jurisdictions as well as with various foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world.


12. Investment in Intellectual Property





In February 2007, the Company entered into an agreement with Sunplus Technology Co., Ltd. (Sunplus) to license certain technology (Sunplus IP) from Sunplus for $40.0 million. The purpose of this licensing agreement is to obtain advanced technology for development of future products. The agreement
provides for the Company to pay an aggregate of $40.0 million to Sunplus, $35.0 million of which is payable in consideration for the Sunplus IP and related deliverables, and $5.0 million of which is payable in consideration for Sunplus support and maintenance obligations. Through June 30, 2009, the Company has paid Sunplus $38.7 million of the consideration for the licensed technology and related deliverables and support. The Company is required to pay the remaining $1.3 million by the end of 2009.








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Table of Contents





13. Fair Value Measurements





The Company records its financial instruments that are accounted for under Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities,(“SFAS 115”),
and derivative contracts at fair value. The determination of fair value is based upon the fair value framework established by SFAS No. 157, Fair Value Measurements,(“SFAS 157”). SFAS 157 provides that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market
for the asset or liability. The carrying value of the Company’s financial instruments including cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, accrued compensation, and other accrued liabilities, approximates fair market value due to the relatively short period of time to maturity. The fair value of investments is determined using quoted market prices for those securities or similar financial instruments.





The Company’s cash equivalents and short term investments are generally classified within level 1 or level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.





The types of instruments valued based on quoted market prices in active markets include most U.S. government and agency securities and most money market securities. Such instruments are generally classified within level 1 of the fair value hierarchy.





The types of instruments valued based on quoted prices in markets that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade corporate bonds, and state, municipal and provincial obligations. Such instruments
are generally classified within level 2 of the fair value hierarchy.





The table below sets forth the Company’s cash and cash equivalents and short-term investments and derivative asset as of June 30, 2009, which are measured at fair value on a recurring basis by level within the fair value hierarchy. As required by SFAS No. 157, these are classified based on
the lowest level of input that is significant to the fair value measurement.




Fair value measurements using


Assets(dollars In thousands)

Level 1


Level 2


Level 3


at fair valueCash and cash equivalents and Short-term investments

$
8,531


$
135,942


$
-


$
144,473Derivative asset


-



30



-



30Total

$
8,531


$
135,972


$
-


$
144,503





Cash and cash equivalents and short term investments in the above table excludes $18.5 million in cash held by the Company or in its accounts with investment fund managers as of June 30, 2009. During the three and six months ended June 30, 2009, the Company held no direct investments in auction
rate securities, collateralized debt obligations, structured investment vehicles or mortgage-backed securities.





The Company’s derivative instruments are classified within Level 2 of the valuation hierarchy. The Company’s derivatives are valued using internal models that use as their basis readily observable market inputs, such as time value, forward interest rates,
volatility factors and foreign currency exchange rates. Refer to Note 14 for more discussion on derivative instruments.





During the three and six months ended June 30, 2009, the Company did not hold financial assets and liabilities which were recorded at fair value in the Level 3 category.




Effective January 1, 2009, the Company fully adopted the provision of SFAS 157 by adopting the provisions relating to its nonfinancial assets and liabilities. The Company adopted the provisions relating to financial assets and liabilities in the prior year and its adoption of SFAS 157 relating
to nonfinancial assets and liabilities did not have a material impact on its consolidated financial position, results of operations, or cash flows.





14.  Derivative Instruments





On January 1, 2009, the Company adopted SFAS 161 as referenced in Note 2. The adoption of SFAS 161 requires additional disclosures about the Company's objectives and strategies for using derivative instruments, the accounting for the derivative instruments and related hedged
items under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), and the effect of derivative instruments and related hedged items on the financial statements. The adoption had no financial impact on the consolidated condensed financial statements.





Silicon Image is a global company that is exposed to foreign currency exchange rate fluctuations in the normal course of its business.The Company has operations in the United States, Europe and Asia, however, a majority of its
revenue, costs of revenue, expense and capital purchasing activities are being transacted in U.S. Dollars. As a corporation with international as well as domestic operations, the Company is exposed to changes in foreign exchange rates. These exposures may change over time and could have a material adverse impact on the Company’s financial results. Periodically, the Company uses foreign currency forward contracts to hedge certain forecasted foreign currency transactions relating to operating expenses. The
Company does not enter into derivatives for speculative or trading purposes. The Company uses derivative instruments primarily to manage exposures to foreign currency fluctuations on forecasted cash flows and balances primarily denominated in Euro. The Company’s primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates. These derivatives are designated as cash flow hedges and have maturities of less than one
year. The effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income and, upon occurrence of the forecasted transaction, is subsequently reclassified into the line item in the consolidated statements of operations to which the hedged transaction relates. The Company records any ineffective portion of the hedging instruments gain (loss) in other income (expense) on its consolidated statements of operations.




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  Table of Contents


The derivatives expose the Company to credit and non performance risks to the extent that the counterparties may be unable to meet the terms of the agreement. The Company seeks to mitigate such risks by limiting the counterparties to major financial institutions.
In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.





The amount of gain recognized in other comprehensive income (“OCI”) on effective cashflow hedges as of June 30, 2009, the amount of gain reclassified from accumulated OCI to operating expenses for the three and six months ended June 30, 2009, and the amount of gain recognized in income on ineffective cashflow
hedges for the three and six months ended June 30, 2009 are insignificant.





As of June 30, 2009, the outstanding foreign currency forward contracts had a notional value of approximately $1.5 million and a fair value of $30,000. The Company recorded an unrealized gain of $30,000 relating to the effective cashflow hedges in accumulated other comprehensive income as part of stockholders' equity and prepaid
expenses and other current assets in the condensed consolidated balance sheet as of June 30, 2009.







15. Impairment of Goodwill and Other Long-lived Assets





The Company periodically reviews the carrying value of intangible assets not subject to amortization, including goodwill, to determine whether impairment may exist. Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill
and Other Intangible Assets, requires that goodwill and certain intangible assets be assessed annually for impairment using fair value measurement techniques. Specifically, goodwill impairment is determined using a two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill
impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined by comparing the fair value of the Company’s
equity as of the date of the impairment testing to the carrying amount of stockholders equity. The impairment charge for other intangible assets not subject to amortization, for which impairment indicators exists, consists of a comparison of the fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. Furthermore, SFAS 142 requires purchased other intangible assets
to be amortized over their useful lives unless these lives are determined to be indefinite.





The Company has one reportable operating segment and the goodwill impairment testing was done at the reporting unit level. In accordance with the current policy, the Company conducted its annual goodwill impairment test on September 30, 2008 and noted no impairment. During the three months ended
March 31, 2009, the Company assessed goodwill for impairment since it observed there were indicators of impairment. The notable indicators were a sustained and significant decline in the Company’s stock price, depressed market conditions and declining industry trends. The Company’s stock price had been in a period of sustained decline and the business climate had deteriorated substantially in the past three months. Based on the results of the first step of the goodwill analysis, it was determined
that the Company’s net book value exceeded its estimated fair value. As a result, the Company performed the second step of the impairment test to determine the implied fair value of goodwill. Under step two, the difference between the estimated fair value of the Company and the sum of the fair value of the identified net assets results in the residual value of goodwill. Specifically, the Company allocated the estimated fair value of the Company as determined in the first step of the goodwill analysis to
the recognized and unrecognized net assets, including allocations to intangible assets. Based on the analysis performed under step two, there was no remaining implied value attributable to goodwill and accordingly, the Company wrote off the entire goodwill balance and recognized goodwill impairment charges of approximately $19.2 million in the consolidated statement of operations under operating expenses, “Impairment of Goodwill.”





As required by Statement of Financial Accounting Standards No. 144 (“SFAS 144”), Accounting for the Impairment or Disposal of Long-Lived Assets, during the three months ended March 31, 2009. The Company also made an impairment
evaluation of its long-lived assets and determined that its long-lived assets were not impaired as of March 31, 2009. No impairment indicators were present during the three months ended June 30, 2009, hence, no impairment loss was recognized in the current period.





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Table of Contents






16. Subsequent Events


Pursuant to the adoption of SFAS No. 165, the Company’s management has evaluated subsequent events through August 10, 2009, which is the date these consolidated financial statements were issued. Based on management’s evaluation, no significant events occurred
after June 30, 2009 which required recognition and/or disclosures in the consolidated financial statements.








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





This report contains forward-looking statements within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933. These
forward-looking statements involve a number of risks and uncertainties, including those identified in the section of this Form 10-Q entitled “Factors Affecting Future Results,” that may cause actual results to differ materially from those discussed in, or implied by, such forward-looking statements. Forward-looking
statements within this Form 10-Q are identified by words such as “believes,” “anticipates,” “expects,” “intends,” “estimates,” “may,” “will” and variations of such words and other similar expressions. However, these words are not the only means of identifying
such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-Q with
the SEC. Our actual results could differ materially from those anticipated in, or implied by, forward-looking statements as a result of various factors,  including the risks outlined elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made by Silicon Image,  Inc. in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risks and factors that may affect our business.





Silicon Image and Simplay HD are trademarks, registered trademarks or service marks of Silicon Image, Inc. in the United States and other countries. HDMITM
and High-Definition Multimedia Interface are trademarks or registered trademarks of HDMI Licensing, LLC in the United States and other countries, and are used under license from HDMI Licensing, LLC. All other trademarks and registered trademarks are the property of their respective owners.





Overview





Silicon Image, Inc. is a technology innovator and a global leader developing high-bandwidth semiconductor and intellectual property (IP) solutions based on our innovative, digital interconnect technology. Our vision is digital content everywhere. Our mission is to be the leader in the innovation,
design, development and implementation of semiconductors and IP solutions for the secure storage, distribution and presentation of high-definition content in the home and mobile environments. We are dedicated to the development and promotion of technologies, standards and products that facilitate the movement of digital content between and among digital devices across the consumer electronics (CE), personal computer (PC) and storage markets. We believe our track record of innovation around our core competencies,
establishing industry standards and building strategic relationships, positions us to continue to drive change in the emerging world for high quality digital media storage, distribution and presentation.





We provide integrated and discrete semiconductor products as well as IP licensing to consumer electronics, computing, display, storage and networking equipment manufacturers. Our product and IP portfolio includes solutions for high-definition television (HDTV), high-definition set-top boxes (STBs),
high-definition digital video disc (DVD) players, digital and personal video recorders (DVRs and PVRs), high-definition game systems, consumer and enterprise storage products and PC display products.





We have worked with industry leaders to create industry standards such as the High-Definition Multimedia Interface (HDMItm) and Digital Visual Interface (DVItm) specifications for digital content delivery. We capitalize on our leadership position through first-to-market, standards-based semiconductor
and IP solutions. Our portfolio of IP solutions that we license to third parties for consumer electronics, PCs, multimedia, communications, networking and storage devices further leverages our expertise in these markets. In addition, through Simplay Labs, LLC, our wholly owned subsidiary, we offer one of the most robust and comprehensive test suites and testing technology platforms in the consumer electronics industry. We utilize independent foundries and third-party subcontractors to manufacture, assemble and
test all of our semiconductor products.




Our customers are equipment manufacturers in each of our target markets — Consumer Electronics, Personal Computer and Storage. Because we leverage our technologies across different markets, certain of our products may be incorporated into equipment used in multiple markets. We sell our products
to original equipment manufacturers (OEMs) throughout the world using a direct sales force and through a network of distributors and manufacturer’s representatives. Our net revenue is generated principally by sales of our semiconductor products, with other revenues derived from IP core licensing and licensing and royalty fees from our standards activities. We maintain relationships with the eco-system of companies that provide the products that drive digital content creation and consumption, including the
major Hollywood studios, consumer electronics companies, retailers and service providers. To that end, we have developed relationships with Hollywood studios such as Universal, Warner Brothers, Disney and Fox and with major consumer electronics companies such as Sony, Hitachi, Toshiba, Matsushita, Phillips and Thomson. Through these and other relationships, we have formed a strong understanding of the requirements for storing, distributing and viewing high quality digital video and audio in the home and mobile
environments, especially in the area of High Definition (HD) content. We have also developed a substantial intellectual property base for building the standards and products necessary to promote opportunities for our products.





20


Table of Contents





Historically, we have grown our business by introducing and promoting the adoption of new standards and entering new markets. We collaborated with several companies and jointly developed the DVI and HDMI standards. Our first products addressed the PC market. Subsequently, we introduced products for a variety
of CE market segments, including DVD, STB, game console and digital television (DTV) markets. More recently, we have expanded our research and development activities and are developing products based on our innovative digital interconnect core technology for the mobile device market, including digital still cameras, HD camcorders, portable media players and smart phones. We are also developing a personal networking technology solution that will enable a consumer to access and display digital content from and
to the various devices in the consumer’s personal domain.





