UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 
 FORM
10-Q
 
 R
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the quarterly period ended September 30, 2008OR£
              TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      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 incorporation or organization)
              (I.R.S.
      Employer Identification No.)
 
 1060
East Arques Avenue
 Sunnyvale,
California 94085
 (Address
of principal executive offices and zip code)
 
 (408)
616-4000
 (Registrant’s
telephone number, including area code)
 
 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 Yes  R No £
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large
      accelerated Filer R
              Accelerated
      Filer £
              Non-Accelerated
      Filer £
              Smaller
      Reporting Company £(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). Yes £ No R
 
 As of
September 30, 2008, there were 74,063,293 shares outstanding of the registrant’s
Common Stock, $0.001 par value per share.
 
 
 
 
 
 
 
 
  
  
 Silicon
Image, Inc.
 Quarterly
Report on Form 10-Q
 Three
and Nine months Ended
 September
30, 2008
 
 Table of Contents
 
 Part I Financial Information
      (Unaudited)Item 1 Financial
      Statements
              3Condensed Consolidated Balance
      Sheets as of September 30, 2008 and December 31,
      2007
              3Condensed Consolidated Statements
      of Operations for the three and nine months ended September 30, 2008
      and 2007
              4Condensed Consolidated Statements
      of Cash Flows for the nine months ended September 30, 2008 and
      2007
              5Notes to Condensed
      Consolidated Financial Statements
              6Item 2 Management’s Discussion
      and Analysis of Financial Condition and Results of
      Operations
              15Item 3 Quantitative and
      Qualitative Disclosures About Market Risk
              23Item 4 Controls and
      Procedures
              23Part II Other
      Information
              24Item 1 Legal
      Proceedings
              24Item 1A Risk
      Factors
              24Item 2 Unregistered Sales
      of Equity Securities and Use of Proceeds
              39Item 3 Defaults Upon Senior
      Securities
              39Item 4 Submission of
      Matters to a Vote of Security Holders
              39Item 5 Other
      Information
              39Item 6
      Exhibits
              40Signatures
              41
 EXHIBIT 31.01
 EXHIBIT 31.02
 EXHIBIT 32.01
 EXHIBIT 32.02
 
  -2-
 Table of Contents
  
 Part I. Financial Information
 
 Item 1. Financial Statements (Unaudited)
 
 Silicon
Image, Inc.
 Condensed Consolidated Balance Sheets
 (in
thousands)
 (unaudited)
 
 
 September
      30, 2008
              
              
              December
      31, 2007AssetsCurrent
      Assets:Cash
      and cash equivalents
              
              $
              72,368
              
              
              $
              137,822Short-term
      investments
              
              
              128,171
              
              
              
              111,889Accounts
      receivable, net of allowances for doubtful accounts
                $1,930
      at September 30, 2008 and $1,565 at December 31, 2007
              
              
              23,603
              
              
              
              21,254Inventories
              
              
              16,503
              
              
              
              20,198Prepaid
      expenses and other current assets
              
              
              9,629
              
              
              
              13,732Deferred
      income taxes, current
              
              
              4,881
              
              
              
              3,984Total
      current assets
              
              
              255,155
              
              
              
              308,879Property
      and equipment, net
              
              
              21,606
              
              
              
              24,191Goodwill
              
              
              19,210
              
              
              
              19,210Intangible
      assets, net
              
              
              34,508
              
              
              
              39,269Deferred
      income taxes, non-current
              
              
              24,387
              
              
              
              19,978Other
      assets
              
              
              1,357
              
              
              
              1,421Total
      assets
              
              $
              356,223
              
              
              $
              412,948Liabilities
      and Stockholders’ EquityCurrent
      Liabilities:Accounts
      payable
              
              $
              32,096
              
              
              $
              17,892Accrued
      and other current liabilities
              
              
              18,033
              
              
              
              36,996Deferred
      license revenue
              
              
              3,045
              
              
              
              3,860Deferred
      margin on sales to distributors
              
              
              23,892
              
              
              
              26,443Total
      current liabilities
              
              
              77,066
              
              
              
              85,191Other
      long-term liabilities
              
              
              10,738
              
              
              
              13,910Total
      liabilities
              
              
              87,804
              
              
              
              99,101Commitments
      and contingencies (See Note 9)Stockholders’
      Equity:Common
      stock
              
              
              92
              
              
              
              90Treasury
      stock
              
              
              (106,276
              )
              
              
              (38,096
              )Additional
      paid-in capital
              
              
              437,456
              
              
              
              418,796Accumulated
      deficit
              
              
              (62,043
              )
              
              
              (67,093
              )Accumulated
      other comprehensive income (loss)
              
              
              (810
              )
              
              
              150Total
      stockholders’ equity
              
              
              268,419
              
              
              
              313,847Total
      liabilities and stockholders’ equity
              
              $
              356,223
              
              
              $
              412,948
 
 
 See
accompanying Notes to Condensed Consolidated Financial Statements.
 `
 
  -3-
 Table of Contents
  
 Silicon
Image, Inc.
 Condensed Consolidated Statements of Operations
 (in
thousands, except per share amounts)
 (unaudited)
  Three
      months ended September 30,
                  
                  
                  Nine
      months ended September 30,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Revenue:Product
                  
                  $
                  64,974
                  
                  
                  $
                  74,827
                  
                  
                  $
                  183,997
                  
                  
                  $
                  197,698Licensing
                  
                  
                  12,802
                  
                  
                  
                  11,455
                  
                  
                  
                  30,975
                  
                  
                  
                  37,474Total
      revenue
                  
                  
                  77,776
                  
                  
                  
                  86,282
                  
                  
                  
                  214,972
                  
                  
                  
                  235,172Cost
      of revenue and operating expenses:Cost
      of revenue (1)
                  
                  
                  31,741
                  
                  
                  
                  37,500
                  
                  
                  
                  88,985
                  
                  
                  
                  105,196Research
      and development (2)
                  
                  
                  20,714
                  
                  
                  
                  20,489
                  
                  
                  
                  64,554
                  
                  
                  
                  56,709Selling,
      general and administrative (3)
                  
                  
                  17,468
                  
                  
                  
                  16,827
                  
                  
                  
                  54,853
                  
                  
                  
                  51,122Amortization
      of intangible assets
                  
                  
                  1,587
                  
                  
                  
                  540
                  
                  
                  
                  4,761
                  
                  
                  
                  1,692Restructuring
      expenses (Note 15)
                  
                  
                  1,876
                  
                  
                  
                  -
                  
                  
                  
                  1,876
                  
                  
                  
                  -Total
      cost of revenue and operating expenses
                  
                  
                  73,386
                  
                  
                  
                  75,356
                  
                  
                  
                  215,029
                  
                  
                  
                  214,719Income
      (loss) from operations
                  
                  
                  4,390
                  
                  
                  
                  10,926
                  
                  
                  
                  (57
                  )
                  
                  
                  20,453Interest
      income and other, net
                  
                  
                  1,798
                  
                  
                  
                  2,302
                  
                  
                  
                  5,094
                  
                  
                  
                  8,618Income
      before income taxes
                  
                  
                  6,188
                  
                  
                  
                  13,228
                  
                  
                  
                  5,037
                  
                  
                  
                  29,071Provision
      (benefit) for income taxes
                  
                  
                  114
                  
                  
                  
                  9,118
                  
                  
                  
                  (13
                  )
                  
                  
                  17,673Net
      income
                  
                  $
                  6,074
                  
                  
                  $
                  4,110
                  
                  
                  $
                  5,050
                  
                  
                  $
                  11,398Net
      income per share – basic and diluted
                  
                  $
                  0.08
                  
                  
                  $
                  0.05
                  
                  
                  $
                  0.07
                  
                  
                  $
                  0.13Weighted
      average shares – basic
                  
                  
                  73,861
                  
                  
                  
                  84,489
                  
                  
                  
                  76,088
                  
                  
                  
                  86,008Weighted
      average shares – diluted
                  
                  
                  75,334
                  
                  
                  
                  85,937
                  
                  
                  
                  77,185
                  
                  
                  
                  88,063_________________(1)
      Includes stock-based compensation expense
                  
                  $
                  351
                  
                  
                  $
                  421
                  
                  
                  $
                  1,132
                  
                  
                  $
                  1,210(2)
      Includes stock-based compensation expense
                  
                  
                  1,753
                  
                  
                  
                  2,181
                  
                  
                  
                  5,200
                  
                  
                  
                  6,545(3)
      Includes stock-based compensation expense
                  
                  
                  2,004
                  
                  
                  
                  2,731
                  
                  
                  
                  8,057
                  
                  
                  
                  6,796
 See
accompanying Notes to Condensed Consolidated Financial Statements.
 
  -4-
 Table of Contents
  
 Silicon Image,
Inc.
 Condensed Consolidated Statements of Cash Flows
 (in
thousands)
 (unaudited)
 
 Nine
      months ended September 30,2008
                
                
                2007Cash
      flows from operating activities:Net
      income
                
                $
                5,050
                
                
                $
                11,398Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
                
                
                7,894
                
                
                
                7,456Amortization
      of intangible assets
                
                
                4,761
                
                
                
                1,692Provision
      for doubtful accounts
                
                
                621
                
                
                
                450Stock-based
      compensation expense
                
                
                14,389
                
                
                
                14,549Income
      tax benefit (deficiency) from employee based compensation
      plans
                
                
                (475
                )
                
                
                789Excess
      tax benefits from employee stock transactions
                
                
                (527
                )
                
                
                (2,880
                )(Accretion)
      of investment discount/Amortization of investment premium
                
                
                768
                
                
                
                (260
                )Realized
      gain on investments
                
                
                (106
                )
                
                
                (27
                )Non-cash
      restructuring expenses
                
                
                459Loss
      on disposal of property and equipment
                
                
                562
                
                
                
                995Deferred
      income taxes
                
                
                (5,306
                )
                