We are headquartered in Sunnyvale, California. Our Internet website address is www.SiliconImage.com. We are not including the information contained on our web site as a part of, or incorporating it by reference into, this Quarterly Report on Form 10-Q. We make available through our Internet website
free of charge, our Annual Report on Form 10-K quarterly reports on Form 10-Q current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable, after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.




Concentrations





Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For instance, our top five customers, including distributors, generated 43.4% and 44.0% of our revenue for the three and six months ended June 30, 2009, respectively and 56.5%
and 56.1% of our revenue for the three and six months ended June 30, 2008. Additionally, the percentage of revenue generated through distributors tends to be significant, since many OEMs rely upon third party manufacturers or distributors to provide purchasing and inventory management services. For the three and six months ended June 30, 2009, 23.2% and 38.1% of our revenue, respectively, was generated through distributors, compared to 53.3% and 52.6% in the comparable periods of 2008, respectively.  Our
licensing revenue is not generated through distributors, and to the extent licensing revenue increases faster than product revenue, we would expect a decrease in the percentage of our total revenue generated through distributors.





A significant portion of our revenue is generated from products sold overseas. Sales to customers in Asia, including distributors, represented 66.1% and 67.0% of our revenue for the three and six months ended June 30, 2009, respectively and 70.9% and 69.4% for the three and six months ended June
30, 2008, respectively. The reason for the geographical concentration in Asia is that most of our products are components of consumer electronics, computer and storage products, the majority of which are manufactured in Asia. The percentage of our revenue derived from any country is dependent upon where our end customers choose to manufacture their products. Accordingly, variability in our geographic revenue is not necessarily indicative of any geographic trends, but rather is the combined effect of new design
wins and changes in customer manufacturing locations. All revenue to date has been denominated in U.S. dollars except for a relatively insignificant portion generated in Euros through our subsidiary in Germany.







Critical Accounting Policies




The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported
in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and all known facts and circumstances that we believe are relevant. Actual results may differ materially from our estimates. We believe the accounting policies discussed below to be most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain.


Revenue recognition
 
 Our revenue recognition policy complies with Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition(SAB No. 104). We recognize revenue when persuasive evidence of an arrangement exists, delivery or performance has occurred, the sales price
is fixed or determinable and collectability is reasonably assured.
 Revenue from products sold directly to end-users, or to distributors that do not receive price concessions and rights of return, is generally recognized when title and risk of loss has passed to the buyer which typically occurs upon shipment. Reserves for sales returns are estimated based primarily on historical experience and are provided at the time of
shipment. All shipping costs are charged to cost of product revenue.
 
 For products sold to distributors with agreements allowing for price concessions and stock rotation rights/product returns, we recognize revenue based on when the distributor reports that it has sold the product to its customer. Our recognition of such distributor sell-through is based on point of sales reports received
from the distributor which establishes a customer, quantity and final price. Revenue is not recognized upon the Company’s shipment of product to the distributor, since, due to certain forms of price concessions, the sales price is not substantially fixed or determinable at the time of shipment. Price concessions are recorded when incurred, which is generally at the time the distributor sells the product to its customer. Additionally, these distributors have stock rotation rights permitting them to return
products to us, up to a specified amount for a given period of time.  When the distributor reports that it has sold product to its customer, our sales price to the distributor is fixed. Once we receive the point of sales reports from a distributor, it has satisfied all the requirements for revenue recognition and any product returns/stock rotation and price concession rights that the distributor has under its distributor agreement with Silicon Image are exhausted. Pursuant to our distributor agreements,
older, end-of-life and certain other products are generally sold with no right of return and are not eligible for price concessions. For these products, revenue is recognized upon shipment and title transfer assuming all other revenue recognition criteria are met.
  At the time of shipment to distributors, we record a trade receivable for the selling price since there is a legally enforceable right to payment, relieves inventory for the carrying value of goods shipped since legal title has passed to the distributor and records the gross margin in “deferred margin on sale
to distributors”, a component of current liabilities in its consolidated balance sheet. Deferred margin on the sale to distributor effectively represents the gross margin on the sale to the distributor. However, the amount of gross margin we recognize in future periods will be less than the originally recorded deferred margin on sales to distributor as a result of negotiated price concessions. We sell each item in its product price book to all of its distributors worldwide at a relatively uniform list price.
However, distributors resell our products to end customers at a very broad range of individually negotiated price points based on customer, product, quantity, geography, competitive pricing and other factors. The majority of our distributors’ resale is priced at a discount from list price. Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed. Thus, a portion of the “deferred margin on the sale to distributor”
balance represents a portion of distributors’ original purchase price that will be remitted back to the distributor in the future. The wide range and variability of negotiated price concessions granted to distributors does not allow us to accurately estimate the portion of the balance in the deferred margin on the sale to distributors line item that will be remitted back to the distributors. We reduce deferred margin by anticipated or determinable future price concessions.
 
  21
 Table of Contents
 
  We derive revenue from license of its internally developed intellectual property (IP). We enter into IP licensing agreements that generally provide licensees the right to incorporate its IP components in their products with terms and conditions that vary by licensee. Revenue earned under contracts with our licensees is classified
as license revenue. Our license fee arrangements generally include multiple deliverables and for multiple deliverable arrangements it follows the guidance in EITF 00-21, Revenue Arrangements with Multiple Deliverables, to determine whether there is more than one unit of accounting. To the extent that the deliverables are separable into multiple units of accounting, we allocate the total fee on
such arrangements to the individual units of accounting using the residual method, if objective and reliable evidence of fair value does not exist for delivered elements. We then recognize revenue for each unit of accounting depending on the nature of the deliverable(s) comprising the unit of accounting in accordance with the provisions of SAB No. 104.
 
 The IP licensing agreements generally include a nonexclusive license for the underlying IP. Fees under these agreements generally include (a) license fees relating to our IP, (b) support, typically for one year; and (c) royalties payable following the sale by our licensees of products incorporating the
licensed technology. The license of our IP has standalone value and can be used by the licensee without support. Further, objective and reliable evidence of fair value exists for support. Accordingly, license and support fees are each treated as separate units of accounting.
 
 Certain licensing agreements provide for royalty payments based on agreed upon royalty rates. Such rates can be fixed or variable depending on the terms of the agreement. The amount of revenue we recognize is determined based on a time period or on the agreed-upon royalty rate, extended by the number of units shipped
by the customer. To determine the number of units shipped, the Company relies upon actual royalty reports from its customers when available and rely upon estimates in lieu of actual royalty reports when we have a sufficient history of receiving royalties from a specific customer for us to make an estimate based on available information from the licensee such as quantities held, manufactured and other information. These estimates for royalties necessarily involve the application of management judgment. As a result
of our use of estimates, period-to-period numbers are “trued-up” in the following period to reflect actual units shipped. In cases where royalty reports and other information are not available to allow us to estimate royalty revenue, we recognize revenue only when royalty reports are received.
 
 For contracts related to licenses of our technology that involve significant modification, customization or engineering services, we recognize revenue in accordance the provisions of SOP 81-1 “Accounting for Performance of
Construction-Type and Certain Production-Type Contracts”. Revenues derived from such license contracts are accounted for using the percentage-of-completion method.
 
 We determine progress to completion based on input measures using labor-hours incurred by our engineers. The amount of revenue recognized is based on the total contract fees and the percentage of completion achieved. Estimates of total project requirements are based on prior experience of customization, delivery and
acceptance of the same or similar technology and are reviewed and updated regularly by management. If there is significant uncertainty about customer acceptance, or the time to complete the development or the deliverables by either party, we apply the completed contract method. If application of the percentage-of-completion method results in recognizable revenue prior to an invoicing event under a customer contract, we recognize the revenue and records an unbilled receivable assuming collectability is reasonably
assured. Amounts invoiced to our customers in excess of recognizable revenues are recorded as deferred revenue.
 
 Cash Equivalents and Short-Term Investments
 
 We account for our investments in debt and equity securities under, SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securitiesand FASB Staff Position, or FSP, SFAS No. 115-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.Management determines the appropriate classification of such securities at the time of purchase and reevaluates such classification as of each balance sheet date. The investments are adjusted for amortization of premiums and discounts to maturity and such amortization is included in interest income. We follow the guidance provided by EITF No. 03-1, The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments, to assess whether our investments with unrealized loss positions are other than temporarily impaired. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in the statements of income. Factors considered in determining whether a loss is temporary include the length of
time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. We place our investments in instruments that meet high credit quality standards, as specified in our investment policy guidelines. These guidelines also limit the amount of credit exposure to any one issue, issuer or type of instrument. Effective
April 1,2009, we adopted FSP FAS 115-2 and FAS 124-2, “ Recognition and Presentation of Other-Than-Temporary Impairments.” Our adoption of this standard did not have any significant impact on its consolidated financial statements.
 
 The longer the duration of our investment securities, the more susceptible they are to changes in market interest rates and bond yields. As yields increase, those securities purchased with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are due to changes in interest rates and bond
yields. We expect to realize the full value of all these investments upon maturity or sale.
 
 The classification of our investments into cash equivalents and short term investments is in accordance with Statement of Financial Accounting Standard No. 95 (SFAS No. 95) Statement of Cash Flows.Cash equivalents consist of short-term, highly
liquid financial instruments with insignificant interest rate risk that are readily convertible to cash and have maturities of three months or less from the date of purchase. Short-term investments consist of taxable commercial paper, United States government agency obligations, corporate/municipal notes and bonds with high-credit quality and money market preferred stock. These securities have maturities greater than three months from the date of purchase.
 
 We believe all of the financial instruments’ recorded values approximate current fair values because of their nature and respective durations. The fair
value of marketable securities is determined using quoted market prices for those securities or similar financial instruments.
  
 22
 Table of Contents
 
  Allowance for Doubtful Accounts
 
 We review collectability of accounts receivable on an on-going basis and provide an allowance for amounts we estimate will not be collectible. During our review, we consider our historical experience, the age of the receivable balance, the credit-worthiness of the customer and the reason for the delinquency. Delinquent
account balances are written-off after management has determined that the likelihood of collection is remote. Write-offs to date have not been material. While we endeavor to accurately estimate the allowance, we may record unanticipated write-offs in the future.
 
 Inventories
 
 We record inventories at the lower of actual cost, determined on a first-in first-out (FIFO) basis, or market. Actual cost approximates standard cost, adjusted for variances between standard and actual. Standard costs are determined based on our estimate of material costs, manufacturing yields, costs to assemble, test
and package our products and allocable indirect costs. We record differences between standard costs and actual costs as variances. These variances are analyzed and are either included on the consolidated balance sheet or the consolidated statement of income in order to state the inventories at actual costs on a FIFO basis. Standard costs are evaluated at least annually.
 
 Provisions are recorded for excess and obsolete inventory and are estimated based on a comparison of the quantity and cost of inventory on hand to management’s forecast of customer demand. Customer demand is dependent on many factors and requires us to use significant judgment in our forecasting process. We must
also make assumptions regarding the rate at which new products will be accepted in the marketplace and at which customers will transition from older products to newer products. Generally, inventories in excess of six months demand are written down to zero and the related provision is recorded as a cost of revenue. Once a provision is established, it is maintained until the product to which it relates is sold or otherwise disposed of, even if in subsequent periods we forecast demand for the product.
 
 Goodwill, intangible and long-lived assets
 
 Consideration paid in connection with acquisitions is required to be allocated to the assets, including identifiable intangible assets and liabilities acquired. Acquired assets and liabilities are recorded based on our estimate of fair value, which requires significant judgment with respect to future cash flows and
discount rates.
 
 For certain long-lived assets, primarily fixed assets and identifiable intangible assets, for example, our IP acquired from Sunplus (refer to Note 12 in our notes to consolidated financial statements), we are required to estimate the useful life of the asset and recognize its cost as an expense over the useful life.
We use the straight-line method to depreciate long-lived assets. We evaluate the recoverability of our long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.Whenever events or circumstances indicate that the carrying amount of long-lived assets may not be recoverable, we compare the carrying amount of long-lived assets to our projection
of future undiscounted cash flows, attributable to such assets. In the event that the carrying amount exceeds the future undiscounted cash flows, we record an impairment charge against income equal to the excess of the carrying amount over the asset’s fair value. Predicting future cash flows attributable to a particular asset is difficult and requires the use of significant judgment.
 
 We assign the following useful lives to our fixed assets — three years for computers and software, one to five years for equipment and five to seven years for furniture and fixtures. Leasehold improvements and assets held under capital leases are amortized on a straight-line basis over the shorter of the
lease term or the estimated useful life, which ranges from two to five years. Depreciation expense was $4.6 million and $5.3 million for the six months ended June 30, 2009 and 2008.
 
 We periodically review the carrying value of intangible assets not subject to amortization, including goodwill, to determine whether impairment may exist. Statement of Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Other Intangible Assets,
requires that goodwill and certain intangible assets be assessed annually for impairment using fair value measurement techniques. Specifically, goodwill impairment is determined using a two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. We have determined based on the criteria of SFAS 142 that we have one reporting unit for this purpose. If the carrying amount
of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value
of goodwill is determined by comparing the fair value of our company’s equity as of the date of the impairment testing to the carrying amount of stockholders equity. The impairment charge for other intangible assets not subject to amortization, for which impairment indicators exists, consists of a comparison of the fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
Furthermore, SFAS 142 requires purchased other intangible assets to be amortized over their useful lives unless these lives are determined to be indefinite. During the six months ended June, 30, 2009, we recognized an impairment loss on goodwill as a result of the periodic review due to the presence of impairment indicators.
 
 Legal Matters
 
 We are subject to various legal proceedings and claims, either asserted or unasserted. We evaluate, among other factors, the degree of probability of an unfavorable outcome and reasonably estimate the amount of the loss. Significant judgment is required in both
the determination of the probability and as to whether an exposure can be reasonably estimated. When we determine that it is probable that a loss has been incurred, the effect is recorded promptly in the consolidated financial statements. Although the outcome of these claims cannot be predicted with certainty, we do not believe that any of the existing legal matters will have a material adverse effect on our financial condition and results of operations. However, significant changes in legal proceedings and claims
or the factors considered in the evaluation of those matters could have a material adverse effect on our business, financial condition and results of operations.








23
  Table of Contents




Results of Operations





REVENUE




Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Product revenue

$
29,436


$
61,836



-52.4
%

$
64,031


$
119,023



-46.2
%Licensing revenue


7,900



8,247



-4.2
%


13,817



18,173



-24.0
%Total revenue

$
37,336


$
70,083



-46.7
%

$
77,848


$
137,196



-43.3
%
   Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Consumer Electronics (1)

$
33,261


$
50,310



-33.9
%

$
66,737


$
99,845



-33.2
%Personal Computers (1)


1,785



11,758



-84.8
%


4,992



22,927



-78.2
%Storage (1)


2,290



8,015



-71.4
%


6,119



14,424



-57.6
%Total revenue

$
37,336


$
70,083



-46.7
%

$
77,848


$
137,196



-43.3
%1) Includes development, licensing and royalty revenue (collectively "licensing revenue")
 
 Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Consumer Electronics

$
25,686


$
44,613



-42.4
%

$
53,262


$
87,065



-38.8
%Personal Computers


1,700



10,970



-84.5
%


5,168



20,977



-75.4
%Storage


2,050



6,253



-67.2
%


5,601



10,981



-49.0
%Licensing revenue


7,900



8,247



-4.2
%


13,817



18,173



-24.0
%Total revenue

$
37,336


$
70,083



-46.7
%

$
77,848


$
137,196



-43.3
%
 
 Total revenue for the three and six months ended June 30, 2009 was $37.3 million and $77.8 million, respectively and represented a decline of 46.7% or $32.7 million and 43.3% or $59.3 million from the same periods in 2008, respectively. The decrease
in our overall revenue was driven primarily by the decrease in our product revenue which decreased by 52.4% or $32.4 million and 46.2% or $55.0 million for the three and six months ended June 30, 2009, respectively when compared to the same periods in prior year. Product shipments decreased by approximately 30.9% and 25.0% and average selling price declined by approximately 31.9% and 29.0% during the three and six months ended June 30, 2009, respectively when compared to the same periods last year primarily
due to the ongoing global recession, our ongoing product transition as customers transition from HDMI receivers to more cost effective Port Processors and increased competition.  We believe that revenue will increase as we start to roll-out our new products in the second half of fiscal year 2009.









24


Table of Contents








COST OF REVENUE AND GROSS PROFIT




Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Product cost of revenue (1)

$
17,264


$
28,615



-39.7
%

$
35,483


$
56,403



-37.1
%Licensing cost of revenue


274



492



-44.3
%


470



841



-44.1
%Total Cost of revenue


17,538



29,107



-39.7
%


35,953



57,244



-38.0
%Total gross profit


19,798



40,976



-51.7
%


41,895



79,952



-47.0
%Gross profit margin


53.0
%


58.5
%






53.8
%


58.3
%_________________(1) Includes stock-based compensation expense

$
244


$
431






$
443


$
781


Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, and costs to license our technology which involves modification, customization or engineering services, as well as other overhead costs relating to the aforementioned costs including stock-based compensation expense. Gross profit, as a percentage of
revenue, was 53.0% and 53.8% for the three and six months ended June 30, 2009, respectively, and 58.5% and 58.3% in the comparable periods in 2008, respectively. Product mix, unfavorable variances and the impact of fixed overhead with lower revenue volume during the three and six months ended June 30, 2009 were the primary reasons for the decrease in gross profit as percentage of revenue.  We believe that gross profit will begin to improve as we start to roll-out new products
and increase revenue volume in the second half of 2009.


OPERATING EXPENSES
  Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Research and development (1)

$
17,619


$
22,298



-21.0
%

$
35,353


$
43,840



-19.4
%Percentage of total revenue


47.2
%


31.8
%






45.4
%


32.0
%_________________(1) Includes stock-based compensation expense

$
1,617


$
2,213






$
2,991


$
3,447
 
 Research and Development
(R&D).R&D expense consists primarily of employee compensation, including stock compensation expense, and other related costs and fees for independent contractors, the cost of software tools used for designing and testing our products, and costs associated with prototype materials. R&D expense for the three and six months ended June 30, 2009 included stock-based compensation expense of $1.6 million and $3.0 million, respectively, as compared to $2.2 million
and $3.4 million for the same periods in 2008, respectively. R&D expense decreased by $4.7 million and $8.5 million for the three and six months ended June 30, 2009, respectively as compared to the same periods in prior year.  The decrease was mainly driven by lower compensation related expenses, including stock-based compensation, and lower project related and tape-out expenses.  The decreases in these expenses were primarily driven by the lower headcount due to the restructuring activities
completed in the third and fourth quarters of 2008. We expect R&D expenses to continue to decline in the second half of fiscal year 2009.


25


Table of Contents






Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Selling, general and administrative (1)

$
12,678


$
19,067



-33.5
%

$
26,393


$
37,385



-29.4
%Percentage of total revenue


34.0
%


27.2
%






33.9
%


27.2
%_________________(1) Includes stock-based compensation expense

$
2,352


$
3,614






$
4,344


$
6,053





Selling, General and Administrative (SG&A). G&A expense consists primarily of compensation, including stock-based compensation, sales commissions, professional
fees, and marketing and promotional expenses. SG&A expense for the three and six months ended June 30, 2009 was $6.4 million and $11.0 million lower than what was incurred in the same periods in prior year, primarily due to lower compensation related expenses, including stock-based compensation, and legal expenses.  The decreases in these expenses are mainly attributable to the decrease in head count because of the reduction in force implemented in the third and fourth quarters of 2008.  We
expect SG&A expenses to continue to decline in the second half of fiscal year 2009.


Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Amortization of intangible assets

$
1,473


$
1,587



-7.2
%

$
2,946


$
3,174



-7.2
%Percentage of total revenue


3.9
%


2.3
%






3.8
%


2.3
%
 
 Amortization of Intangible Assets.The decrease in the amortization of intangible assets is primarily due to the complete amortization of certain intangible assets related to the sci-worx acquisition.




Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Interest income and other, net

$
598


$
1,380



-56.7
%

$
1,537


$
3,296



-53.4
%Percentage of total revenue


1.6
%


2.0
%






2.0
%


2.4
%





Interest Income and other, net.The net amount of interest income and other principally includes interest income. The decrease was primarily due to lower interest rates earned on our short-term investments
as well as lower average total cash balances.


Three months ended June 30,


Six months ended June 30,2009


2008


Change


2009


2008


Change(dollars in thousands)





(dollars in thousands)Income tax benefit

$
(5,143
)

$
(134
)


3738.1
%

$
(1,669
)

$
(127
)


1214.2
%Percentage of total revenue


-13.8
%


-0.2
%






-2.1
%


-0.1
%
 
 Provision (Benefit) for Income Taxes.For the three and six months ended June 30, 2009, we recorded an income
tax benefit of ($5.1) million and ($1.7) million, respectively. The effective tax rate for the three and six months ended June 30, 2009 was 27.9% and 3.5%, respectively and was based on our projected taxable income for 2009, plus certain discrete items recorded during the quarter. The difference between the provision for income taxes and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to various forecasted items including tax exempt income, SFAS 123(R) expense,
tax credits and foreign taxes, adjusted for certain discrete items recorded during the quarter.


For the three and six months ended June 30, 2008, we recorded a benefit for income taxes of ($134,000) and ($127,000), respectively. The effective tax rate for the three and six months ended June 30, 2008 was 22.5% and 11.0% and was based on our projected taxable
income for 2008, plus certain discrete items recorded during the quarter. The difference between the provision for income taxes and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to various forecasted items including tax exempt income, state taxes and foreign taxes, adjusted for certain discrete items recorded during the quarter.




26


Table of Contents





Recent Accounting Pronouncements





See Note 2, “Recent Accounting Pronouncements” in the Notes to Condensed Consolidated Financial Statements under Part I Item I of this report.





LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION





The following sections discuss the effects of changes in our balance sheet and cash flows, contractual obligations, other commitments, and the stock repurchase program on our liquidity and capital resources.





Cash and Cash Equivalents, Investments and Working Capital. The table below summarizes our cash and cash equivalents, investments and working capital and the related movements.








June 30, 2009


December 31, 2008


Change(dollars in thousands)Cash and cash equivalents

$
18,583


$
95,414



-80.5
%Short-term investments


144,370



89,591



61.1
%Total cash and cash equivalents and short-term  investments

$
162,953


$
185,005



-11.9
%Total current assets

$
216,722


$
225,642



-4.0
%Total current liabilities

$
35,517


$
39,530



-10.2
%Working capital

$
181,205


$
186,112



-2.6
%




Cash and cash equivalents and short-term investments were $162.9 million at June 30, 2009, a decrease of $22.1 million from $185.0 million at December 31, 2008. The decrease was primarily due to the cash used in operations.
 
 The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, and prepaid expenses and other current assets, inventories and deferred income taxes reduced by accounts payable, accrued and other current liabilities, deferred license revenue, and deferred margin on
sales to distributors. Working capital at June 30, 2009 slightly decreased by approximately $4.9 million when compared to the working capital at December 31, 2008 primarily due to the decreases in inventories and in cash and cash equivalents and short-term investments, and the increase in accounts payable, partially offset by the increases in operating assets, such as accounts receivable and prepaid expenses and other current assets and the decreases in operating liabilities, such as accrued
and other current liabilities and deferred margin on sales to distributors.
 
 Summary of Cash Flows. The table below summarizes the cash and cash equivalents provided by (used in) in our operating, investing and financing activities.
  Six months ended June 30,2009


2008


Change(dollars in thousands)Cash provided by (used in) operating activities

$
(19,637
)

$
11,533



-270.3
%Cash provided by (used in) investing activities


(58,118
)


28,122



-306.7
%Cash provided by (used in) financing activities


865



(70,945
)


-101.2
%Effect of exchange rate changes on cash and cash equivalents


59



13



353.8
%Net decrease in cash and cash equivalents

$
(76,831
)

$
(31,277
)


145.6
%


In the six months ended June 30, 2009, cash and cash equivalents decreased by $76.8 million. This decrease was the result of cash used in our operating and investing activities of $19.6 million and $58.1 million, respectively, partially offset by the cash generated from our financing activities of $0.9 million.


Operating Activities
 
 The $19.6 million net cash used in operating activities during the six months ended June 30, 2009 was primarily due to the cash used for working capital as a result of the increase in accounts receivable, and prepaid expenses and other current assets, and the decrease in deferred margin on sales to distributors, partially offset
by the increase in accounts payable and the decrease in inventories.
 
 Investing Activities
 
 The $58.1 million  net cash used in investing activities during the six months ended June 30, 2009 was due primarily net purchases of short-term investments of approximately $56.4 million and net investment in property and equipment of approximately $1.8million. For the six months ended June 30, 2009, we purchased $128.4
million and sold $72.0 million of short-term investments.


27


Table of Contents


Accounts Receivable, Net. The table below summarizes our accounts receivable, net (in thousands):





June 30,


December 31,2009


2008


Change(dollars in thousands)Accounts receivable, net

$
19,059


$
5,922



221.8
% Net accounts receivable as of June 30, 2009 were $19.1 million, which represents 46 days of sales outstanding. This compares to 9 days of sales outstanding on December 31, 2008. Accounts receivable as of June 30, 2009 significantly increased compared to the balance as
of December 31, 2008 primarily due to the timing of shipments and collections of cash.  Inventory.The table below shows our inventory (in thousands):




June 30,


December 31,2009


2008


Change(dollars in thousands)Inventory

$
9,169


$
12,775



-28.2
%


Our inventories are accounted for at the lower of cost or market. Inventory is written down for excess and obsolete inventories determined primarily by future demand forecasts. Inventory write downs are measured as the difference between the cost of the inventory and market, based upon assumptions about future demand, and are charged to cost of product revenue.
Inventory decreased by $3.6 million or $28.2% primarily due to our continuous process improvement and better inventory management.




Commitments and Contractual Obligations





See Note 9, “Commitments and Contingencies,” in the Notes to Condensed Consolidated Financial Statements under Part I Item I of this report.





We purchase components from a variety of suppliers and use several contract manufacturers to provide manufacturing services for our products. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, we enter into agreements with
contract manufacturers and suppliers that either allow them to procure inventory based upon criteria as defined by us or that establish the parameters defining our requirements. In certain instances, these agreements allow us the option to cancel, reschedule, and adjust our requirements based on our business needs prior to firm orders being placed. Consequently, only a portion of our reported purchase commitments arising from these agreements are firm, non-cancelable, and unconditional commitments.





Liquidity and Capital Resource Requirements





Based on our estimated cash flows, we believe our existing cash and short-term investments are sufficient to meet our capital and operating requirements for at least the next 12 months. Our future operating and capital requirements depend on many factors, including the levels at which we generate
product revenue and related margins, the extent to which we generate cash through stock option exercises and proceeds from sales of shares under our employee stock purchase plan, the timing and extent of development, licensing and royalty revenue, investments in inventory and accounts receivable, the cost of securing access to adequate manufacturing capacity, our operating expenses, including legal and patent assertion costs, and general economic conditions. In addition, cash may be required for future acquisitions
should we choose to pursue any. To the extent existing resources and cash from operations are insufficient to support our activities; we may need to raise additional funds through public or private equity or debt financing. These funds may not be available, or if available, we may not be able to obtain them on terms favorable to us.








28
 
 Table of Contents




Item 3. Quantitative and Qualitative Disclosures about Market Risk





Interest Rate Risk





A sensitivity analysis was performed on our investment portfolio as of June 30, 2009. This sensitivity analysis was based on a modeling technique that measures the hypothetical market value changes that would result from a parallel shift in the yield curve of plus 50, 100, or 150 basis points over a twelve-month time
horizon. The following represents the potential decrease to the value of our investments given a negative shift in the yield curve used in our sensitivity analysis.








0.5
%


1.0
%


1.5
%$ 549,000



$ 1,098,000



$ 1,647,000





Foreign Currency Exchange Risk





A majority of our revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, certain operating expenditures and capital purchases are incurred in or exposed to other currencies, primarily the Euro, British Pound, the South Korean
Won, Taiwan Dollar and the Chinese Yuan. Additionally, many of our foreign distributors price our products in the local currency of the countries in which they sell. Therefore, significant strengthening or weakening of the U.S. dollar relative to those foreign currencies could result in reduced demand or lower U.S. dollar prices or vice versa, for our products, which would negatively affect our operating results. Cash balances held in foreign countries are subject to local banking laws and may bear
higher or lower risk than cash deposited in the United States. The following represents the potential impact of a change in the value of the U.S. dollar compared to the foreign currencies which we use in our operations.  As of June 30, 2009, cash held in foreign countries was approximately $2.6 million. The following represents the potential impact of a change in the value of the U.S. dollar compared to the Euro, British Pound, Japanese Yen, Chinese Yuan, Taiwan Dollar and Korean
Won.  This sensitivity analysis aggregates our six months activity in these currencies, translated to U.S. dollars, and applies a change in the U.S. dollar value of 5%, 7.5% and 10%.




5.0
%


7.5
%


10.0
%$ 823,000



$ 1,234,000



$ 1,646,000





Derivative Instruments





We have operations in the United States, Europe and Asia, however, the majority of our revenue, costs of sales, expense and capital purchasing activities are transacted in U.S. Dollars. As a corporation with international as well as domestic operations, we are exposed to changes in foreign
exchange rates. These exposures may change over time and could have a material adverse impact on our financial results. Periodically, we use foreign currency forward contracts to hedge certain forecasted foreign currency transactions relating to operating expenses.  We do not enter into derivatives for speculative or trading purposes. We use derivative instruments primarily to manage exposures to foreign currency fluctuations on forecasted cash flows and balances primarily denominated in Euro. Our primary
objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates. These derivatives are designated as cash flow hedges and have maturities of less than one year. The effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income and, upon occurrence of the forecasted transaction, is subsequently reclassified into the line item in the consolidated statements
of operations to which the hedged transaction relates. We record any ineffective portion of the hedging instruments gain (loss) in other income (expense) on our consolidated statements of operations.





Our derivatives expose us to credit and non performance risks to the extent that the counterparties may be unable to meet the terms of the agreement. We seek to mitigate such risks by limiting the counterparties to major financial institutions. In addition, the potential risk of loss with any one
counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.





As of June 30, 2009, the outstanding foreign exchange contracts had a total notional value of $1.5 million and a fair value of $30,000.  See Note 14 to the Consolidated Financial Statements.





29


Table of Contents







Item 4. Controls and Procedures





Evaluation of Disclosure Controls and Procedures





Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded
that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.





Changes in Internal Control over Financial Reporting





There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our second quarter of fiscal 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.




Part II. Other Information





Item 1. Legal Proceedings





Please refer to Note 9 to our consolidated financial statements under Part I Item I financials statements.





Item 1A. Risk Factors





A description of the risk factors associated with our business is set forth below. You should carefully consider the following risk factors, together with all other information
contained or incorporated by reference in this filing, before you decide to purchase shares of our common stock. These factors could cause our future results to differ materially from those expressed in or implied by forward-looking statements made by us. Additional risks and uncertainties not presently known to us or that we currently
deem immaterial may also harm our business. The trading price of our common stock could decline due to any of these risks and you may lose all or part of your investment.





Our annual and quarterly operating results may fluctuate significantly and are difficult to predict, particularly given adverse domestic and global economic conditions.





Our annual and quarterly operating results are likely to vary significantly in the future based on a number of factors many of which we have little or no control. These factors include, but are not limited to:





•
the growth, evolution and rate of adoption of industry standards for our key markets, including consumer electronics, digital-ready PCs and displays and storage devices and systems;





•
the fact that our licensing revenue is heavily dependent on a few key licensing transactions being completed for any given period, the timing of which is not always predictable and is especially susceptible to delay beyond the period in which completion is expected and our concentrated dependence on a few licensees in any period for substantial
portions of our expected licensing revenue and profits;





•
the fact that our licensing revenue has been uneven and unpredictable over time and is expected to continue to be uneven and unpredictable for the foreseeable future, resulting in considerable fluctuation in the amount of revenue recognized in a particular quarter;





•
competitive pressures, such as the ability of competitors to successfully introduce products that are more cost-effective or that offer greater functionality than our products, including integration into their products of functionality offered by our products, the prices set by competitors for their products and the potential for alliances,
combinations, mergers and acquisitions among our competitors;




•
average selling prices of our products, which are influenced by competition and technological advancements, among other factors;




•
government regulations regarding the timing and extent to which digital content must be made available to consumers;




•
the availability of other semiconductors or other key components that are required to produce a complete solution for the customer, usually, we supply one of many necessary components; and,





•
the cost of components for our products and prices charged by the third parties who manufacture, assemble and test our products.




•
in order to address fluctuations in market demand, one-time sales opportunities and meet sales goals, we sometimes engage in heightened sales efforts during a given period that may adversely affect our sales in future periods.
  Because we have little or no control over these factors and/or their magnitude, our operating results are difficult to predict. Any substantial adverse change in any of these factors could negatively affect our business and results of operations.





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Our future annual and quarterly operating results are highly dependent upon how wellwe manage our business.





Our annual and quarterly operating results may fluctuate based on how well we manage our business. Some of these factors include the following:





•
our ability to manage product introductions and transitions, develop necessary sales and marketing channels and manage other matters necessary to enter new market segments;





•
our ability to successfully manage our business in multiple markets such as CE, PC and storage, which may involve additional research and development, marketing or other costs and expenses;





•
our ability to enter into licensing deals when expected and make timely deliverables and milestones on which recognition of revenue often depends;





•
our ability to engineer customer solutions that adhere to industry standards in a timely and cost-effective manner;





•
our ability to achieve acceptable manufacturing yields and develop automated test programs within a reasonable time frame for our new products;





•
our ability to manage joint ventures and projects, design services and our supply chain partners;





•
our ability to monitor the activities of our licensees to ensure compliance with license restrictions and remittance of royalties;





•
our ability to structure our organization to enable achievement of our operating objectives and to meet the needs of our customers and markets;





•
the success of the distribution and partner channels through which we choose to sell our products and





•
our ability to manage expenses and inventory levels; and





•
our ability to successfully maintain certain structural and various compliance activities in support of our global structure which in the long run, will result in certain operational benefits as well as achieve an overall lower tax rate.





If we fail to effectively manage our business, this could adversely affect our results of operations.





Our business has been and may continue to be significantly impacted by the deterioration in worldwide economic conditions, and the current uncertainty in the outlook for the global economy makes it more likely that our actual results will differ materially from expectations.





Global credit and financial markets have been experiencing extreme disruptions in recent months, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and uncertainty about economic stability.
There can be no assurance that there will not be further deterioration in credit and financial markets and confidence in economic conditions.  These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. The current tightening of credit in financial markets may lead consumers and businesses to postpone spending, which may cause our customers to cancel, decrease or delay their existing and future orders
with us. In addition, financial difficulties experienced by our suppliers or distributors could result in product delays, increased accounts receivable defaults and inventory challenges. The volatility in the credit markets has severely diminished liquidity and capital availability.  Our CE product revenue, which comprised approximately 89.1% and 85.7% of total revenue for the three and six months ended June 30, 2009, respectively, is dependent on continued demand for consumer electronics, including
but not limited to, DTVs, STBs, DVDs and game consoles. Demand for consumer electronics business is a function of the health of the economies in the United States and around the world. Since the US economy and other economies around the world have moved into a recession, the demand for overall consumer electronics have been and may continue to be adversely affected and therefore, demand for our CE, PC and storage products and our operating results have been and may continue to be adversely affected as well. We
cannot predict the timing, strength or duration of any economic disruption or subsequent economic recovery, worldwide, in the United States, in our industry, or in the consumer electronics market. These and other economic factors have had and may continue to have a material adverse effect on demand for our CE, PC and storage products and on our financial condition and operating results.





Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate debt securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if
interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates. We may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. Recent adverse events in the global economy and in the credit markets could negatively impact our return on investment for these debt securities and thereby reduce the amount of cash and cash equivalents and investments on our balance sheet.





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The licensing component of our business strategy increases business risk and volatility.





Part of our business strategy is to license intellectual property (IP) through agreements with companies whereby companies incorporate our IP into their respective technologies that address markets in which we do not want to directly participate. There can be no assurance that additional companies
will be interested in purchasing our technology on commercially favorable terms or at all. We also cannot ensure that companies who purchase our technology will introduce and sell products incorporating our technology, will accurately report royalties owed to us, will pay agreed upon royalties, will honor agreed upon market restrictions, will not infringe upon or misappropriate our intellectual property and will maintain the confidentiality of our proprietary information. The IP agreements are complex and depend
upon many factors including completion of milestones, allocation of values to delivered items and customer acceptances. Many of these factors require significant judgments. Licensing revenue could fluctuate significantly from period to period because it is heavily dependent on a few key deals being completed in a particular period, the timing of which is difficult to predict and may not match our expectations. Because of its high margin content, the licensing mix of our revenue can have a disproportionate impact
on gross profit and profitability. Also, generating revenue from these arrangements is a lengthy and complex process that may last beyond the period in which efforts begin and once an agreement is in place, the timing of revenue recognition may be dependent on customer acceptance of deliverables, achievement of milestones, our ability to track and report progress on contracts, customer commercialization of the licensed technology and other factors. Licensing that occurs in connection with actual or contemplated
litigation is subject to risk that the adversarial nature of the transaction will induce non-compliance or non-payment. The accounting rules associated with recognizing revenue from these transactions are increasingly complex and subject to interpretation. Due to these factors, the amount of license revenue recognized in any period may differ significantly from our expectations.





We face intense competition in our markets, which may lead to reduced revenue from sales of our products and increased losses.





The CE, PC and storage markets in which we operate are intensely competitive. These markets are characterized by rapid technological change, evolving standards, short product life cycles and declining selling prices. We expect competition for many of our products to increase, as industry standards
become widely adopted and as new competitors enter our markets.





Our products face competition from companies selling similar discrete products and from companies selling products such as chipsets with integrated functionality. Our competitors include semiconductor companies that focus on the CE, display or storage markets, as
well as major diversified semiconductor companies and we expect that new competitors will enter our markets. Current or potential customers, including our own licensees, may also develop solutions that could compete with us, including solutions that integrate the functionality of our products into their solutions. In addition, current or potential OEM customers may have internal semiconductor capabilities and may develop their own solutions for use in their products rather than purchasing them from companies
such as us. Some of our competitors have already established supplier or joint development relationships with current or potential customers and may be able to leverage their existing relationships to discourage these customers from purchasing products from us or persuade them to replace our products with theirs. Many of our competitors have longer operating histories, greater presence in key markets, better name recognition, access to larger customer bases and significantly greater financial, sales and marketing,
manufacturing, distribution, technical and other resources than we do and as a result, they may be able to adapt more quickly to new or emerging technologies and customer requirements, or devote greater resources to the promotion and sale of their products. In particular, well-established semiconductor companies, such as Analog Devices, Intel, National Semiconductor and Texas Instruments and CE manufacturers, such as Hitachi, Matsushita, Philips, Sony, Thomson and Toshiba, may compete against us in the future.
Some of our competitors could merge, which may enhance their market presence. Existing or new competitors may also develop technologies that more effectively address our markets with products that offer enhanced features and functionality, lower power requirements, greater levels of integration or lower cost. Increased competition has resulted in and is likely to continue to result in price reductions and loss of market share in certain markets. We cannot assure you that we can compete successfully against current
or potential competitors, or that competition will not reduce our revenue and gross margins.





We operate in rapidly evolving markets, which makes it difficult to evaluate our future prospects.





The markets in which we compete are characterized by rapid technological change, evolving customer needs and frequent introductions of new products and standards. As we adjust to evolving customer requirements and technological advances, we may be required to further reposition our existing offerings
and to introduce new products and services. We may not be successful in developing and marketing such new offerings, or we may experience difficulties that could delay or prevent the development and marketing of such new offerings. Moreover, new standards that compete with standards that we promote have been and in the future may be introduced from time to time, which could impact our success. Accordingly, we face risks and difficulties frequently encountered by companies in new and rapidly evolving markets.
If we do not successfully address these risks and difficulties, our results of operations could be negatively affected.




Our success depends on demand for our new products.





Our future growth and success depends on our ability to develop and bring to market on a timely basis new products, such as our HDTV port and input processors, MHL and LiquidHD products, which we have recently introduced into the market. There can be no assurance that we will be successful in developing
and marketing these new or other future products. Moreover, there is no assurance that our new or future products will achieve the desired level of market acceptance in the anticipated timeframes or that any such new or future products will contribute significantly to our revenue. Our new products face significant competition from established companies that have been selling competitive products for longer periods of time than we have.







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Demand for our HDMI based products is dependent on continued adoption and widespread implementation of the HDMI specification.





Our success in the HDMI market is largely dependent upon the continued adoption and widespread implementation of the HDMI specification. Demand for our products may be inhibited by unanticipated unfavorable changes in or new regulations that delay or impede the transition to digital broadcast technologies
in the U.S. or abroad. Demand for our consumer electronics products may also be inhibited in the event of negative consumer experience with HDMI technology as more consumers put it into service. Transmission of audio and video from “player devices” (such as a DVD player or set-top box) to intermediary devices (such as an audio-video receiver (AVR)) to displays (such as an HDTV) over HDMI with HDCP represents a combination of new technologies working in concert. Complexities with these technologies,
the interactions between content protection technologies and HDMI with HDCP and the variability in HDMI implementations between manufacturers may cause some of these products to work incorrectly, or for the transmissions to not occur correctly, or for certain products not to be interoperable. Delays or difficulties in integration of these technologies into products or failure of products incorporating this technology to achieve market acceptance could have an adverse effect on our business. In addition, we believe
that the rate of HDMI adoption may be affected by changes in FCC rules and European Information Communications and Consumer Electronics Technology Industry Associations (EICTA) and Cable & Satellite Broadcasting Association of Asia (CASBAA) recommendations described below.





In the United States, the FCC issued its Plug and Play order in October 2003. In November 2003 and March 2004, these rules, known as the Plug & Play Final Rules (Plug & Play Rules), became effective. The Plug and Play Rules are relevant to
DVI and HDMI with respect to high definition set-top boxes and the labeling of digital cable ready televisions. Regarding high-definition set-top boxes, the FCC stated that, as of July 1, 2005, all high definition set-top boxes acquired by cable operators for distribution to subscribers would need to include either a DVI or HDMI with HDCP. Regarding digital cable ready televisions, the FCC stated that a 720p or 1080i unidirectional digital cable television may not be labeled or marketed as “digital
cable ready” unless it includes either a DVI or HDMI with HDCP, according to a phase-in timetable. In the past, the FCC has made modifications to its rules and timetable for the DTV transition and it may do so in the future. We cannot predict whether these FCC rules will be amended prior to completion of the phase-in dates or that such phase-in dates will not be delayed. In addition, we cannot guarantee that the FCC will not in the future reverse these rules or adopt rules requiring or supporting different
interface technologies, either of which would adversely affect our business.





In January 2005, the European Industry Association for Information Systems, Communication Technologies and Consumer Electronics (EICTA) issued its “Conditions for High Definition Labeling of Display Devices” which requires all HDTVs using the “HD
Ready” logo to have either an HDMI or DVI input with HDCP. In August 2005, EICTA issued its “Minimum Requirements for HD Television Receivers” which requires HD Receivers without an integrated display (e.g. HD STBs) utilizing the “HDTV” logo and intended for use with HD sources (e.g. television broadcasts), some of which require content protection in order to permit HD quality output, to have either a DVI or HDMI output with HDCP.





In August 2005, the Cable and Satellite Broadcasting Association of Asia (CASBAA) issued a series of recommendations in its “CASBAA Principles for Content Protection in the Asia-Pacific Pay-TV Industry” for handling digital output from future generations of set-top boxes for VOD, PPV,
Pay-TV and other encrypted digital programming applications. These recommendations include the use of one or more HDMI with HDCP or DVI with HDCP digital outputs for set-top boxes capable of outputting uncompressed high-definition content.


With respect to the EICTA and CASBAA recommendations, we cannot predict the rate at which manufacturers will implement the HDMI-related recommendations in their products.





The HDMI founders decided to reduce the annual license fee payable by HDMI adopters from $15,000 to $10,000 per year effective on November 1, 2006 for all adopters after that date in order to encourage more widespread adoption of HDMI. The annual fees collected by our subsidiary HDMI Licensing,
LLC are recognized as revenues by us. Accordingly, if there are not sufficient new adopters of HDMI to offset the reduction in the annual license fee payable per adopter, our revenues will be negatively impacted. In addition, during 2007, at a founders meeting, the founders decided to share the HDMI adopter’s royalty revenues among the various founders. Our subsidiary no longer recognizes 100% of the HDMI adopter royalty revenues.





We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration, which may result in reduced manufacturing yields, delays in product deliveries and increased expenses




To remain competitive, we expect to continue to transition our semiconductor products to increasingly smaller line width geometries. This transition requires us to modify the manufacturing processes for our products and to redesign some products as well as standard
cells and other integrated circuit designs that we may use in multiple products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs. Currently most of our products are manufactured in .18 micron and .13 micron, geometry processes. We are now designing a new product in 65 nanometer process technology and planning for the transition to smaller process geometries. In the past, we have experienced some difficulties
in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. The transition to 65 nanometer geometry process technology will result in significantly higher mask and prototyping costs, as well as additional expenditures for engineering design tools and related computer hardware. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry
processes.





We are dependent on our relationships with our foundry subcontractors to transition to smaller geometry processes successfully. We cannot assure you that the foundries that we use will be able to effectively manage the transition in a timely manner, or at all,
or that we will be able to maintain our existing foundry relationships or develop new ones. If any of our foundry subcontractors or we experience significant delays in this transition or fail to efficiently implement this transition, we could experience reduced manufacturing yields, delays in product deliveries and increased expenses, all of which could harm our relationships with our customers and our results of operations.





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We will have difficulty selling our products if customers do not design our products into their product offerings or if our customers’ product offerings are not commercially
successful.





Our products are generally incorporated into our customers’ products at the design stage. As a result, we rely on equipment manufacturers to select our products to be designed into their products. Without these “design wins,” it is very difficult to sell our products. We often
incur significant expenditures on the development of a new product without any assurance that an equipment manufacturer will select our product for design into its own product. Additionally, in some instances, we are dependent on third parties to obtain or provide information that we need to achieve a design win. Some of these third parties may be our competitors and, accordingly, may not supply this information to us on a timely basis, if at all. Once an equipment manufacturer designs a competitor’s product
into its product offering, it becomes significantly more difficult for us to sell our products to that customer because changing suppliers involves significant cost, time, effort and risk for the customer. Furthermore, even if an equipment manufacturer designs one of our products into its product offering, we cannot be assured that its product will be commercially successful or that we will receive any revenue from that product. Sales of our products largely depend on the commercial success of our customers’
products. Our customers generally can choose at any time to stop using our products if their own products are not commercially successful or for any other reason. We cannot assure you that we will continue to achieve design wins or that our customers’ equipment incorporating our products will ever be commercially successful.





Our products typically have lengthy sales cycles. A customer may decide to cancel or change its product plans, which could cause us to lose anticipated sales. In addition, our
average product life cycles tend to be short and, as a result, we may hold excess or obsolete inventory that could adversely affect our operating results.





After we have developed and delivered a product to a customer, the customer will usually test and evaluate our product prior to designing its own equipment to incorporate our product. Our customers generally need three months to over six months to test, evaluate and adopt our product and an additional
three months to over nine months to begin volume production of equipment that incorporates our product. Due to this lengthy sales cycle, we may experience significant delays from the time we incur operating expenses and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring such expenditures. Even if a customer selects our product to incorporate into its equipment, we have no assurances
that the customer will ultimately market and sell its equipment or that such efforts by our customer will be successful. The delays inherent in our lengthy sales cycle increase the risk that a customer will decide to cancel or change its product plans. Such a cancellation or change in plans by a customer could cause us to lose sales that we had anticipated. In addition, anticipated sales could be materially and adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle
or chooses not to release equipment that contains our products. Further, the combination of our lengthy sales cycles coupled with worldwide economic conditions could have a compounding negative impact on the results of our operations.





While our sales cycles are typically long, our average product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, the resources devoted to product sales and marketing may not generate material
revenue for us and from time to time, we may need to write off excess and obsolete inventory. If we incur significant marketing expenses and investments in inventory in the future that if we are not able to recover and we are not able to compensate for those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions but still hold higher cost products in inventory, our operating results would be harmed.





Our customers may not purchase anticipated levels of products, which can result in excess inventories.





We generally do not obtain firm, long-term purchase commitments from our customers and, in order to accommodate the requirements of certain customers, we may from time to time build inventory that is specific to that customer in advance of receiving firm purchase orders. The short-term nature of
our customers’ commitments and the rapid changes in demand for their products reduce our ability to accurately estimate the future requirements of those customers. Should the customer’s needs shift so that they no longer require such inventory, we may be left with excessive inventories, which could adversely affect our operating results.





We depend on a few key customers and the loss of any of them could significantlyreduce our revenue.





Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For the three months ended June 30, 2009, shipments to Microtek Corporation generated 12.6% of our revenue. For the six months ended June 30, 2009, shipments to Microtek
Corporation and Weiking Industrial generated 11.1% and 10.9% of our revenue, respectively.  For the three months ended June 30, 2008, shipments to World Peace Industrial, Microtek Corporation, and Innotech Corporation generated 15.3%, 12.3% and 12.2% of our revenue, respectively. For the six months ended June 30, 2008, shipments to World Peace Industrial, Microtek Corporation and Innotech Corporation accounted for 14.9%, 12.3% and 11.6% of our revenue, respectively.   In addition, an
end-customer may buy our products through multiple distributors, contract manufacturers and /or directly, which could create an even greater concentration. We cannot be certain that customers and key distributors that have accounted for significant revenue in past periods, individually or as a group, will continue to sell our products and generate revenue. As a result of this concentration of our customers, our results of operations could be negatively affected if any of the following occurs:





•
one or more of our customers, including distributors, becomes insolvent or goes out of business;





•
one or more of our key customers or distributors significantly reduces, delays or cancels orders; and/or





•
one or more significant customers selects products manufactured by one of our competitors for inclusion in their future product generations.





While our participation in multiple markets, has broadened our customer base, as product mix fluctuates from quarter to quarter, we may become more dependent on a small number of customers or a single customer for a significant portion of our revenue in a particular
quarter, the loss of which could adversely affect our operating results.





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We sell our products through distributors, which limits our direct interaction withour end customers, therefore reducing our ability to forecast sales and increasing thecomplexity
of our business.





Many original equipment manufacturers (“OEMs”) rely on third-party manufacturers or distributors to provide inventory management and purchasing functions. For the three and six months ended June 30, 2009, distributors generated 23.2% and 38.1% of our revenue, respectively. Sales to
distributors accounted for 53.3% and 52.6% of our revenue for the three and six months ended June 30, 2008, respectively.  Selling through distributors reduces our ability to forecast sales and increases the complexity of our business, requiring us to:





•
manage a more complex supply chain;





•
monitor and manage the level of inventory of our products at each distributor;





•
estimate the impact of credits, return rights, price protection and unsold inventory at distributors; and,




•
monitor the financial condition and credit-worthiness of our distributors, many of which are located outside of the United States and the majority of which are not publicly traded.





Since we have limited ability to forecast inventory levels at our end customers, it is possible that there may be significant build-up of inventories in the distributor channel, with the OEM or the OEM’s contract manufacturer. Such a buildup could result in a slowdown in orders, requests
for returns from customers, or requests to move out planned shipments. This could adversely impact our revenues and profits.





Any failure to manage these challenges could disrupt or reduce sales of our products and unfavorably impact our financial results.





Our success depends on the development and introduction of new products, which we may not be able to do in a timely manner because the process of developing high-speed semiconductor
products is complex and costly.





The development of new products is highly complex and we have experienced delays, some of which exceeded one year, in the development and introduction of new products on several occasions in the past. We have recently introduced new products and will continue to introduce new products in the future.
As our products integrate new, more advanced functions, they become more complex and increasingly difficult to design, manufacture and debug. Successful product development and introduction depends on a number of factors, including, but not limited to:





•
accurate prediction of market requirements and the establishment of market standards and the evolution of existing standards, including enhancements or modifications to existing standards such as HDMI, HDCP, DVI, SATA I and SATA II;





•
identification of customer needs where we can apply our innovation and skills to create new standards or areas for product differentiation that improve our overall competitiveness either in an existing market or in a new market;





•
development of advanced technologies and capabilities and new products that satisfy customer requirements;




•
competitors' and customers' integration of the functionality of our products into their products, which puts pressure on us to continue to develop and introduce new products with new functionality;




•
timely completion and introduction of new product designs;





•
management of product life cycles;





•
use of leading-edge foundry processes, when use of such processes are required and achievement of high manufacturing yields and low cost testing;





•
market acceptance of new products; and,




•
market acceptance of new architectures such as our input processors.


Accomplishing all of this is extremely challenging, time-consuming and expensive and there is no assurance that we will succeed. Product development delays may result from unanticipated engineering complexities, changing market or competitive product requirements or specifications, difficulties
in overcoming resource constraints, the inability to license third-party technology or other factors. Competitors and customers may integrate the functionality of our products into their own products, thereby reducing demand for our products. If we are not able to develop and introduce our products successfully and in a timely manner, our costs could increase or our revenue could decrease, both of which would adversely affect our operating results. In addition, it is possible that we may experience delays in
generating revenue from these products or that we may never generate revenue from these products. We must work with a semiconductor foundry and with potential customers to complete new product development and to validate manufacturing methods and processes to support volume production and potential re-work. Each of these steps may involve unanticipated difficulties, which could delay product introduction and reduce market acceptance of the product. In addition, these difficulties and the increasing complexity
of our products may result in the introduction of products that contain defects or that do not perform as expected, which would harm our relationships with customers and our ability to achieve market acceptance of our new products. There can be no assurance that we will be able to achieve design wins for our planned new products, that we will be able to complete development of these products when anticipated, or that these products can be manufactured in commercial volumes at acceptable yields, or that any design
wins will produce any revenue. Failure to develop and introduce new products, successfully and in a timely manner, may adversely affect our results of operations.





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There are risks to our global strategy.





In 2006, we implemented a global strategy that involves maintaining operations in various countries around the world. Since its implementation, we have begun to realize certain operational benefits from our global strategy and our overall tax rate has benefited favorably. The effectiveness of the
strategy requires, in addition to maintaining and increasing profitability, continued maintenance of a certain corporate structure and various compliance activities required by foreign jurisdictions in support of the structure. Should management fail to adhere to these compliance requirements or fail to maintain supportive processes, our ability to continue to realize the benefits of our global strategy may be jeopardized, which may adversely affect our business, operating results or financial condition.




Potential Tax Law Changes – Changes in tax laws could have an adverse impact on our effective tax rates.
  Recent federal and state tax legislation has been proposed, and additional tax legislation may be proposed in the future which, if enacted, could have an adverse tax impact on either Silicon Image or our shareholders. For example, the ability to defer taxes as a result of permanent investments
offshore could be limited, thus raising the Company’s effective tax rate.


We have made acquisitions in the past and may make acquisitions in the future, and these acquisitions involve numerous risks.





Our growth depends upon market growth and our ability to enhance our existing products and introduce new products on a timely basis. Acquisitions of companies or intangible assets is a strategy we may use to develop new products and enter new markets. In January 2007, we completed the acquisition
of sci-worx, now Silicon Image, GmbH. We may acquire additional companies or technologies in the future. Acquisitions involve numerous risks, including, but not limited to, the following:





•
difficulty and increased costs in assimilating employees, including our possible inability to keep and retain key employees of the acquired business;





•
disruption of our ongoing business;





•
discovery of undisclosed liabilities of the acquired companies and legal disputes with founders or shareholders of acquired companies;





•
inability to successfully incorporate acquired technology and operations into our business and maintain uniform standards, controls, policies and procedures;





•
inability to commercialize acquired technology; and





•
the need to take impairment charges or write-downs with respect to acquired assets.





No assurance can be given that our prior acquisitions or our future acquisitions, if any, will be successful or provide the anticipated benefits, or that they will not adversely affect our business, operating results or financial condition. Failure to manage growth effectively and to successfully integrate acquisitions
made by us could materially harm our business and operating results.





Industry cycles may strain our management and resources.





Cycles of growth and contraction in our industry may strain our management and resources. To manage these industry cycles effectively, we must:





•
improve operational and financial systems;





•
train and manage our employee base;





•
successfully integrate operations and employees of businesses we acquire or have acquired;





•
attract, develop, motivate and retain qualified personnel with relevant experience; and





•
adjust spending levels according to prevailing market conditions.








If we cannot manage industry cycles effectively, our business could be seriously harmed.








The cyclical nature of the semiconductor industry may create constrictions in ourfoundry, test and assembly capacity.





The semiconductor industry is characterized by significant downturns and wide fluctuations in supply and demand. This cyclicality has led to significant fluctuations in product demand and in the foundry, test and assembly capacity of third-party suppliers. Production capacity for fabricated semiconductors
is subject to allocation, whereby not all of our production requirements would be met. This may impact our ability to meet demand and could also increase our production costs and inventory levels. Cyclicality has also accelerated decreases in average selling prices per unit. We may experience fluctuations in our future financial results because of changes in industry-wide conditions. Our financial performance has been and may in the future be, negatively impacted by downturns in the semiconductor industry. In
a downturn situation, we may incur substantial losses if there is excess production capacity or excess inventory levels in the distribution channel.





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We depend on third-party sub-contractors to manufacture, assemble and test nearly allof our products, which reduce our control over the production process.





We do not own or operate a semiconductor fabrication facility. We rely on one third party semiconductor company overseas to produce substantially all of our semiconductor products.   We also rely on outside assembly and test services to test all of our semiconductor products. Our
reliance on independent foundries, assembly and test facilities involves a number of significant risks, including, but not limited to:





•
reduced control over delivery schedules, quality assurance, manufacturing yields and production costs;





•
lack of guaranteed production capacity or product supply, potentially resulting in higher inventory levels;





•
lack of availability of, or delayed access to, next-generation or key process technologies; and,





•
limitations on our ability to transition to alternate sources if services are unavailable from primary suppliers.





We do not have a long-term supply agreement with all of our subcontractors and instead obtain production services on a purchase order basis. Our outside sub-contractors have no obligation to manufacture our products or supply products to us for any specific period
of time, in any specific quantity or at any specific price, except as set forth in a particular purchase order. Our requirements represent a small portion of the total production capacity of our outside foundries, assembly and test facilities and our sub-contractors may reallocate capacity on short notice to other customers who may be larger and better financed than we are, or who have long-term agreements with our sub-contractors, even during periods of high demand for our products. These foundries may allocate
or move production of our products to different foundries under their control, even in different locations, which may be time consuming, costly and difficult, have an adverse affect on quality, yields and costs and require us and/or our customers to re-qualify the products, which could open up design wins to competition and result in the loss of design wins and design-ins. If our subcontractors are unable or unwilling to continue manufacturing our products in the required volumes, at acceptable quality, yields
and costs and in a timely manner, our business will be substantially harmed. As a result, we would have to identify and qualify substitute sub-contractors, which would be time-consuming, costly and difficult; there is no guarantee that we would be able to identify and qualify such substitute sub-contractors on a timely basis or obtain commercially reasonable terms from them. This qualification process may also require significant effort by our customers and may lead to re-qualification of parts, opening
up design wins to competition and loss of design wins and design-ins. Any of these circumstances could substantially harm our business. In addition, if competition for foundry, assembly and test capacity increases, our product costs may increase and we may be required to pay significant amounts or make significant purchase commitments to secure access to production services.





The complex nature of our production process, which can reduce yields and preventidentification of problems until well into the production cycle or, in some cases,after
the product has been shipped.





The manufacture of semiconductors is a complex process and it is often difficult for semiconductor foundries to achieve acceptable product yields. Product yields depend on both our product design and the manufacturing process technology unique to the semiconductor foundry. Since low yields may
result from either design or process difficulties, identifying problems can often only occur well into the production cycle, when an actual product exists that can be analyzed and tested.





Further, we only test our products after they are assembled, as their high-speed nature makes earlier testing difficult and expensive. As a result, defects often are not discovered until after assembly. This could result in a substantial number of defective
products being assembled and tested or shipped, thus lowering our yields and increasing our costs. These risks could result in product shortages or increased costs of assembling, testing or even replacing our products.





Although we test our products before shipment, they are complex and may contain defects and errors. In the past we have encountered defects and errors in our products. Because our products are sometimes integrated with products from other vendors, it can be difficult to identify the source of any
particular problem. Delivery of products with defects or reliability, quality or compatibility problems, may damage our reputation and our ability to retain existing customers and attract new customers. In addition, product defects and errors could result in additional development costs, diversion of technical resources, delayed product shipments, increased product returns, warranty and product liability claims against us that may not be fully covered by insurance. Any of these circumstances could substantially
harm our business.







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We face foreign business, political and economic risks because a majority of ourproducts and our customers’ products are manufactured and sold outside of the UnitedStates.





A substantial portion of our business is conducted outside of the United States. As a result, we are subject to foreign business, political and economic risks. Nearly all of our products are manufactured in Taiwan or elsewhere in Asia. For the three and six months ended June 30, 2009, approximately 75.7% and 79.1% of our revenue, respectively,
was generated from customers and distributors located outside of the United States, primarily in Asia. We anticipate that sales outside of the United States will continue to account for a substantial portion of our revenue in future periods. In addition, we undertake various sales and marketing activities through regional offices in several other countries and we have significantly expanded our research and development operations outside of the United States. We intend to continue to expand our international
business activities. Accordingly, we are subject to international risks, including, but not limited to:


•
political, social and economic instability;





•
exposure to different business practices and legal standards, particularly with respect to intellectual property;





•
natural disasters and public health emergencies;





•
nationalization of business and blocking of cash flows;





•
trade and travel restrictions





•
the imposition of governmental controls and restrictions;





•
burdens of complying with a variety of foreign laws;





•
import and export license requirements and restrictions of the United States and each other country in which we operate;





•
unexpected changes in regulatory requirements;





•
foreign technical standards;





•
changes in taxation and tariffs;





•
difficulties in staffing and managing international operations;





•
fluctuations in currency exchange rates;





•
difficulties in collecting receivables from foreign entities or delayed revenue recognition;





•
expense and difficulties in protecting our intellectual property in foreign jurisdictions;





•
exposure to possible litigation or claims in foreign jurisdictions; and





•
potentially adverse tax consequences.





Any of the factors described above may have a material adverse effect on our ability to increase or maintain our foreign sales. In addition, original equipment manufacturers that design our semiconductors into their products sell them outside of the United States. This exposes us indirectly to
foreign risks. Because sales of our products are denominated exclusively in United States dollars, relative increases in the value of the United States dollar will increase the foreign currency price equivalent of our products, which could lead to a change in the competitive nature of these products in the marketplace. This in turn could lead to a reduction in sales and profits.





The success of our business depends upon our ability to adequately protect ourintellectual property.





We rely on a combination of patent, copyright, trademark, mask work and trade secret laws, as well as nondisclosure agreements and other methods, to protect our proprietary technologies. We have been issued patents and have a number of pending patent applications. However, we cannot assure you
that any patents will be issued as a result of any applications or, if issued, that any claims allowed will protect our technology. In addition, we do not file patent applications on a worldwide basis, meaning we do not have patent protection in some jurisdictions. It may be possible for a third-party, including our licensees, to misappropriate our copyrighted material or trademarks. It is possible that existing or future patents may be challenged, invalidated or circumvented and effective patent, copyright,
trademark and trade secret protection may be unavailable or limited in foreign countries. It may be possible for a third-party to copy or otherwise obtain and use our products or technology without authorization, develop similar technology independently or design around our patents in the United States and in other jurisdictions. It is also possible that some of our existing or new licensing relationships will enable other parties to use our intellectual property to compete against us. Legal actions to enforce
intellectual property rights tend to be lengthy and expensive and the outcome often is not predictable. As a result, despite our efforts and expenses, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business. In addition, practicality also limits our assertion of intellectual property rights. Patent litigation is expensive and its results are often unpredictable. Assertion of intellectual property rights often results in counterclaims
for perceived violations of the defendant’s intellectual property rights and/or antitrust claims. Certain parties after receipt of an assertion of infringement will cut off all commercial relationships with the party making the assertion, thus making assertions against suppliers, customers and key business partners risky. If we forgo making such claims, we may run the risk of creating legal and equitable defenses for an infringer.




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We generally enter into confidentiality agreements with our employees, consultants and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, internal
or external parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. Also, current or former employees may seek employment with our business partners, customers or competitors, and we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, current, departing or former employees or third parties could attempt to penetrate our computer systems and networks to
misappropriate our proprietary information and technology or interrupt our business. Because the techniques used by computer hackers and others to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate, counter or ameliorate these techniques. As a result, our technologies and processes may be misappropriated, particularly in countries where laws may not protect our proprietary rights as fully as in the United States.





Our products may contain technology provided to us by other parties such as contractors, suppliers or customers. We may have little or no ability to determine in
advance whether such technology infringes the intellectual property rights of a third party. Our contractors, suppliers and licensors may not be required to indemnify us in the event that a claim of infringement is asserted against us, or they may be required to indemnify us only up to a maximum amount, above which we would be responsible for any further costs or damages. In addition, we may have little or no ability to correct errors in the technology provided by such contractors, suppliers and licensors, or
to continue to develop new generations of such technology. Accordingly, we may be dependent on their ability and willingness to do so. In the event of a problem with such technology, or in the event that our rights to use such technology become impaired, we may be unable to ship our products containing such technology, and may be unable to replace the technology with a suitable alternative within the time frame needed by our customers.





Our participation in working groups for the development and promotion of industrystandards in our target markets, including the Digital Visual Interface and HDMIspecifications,
requires us to license some of our intellectual property for free orunder specified terms and conditions, which may make it easier for others to competewith us in such markets.





A key element of our business strategy includes participation in working groups to establish industry standards in our target markets, promote and enhance specifications and develop and market products based on such specifications and future enhancements. We are a promoter of the Digital Display
Working Group (DDWG), which published and promotes the DVI specification and a founder in the working group that develops and promotes the HDMI specification. In connection with our participation in such working groups:





•
we must license for free specific elements of our intellectual property to others for use in implementing the DVI specification; and we may license additional intellectual property for free as the DDWG promotes enhancements to the DVI specification; and,




•
we must license specific elements of our intellectual property to others for use in implementing the HDMI specification and we may license additional intellectual property as the HDMI founders group promotes enhancements to the HDMI specification.





Accordingly, certain companies that implement the DVI and HDMI specifications in their products can use specific elements of our intellectual property to compete with us, in certain cases for free. Although in the case of the HDMI specification, there are annual fees and royalties associated with
the adopters’ agreements, there can be no assurance that such annual fees and royalties will adequately compensate us for having to license our intellectual property. Fees and royalties received during the early years of adoption of HDMI will be used to cover costs we incur to promote the HDMI standard and to develop and perform interoperability tests; in addition, after an initial period during which we received all of the royalties associated with HDMI adopters’ agreements, in 2007, the HDMI founders
reallocated the royalties to reflect each founder’s relative contribution of intellectual property to the HDMI specification. Our subsidiary no longer recognizes 100% of the HDMI adopter royalty revenues.





We intend to promote and continue to be involved and actively participate in other standard setting initiatives. For example, we also recently joined the Serial Port Memory Technology Working Group (SPMTWG) to develop and promote a new memory technology.  Accordingly, we may license additional
elements of our intellectual property to others for use in implementing, developing, promoting or adopting standards in our target markets, in certain circumstances at little or no cost. This may make it easier for others to compete with us in such markets. In addition, even if we receive license fees and/or royalties in connection with the licensing of our intellectual property, there can be no assurance that such license fees and/or royalties will adequately compensate us for having to license our intellectual
property.





Our success depends in part on our relationships with Sunplus and other strategicpartners.





We have entered into and expect to continue to enter into, strategic partnerships with third parties. In February 2007, we entered into a licensing agreement with Sunplus Technology, which grants us the rights to use and further develop advanced intellectual property (IP) technology. We believe
that the IP licensed under this agreement is enhancing our ability to develop DTV technology and other consumer product offerings. but the success of the arrangement depends upon our successful integration of the operations of the former sci-worx, which will be critical to our ability to develop products based on the licensed IP. The success of this strategic relationship also depends upon the continued market acceptance of our HDTV and consumer products. There is no assurance that we will be successful in integrating
the operations of sci-worx or in developing successful products based on the Sunplus technology. While our relationship with Sunplus and other strategic partners are designed to drive revenue growth and adoption of our technologies and industry standards promulgated by us and also reduce our research and development expenses, there is no guarantee that these strategic partnerships will be successful. Negotiating and performing under these strategic partnerships involves significant time and expense; we may
not realize anticipated increases in revenue, standards adoption or cost savings; and these strategic partnerships may make it easier for the third parties to compete with us; any of which may have a negative effect our business and results of operations.





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Our success depends on managing our relationship with Intel.





Intel has a dominant role in many of the markets in which we compete, such as PCs and storage and is a growing presence in the CE market. We have a multi-faceted relationship with Intel that is complex and requires significant management attention, including:





•
Intel and Silicon Image have been parties to business cooperation agreements;





•
Intel and Silicon Image are parties to a patent cross-license;





•
Intel and Silicon Image worked together to develop HDCP;





•
an Intel subsidiary has the exclusive right to license HDCP, of which we are a licensee;





•
Intel and Silicon Image were two of the promoters of the DDWG;





•
Intel is a promoter of the SATA working group, of which we are a contributor;





•
Intel is a supplier to us and a customer for our products;





•
we believe that Intel has the market presence to drive adoption of SATA by making it widely available in its chipsets and motherboards, which could affect demand for our products;





•
we believe that Intel has the market presence to affect adoption of HDMI by either endorsing complementary technology or promulgating a competing standard, which could affect demand for our products;





•
Intel may potentially integrate the functionality of our products, including SATA, DVI, or HDMI into its own chips and chipsets, thereby displacing demand for some of our products;





•
Intel may design new technologies that would require us to re-design our products for compatibility, thus increasing our R&D expense and reducing our revenue;





•
Intel’s technology, including its 845G chipset, may lower barriers to entry for other parties who may enter the market and compete with us; and





•
Intel may enter into or continue relationships with our competitors that can put us at a relative disadvantage.





Our cooperation and competition with Intel can lead to positive benefits, if managed effectively. If our relationship with Intel is not managed effectively, it could seriously harm our business, negatively affect our revenue and increase our operating expenses.





We have granted Intel rights with respect to our intellectual property, which couldallow Intel to develop products that compete with ours or otherwise reduce the valueof
our intellectual property.





We entered into a patent cross-license agreement with Intel in which each of us granted the other a license to use the patents filed by the grantor prior to a specified date, except for identified types of products. We believe that the scope of our license to Intel excludes our current products
and anticipated future products. Intel could, however, exercise its rights under this agreement to use our patents to develop and market other products that compete with ours, without payment to us. Additionally, Intel’s rights to our patents could reduce the value of our patents to any third-party who otherwise might be interested in acquiring rights to use our patents in such products. Finally, Intel could endorse competing products, including a competing digital interface, or develop its own proprietary
digital interface. Any of these actions could substantially harm our business and results of operations.





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We may become engaged in additional intellectual property litigation that could betime-consuming, may be expensive to prosecute or defend and could adversely affectour
ability to sell our product.





In recent years, there has been significant litigation in the United States and in other jurisdictions involving patents and other intellectual property rights. This litigation is particularly prevalent in the semiconductor industry, in which a number of companies aggressively use their patent
portfolios to bring infringement claims. In addition, in recent years, there has been an increase in the filing of so-called “nuisance suits,” alleging infringement of intellectual property rights. These claims may be asserted as counterclaims in response to claims made by a company alleging infringement of intellectual property rights. These suits pressure defendants into entering settlement arrangements to quickly dispose of such suits, regardless of merit. In addition, as is common in the semiconductor
industry, from time to time we have been notified that we may be infringing certain patents or other intellectual property rights of others. Responding to such claims, regardless of their merit, can be time consuming, result in costly litigation, divert management’s attention and resources and cause us to incur significant expenses. As each claim is evaluated, we may consider the desirability of entering into settlement or licensing agreements. No assurance can be given that settlements will occur or that
licenses can be obtained on acceptable terms or that litigation will not occur. In the event there is a temporary or permanent injunction entered prohibiting us from marketing or selling certain of our products, or a successful claim of infringement against us requiring us to pay damages or royalties to a third-party and we fail to develop or license a substitute technology, our business, results of operations or financial condition could be materially adversely affected.





Any potential intellectual property litigation against us or in which we become involved may be expensive and time-consuming and may divert our resources and the attention of our executives.  It could also force us to do one or more of the following:





•
stop selling products or using technology that contains the allegedly infringing intellectual property;





•
attempt to obtain a license to the relevant intellectual property, which license may not be available on reasonable terms or at all; and





•
attempt to redesign products that contain the allegedly infringing intellectual property.





If we take any of these actions, we may be unable to manufacture and sell our products. We may be exposed to liability for monetary damages, the extent of which would be very difficult to accurately predict. In addition, we may be exposed to customer claims, for potential indemnity obligations
and to customer dissatisfaction and a discontinuance of purchases of our products while the litigation is pending. Any of these consequences could substantially harm our business and results of operations.





We have entered into and may again be required to enter into, patent or otherintellectual property cross-licenses.





Many companies have significant patent portfolios or key specific patents, or other intellectual property in areas in which we compete. Many of these companies appear to have policies of imposing cross-licenses on other participants in their markets, which may include areas in which we compete.
As a result, we have been required, either under pressure of litigation or by significant vendors or customers, to enter into cross licenses or non-assertion agreements relating to patents or other intellectual property. This permits the cross-licensee, or beneficiary of a non-assertion agreement, to use certain or all of our patents and/or certain other intellectual property for free to compete with us.





We indemnify certain of our licensing customers against infringement.





We indemnify certain of our licensing agreements customers for any expenses or liabilities resulting from third-party claims of infringements of patent, trademark, trade secret, or copyright rights by the technology we license. Certain of these indemnification provisions are perpetual from execution
of the agreement and, in some instances; the maximum amount of potential future indemnification is not limited. To date, we have not paid any such claims or been required to defend any lawsuits with respect to any claim. In the event that we were required to defend any lawsuits with respect to our indemnification obligations, or to pay any claim, our results of operations could be materially adversely affected.





We must attract and retain qualified personnel to be successful and competition forqualified personnel is increasing in our market.





Our success depends to a significant extent upon the continued contributions of our key management, technical and sales personnel, many of who would be difficult to replace. The loss of one or more of these employees could harm our business. Although we have entered into a limited number of employment
contracts with certain executive officers, we generally do not have employment contracts with our key employees. Our success also depends on our ability to identify, attract and retain qualified technical, sales, marketing, finance and managerial personnel. Competition for qualified personnel is particularly intense in our industry and in our location. This makes it difficult to retain our key personnel and to recruit highly qualified personnel. We have experienced and may continue to experience, difficulty
in hiring and retaining candidates with appropriate qualifications. To be successful, we need to hire candidates with appropriate qualifications and retain our key executives and employees. Replacing departing executive officers and key employees can involve organizational disruption and uncertain timing.





The volatility of our stock price has had an impact on our ability to offer competitive equity-based incentives to current and prospective employees, thereby affecting our ability to attract and retain highly qualified technical personnel. If these adverse conditions
continue, we may not be able to hire or retain highly qualified employees in the future and this could harm our business. In addition, regulations adopted by The NASDAQ Stock Market requiring shareholder approval for all stock option plans, as well as regulations adopted by the New York Stock Exchange prohibiting NYSE member organizations from giving a proxy to vote on equity compensation plans unless the beneficial owner of the shares has given voting instructions, could make it more difficult for us to grant
options to employees in the future. In addition, SFAS No. 123R, Share Based Payment, requires us to record compensation expense for options granted to employees. To the extent that new regulations make it more difficult or expensive to grant options to employees, we may incur increased cash compensation costs or find it difficult to attract, retain and motivate employees, either of which could harm our business.







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If our internalcontrol over financial reporting or disclosure controls and procedures are noteffective, there may be
errors in our financial statements that could requirea restatement or our filings may not be timely and investors may loseconfidence in our reported financial information, which could lead to adecline in our stock price.  While we have not identified any material weaknesses in
the past three years, we cannot assure you that amaterial weakness will not be identified in the future.





Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each year and to include a management report assessing the effectiveness of our internal control over financial reporting in each Annual
Report on Form 10-K. Section 404 also requires our independent registered public accounting firm to report on, our internal control over financial reporting.





Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance
that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because changes in conditions or deterioration in the degree of compliance with policies or procedures
may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.





As a result, we cannot assure you that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties
we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding disclosure controls and the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley
Act of 2002 and the rules promulgated thereunder. The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause us to fail to timely meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.





We have experienced transitions in our management team, our board of directors in the past and may continue to doso in the future, which could result in disruptions in our operations and require
additional costs.





We have experienced a number of transitions with respect to our board of directors and executive officers in recent quarters, including the following:





•
In January 2006, Dale Zimmerman was appointed as our vice president of worldwide marketing.





•
In February 2006, John Hodge was elected to our board of directors.




•
In September 2006,  Patrick Reutens resigned from the position of chief legal officer.




•
In January 2007, Edward Lopez was appointed as our chief legal officer.





•
In February 2007, David Hodges advised our board of directors that he decided to retire and he did not stand for reelection to our board of directors when his term expired at our 2007 Annual Meeting of Stockholders.





•
In April 2007, Robert R. Freeman, announced his intention to retire from his position as chief financial officer.





•
In April 2007, Rob Valiton resigned from his position as vice president of worldwide sales and Sal Cobar was appointed as his successor.





•
In July 2007, Paul Dal Santo was appointed as chief operating officer.





•
In October 2007, Robert Freeman resigned from his position as chief financial officer.





•
In October 2007, Harold L. Covert was appointed as chief financial officer.





•
In October 2008, John Shin resigned from his position as vice president, strategic technology initiatives.





•
In December 2008, Dale Zimmerman resigned from his position as vice president of worldwide marketing.




•
In March 2009, Paul Dal Santo resigned from his position as chief operating officer.




•
In June 2009, Timothy Vehling joined the Company as vice president of worldwide  marketing.





Any future transitions may result in disruptions in our operations and require additional costs.







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   We have been and may continue to become the target of securities class action suitsand derivative suits which could result in substantial costs and divert managementattention and resources.





Securities class action suits and derivative suits are often brought against companies, particularly technology companies, following periods of volatility in the market price of their securities. Defending against these suits, even if meritless, can result in substantial costs to us and could divert the attention of
our management.





On December 7, 2001, we and certain of our officers and directors were named as defendants along with the underwriters of the Company’s initial public offering, in a securities class action lawsuit. The lawsuit alleges that the defendants participated
in a scheme to inflate the price of our stock in our initial public offering and in the aftermarket through a series of misstatements and omissions associated with the offering.   On January 31, 2005, we and certain of our officers were named as defendants in a securities class action captioned “Curry v. Silicon Image, Inc., Steve Tirado and Robert Gargus.” Plaintiffs filed the action on behalf of a putative class of stockholders who purchased Silicon Image stock between October 19,
2004 and January 24, 2005. The lawsuit alleged that Silicon Image and certain of its officers and directors violated securities laws and made alleged misstatements of material facts. For more information, please see Part I, Item 3 of this report.





Our operations and the operations of our significant customers, third-party waferfoundries and third-party assembly and test subcontractors are located in areassusceptible
to natural disasters.





Our operations are headquartered in the San Francisco Bay Area, which is susceptible to earthquakes. TSMC, the outside foundry that produces the majority of our semiconductor products, is located in Taiwan.  Siliconware
Precision Industries Co. Ltd., or SPIL, Advanced Semiconductor Engineering, or ASE, and Amkor Taiwan are subcontractors located in Taiwan that assemble and test our semiconductor products. For the three and six months period ended June 30, 2009 customers and distributors located in Japan generated 26.0% and 25.5% of our revenue, respectively, and customers and distributors located in Taiwan generated 25.4% and 25.9% of our revenue, respectively. For the three and six months ended June 30, 2008, customers and
distributors located in Japan accounted for 29.8% and 30.5% of our revenue, respectively and customers and distributors located in Taiwan generated 19.5% and 20.0% of our revenue, respectively.  Both Taiwan and Japan are susceptible to earthquakes, typhoons and other natural disasters.





Our business would be negatively affected if any of the following occurred:





•
an earthquake or other disaster in the San Francisco Bay Area or the Los Angeles area damaged our facilities or disrupted the supply of water or electricity to our headquarters or our Irvine facility;





•
an earthquake, typhoon or other disaster in Taiwan or Japan resulted in shortages of water, electricity or transportation, limiting the production capacity of our outside foundries or the ability of ASE to provide assembly and test services;





•
an earthquake, typhoon or other disaster in Taiwan or Japan damaged the facilities or equipment of our customers and distributors, resulting in reduced purchases of our products; or





•
an earthquake, typhoon or other disaster in Taiwan or Japan disrupted the operations of suppliers to our Taiwanese or Japanese customers, outside foundries or ASE, which in turn disrupted the operations of these customers, foundries or ASE and resulted in reduced purchases of our products or shortages in our product supply.




Terrorist attacks or war could lead to economic instability and adversely affect ouroperations, results of operations and stock price.





The United States has taken and continues to take, military action against terrorism and currently has troops in Iraq and in Afghanistan. In addition, the current tensions regarding nuclear arms in North Korea and Iran could escalate into armed hostilities or war. Acts of terrorism or armed hostilities
may disrupt or result in instability in the general economy and financial markets and in consumer demand for the OEM’s products that incorporate our products. Disruptions and instability in the general economy could reduce demand for our products or disrupt the operations of our customers, suppliers, distributors and contractors, many of whom are located in Asia, which would in turn adversely affect our operations and results of operations. Disruptions and instability in financial markets could adversely
affect our stock price. Armed hostilities or war in South Korea could disrupt the operations of the research and development contractors we utilize there, which would adversely affect our research and development capabilities and ability to timely develop and introduce new products and product improvements.





Changes in environmental rules and regulations could increase our costs and reduceour revenue.





Several jurisdictions have implemented rules that would require that certain products, including semiconductors, be made “green,” which means that the products need to be lead free and be free of certain banned substances. All of our products are available to customers in a green format.
While we believe that we are generally in compliance with existing regulations, such environmental regulations are subject to change and the jurisdictions may impose additional regulations which could require us to incur costs to develop replacement products. These changes will require us to incur cost or may take time or may not always be economically or technically feasible, or may require disposal of non-compliant inventory. In addition, any requirement to dispose or abate previously sold products would require
us to incur the costs of setting up and implementing such a program.





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Provisions of our charter documents and Delaware law could prevent or delay a changein control and may reduce the market price of our common stock.





Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These provisions include:





•
authorizing the issuance of preferred stock without stockholder approval;





•
providing for a classified board of directors with staggered, three-year terms;





•
requiring advance notice of stockholder nominations for the board of directors;





•
providing the board of directors the opportunity to expand the number of directors without notice to stockholders;





•
prohibiting cumulative voting in the election of directors;





•
requiring super-majority voting to amend some provisions of our certificate of incorporation and bylaws;





•
limiting the persons who may call special meetings of stockholders; and





•
prohibiting stockholder actions by written consent.





Provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with us.





The price of our stock fluctuates substantially and may continue to do so.





The stock market has experienced extreme price and volume fluctuations that have affected the market valuation of many technology companies, including Silicon Image. These factors, as well as general economic and political conditions, may materially and adversely affect the market price of our
common stock in the future. The market price of our common stock has fluctuated significantly and may continue to fluctuate in response to a number of factors, including, but not limited to:





•
actual or anticipated changes in our operating results;





•
changes in expectations of our future financial performance;





•
changes in market valuations of comparable companies in our markets;





•
changes in market valuations or expectations of future financial performance of our vendors or customers;





•
changes in our key executives and technical personnel; and





•
announcements by us or our competitors of significant technical innovations, design wins, contracts, standards or acquisitions.





Due to these factors, the price of our stock may decline. In addition, the stock market experiences volatility that is often unrelated to the performance of particular companies. These market fluctuations may cause our stock price to decline regardless of our performance.





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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds (in thousands, except per share amounts)





None.





Item 3. Defaults Upon Senior Securities





None.





Item 4. Submission of Matters to a Vote of Security Holders





We held our 2009 Annual Meeting of Stockholders on May 20, 2009. The first matter voted upon at the meeting was the election of two Class I directors to serve until the 2012 Annual Meeting of Stockholders. At the meeting, Peter Hanelt and William George were elected as Class I directors, in an uncontested election,
by the following vote:




Name

Shares for


Shares Against


Shares Abstaining


Shares Witheld


Broker
Non VotesPeter Hanelt


58,813,781



-



-



9,530,687



-William George


58,992,917



-



-



9,351,551



-





Our board of directors consists of six members and is divided into three classes, with each class serving staggered three-year terms. The term of the Class I directors, currently Peter Hanelt and William George, will expire at the 2012 Annual Meeting of Stockholders, the term of the Class II
directors, currently Masood Jabbar and John Hodge, will expire at the 2012 Annual Meeting of Stockholders, and the term of the Class III directors, currently Steve Tirado and William Raduchel will expire at the 2011 Annual Meeting of Stockholders.




The second matter voted upon at the meeting was the approval of the Stock Option Exchange Program, which will give our employees the opportunity to exchange outstanding underwater stock options for a lesser number of restricted stock units, if and when determined by the Board within one year and
in accordance with the terms described in the Proxy Statement as filed with the SEC on April 14, 2009. The Stock Option Exchange Program was approved by the following vote:




Shares for


Shares Against


Shares Abstaining


Shares Witheld


Broker
Non VotesStock Option Exchange Program


39,452,902



9,822,737



107,454



-



18,961,375


The third matter voted upon at the meeting was the ratification of the appointment of Deloitte & Touche LLP as Silicon Image’s independent registered public accounting firm for the fiscal year ending December 31, 2009. At the meeting, the appointment of Deloitte & Touche LLP as independent accountants was ratified by the following vote:




Shares for


Shares Against


Shares Abstaining


Shares Witheld


Broker
Non VotesAppointment of Deloitte & Touche LLP


66,213,924



1,859,350



271,194



-



-


Item 5. Other Information





None.





45
  Table of Contents







Item 6. Exhibits





(a) Exhibits





3131.01
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 20023131.02
Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 20023232.01*
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 20023232.02*
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


____________





*
This exhibit is being furnished, rather than filed, and shall not be deemed incorporated by reference into any filing of the registrant, in accordance with Item 601 of Regulation S-K.




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Table of Contents







Signatures




Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.







Date: August 10, 2009
Silicon Image, Inc.
  
 /s/ Harold CovertHarold Covert
 Chief Financial Officer (Principal Financial Officer)


47
 Table of Contents





Exhibit Index


3131.01
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 20023131.02
Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 20023232.01*
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 20023232.02*
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


____________








*
This exhibit is being furnished, rather than filed, and shall not be deemed incorporated by reference into any filing of the registrant, in accordance with Item 601 of Regulation S-K.






48