                
                (206
                )Changes
      in assets and liabilities:Accounts
      receivable
                
                
                (2,835
                )
                
                
                (3,029
                )Inventories
                
                
                3,695
                
                
                
                8,736Prepaid
      expenses and other assets
                
                
                4,167
                
                
                
                1,167Accounts
      payable
                
                
                4,590
                
                
                
                6,421Accrued
      liabilities and other liabilities
                
                
                (7,090
                )
                
                
                (22,263
                )Deferred
      revenue
                
                
                (815
                )
                
                
                (839
                )Deferred
      margin on sales to distributors
                
                
                (2,551
                )
                
                
                12,852Cash
      provided by operating activities
                
                
                27,251
                
                
                
                37,001Cash
      flows from investing activities:Proceeds
      from sales and maturities of short-term investments
                
                
                171,231
                
                
                
                100,434Purchases
      of short-term investments
                
                
                (188,443
                )
                
                
                (26,287
                )Business
      acquisition, net of cash acquired
                
                
                -
                
                
                
                (13,751
                )Purchases
      of property and equipment
                
                
                (6,028
                )
                
                
                (10,105
                )Purchase
      of intellectual property
                
                
                -
                
                
                
                (15,040
                )Cash
      provided by (used in) investing activities
                
                
                (23,240
                )
                
                
                35,251Cash
      flows from financing activities:Proceeds
      from issuances of common stock, net
                
                
                4,748
                
                
                
                12,305Excess
      tax benefits from employee stock transactions
                
                
                527
                
                
                
                2,880Payment
      for vendor financed software and intangibles purchased
                
                
                (6,153
                )
                
                
                (528
                )Payments
      to acquire treasury stock
                
                
                (68,180
                )
                
                
                (38,096
                )Cash
      used in financing activities
                
                
                (69,058
                )
                
                
                (23,439
                )Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (407
                )
                
                
                (76
                )Net
      increase (decrease) in cash and cash equivalents
                
                
                (65,454
                )
                
                
                48,737Cash
      and cash equivalents — beginning of period
                
                
                137,822
                
                
                
                81,921Cash
      and cash equivalents — end of period
                
                $
                72,368
                
                
                $
                130,658Supplemental
      cash flow information:Cash
      payment for interest
                
                $
                38
                
                
                $
                33Cash
      payment for income taxes
                
                
                1,924
                
                
                
                29,018Unrealized
      net gain (loss) on investment securities
                
                
                (399
                )
                
                
                163Property
      and equipment purchased but not paid for
                
                
                302
                
                
                
                1,604
 
 
 See
accompanying Notes to Condensed Consolidated Financial Statements.
 
  -5-
 Table of Contents
  
 Silicon
Image, Inc.
 Notes to Condensed Consolidated Financial Statements
 September
30, 2008
 (unaudited)
 
 1.
Basis of Presentation
 
 In the
opinion of management, the accompanying unaudited condensed consolidated
financial statements of Silicon Image, Inc. and its subsidiaries (the “Company”,
“Silicon Image”, “we” or “our”) included herein have been prepared on a basis
consistent with our December 31, 2007 audited financial statements and include
all adjustments, consisting of normal recurring adjustments, necessary to fairly
state the condensed consolidated balance sheets of Silicon Image as of September
30, 2008 and December 31, 2007, the related condensed consolidated
statements of operations for the three and nine months ended September 30, 2008
and 2007, and the related condensed consolidated statements of cash flows for
the nine months ended September 30, 2008 and 2007. 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, 2007. The Condensed Consolidated Statements of Operations for
the three and nine months ended September 30, 2008 is not necessarily indicative
of future operating results to be expected for the fiscal year ending December
31, 2008.
 
 Certain
prior period amounts have been reclassified to conform to the current period
presentation, including the reclassification of revenue generated by our Simplay
subsidiary from the “Licensing revenue” caption to “Product revenue” and revenue
between our lines of business, in order to more closely align our revenue
presentation with our key operating metrics. We have also renamed the caption
“Development, licensing and royalty” revenue as “Licensing
revenue”.
 
 2.
Recent Accounting Pronouncements
  In April
2008, the FASB issued Staff Position No. FAS 142-3, Determination of the Useful
Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors
that should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). The intent of
FSP FAS 142-3 is to improve the consistency between the useful life of a
recognized intangible asset under SFAS 142 and the period of expected cash flows
used to measure the fair value of the asset under SFAS 141(R) and other
applicable accounting literature. FSP FAS 142-3 is effective for fiscal years
beginning after December 15, 2008. The Company is currently evaluating the
potential impact of FSP FAS 142-3 on its consolidated financial
statements.
 
 In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133”
(“SFAS 161”), 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 is currently
assessing the impact that the adoption of SFAS 161 will have on its
consolidated financial statements.
 
 In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS 141(R)”) and SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS 160”).
SFAS 141(R)  significantly changes 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; requires assets acquired and
liabilities assumed from contractual and non-contractual contingencies to be
recognized at their acquisition-date fair values with subsequent changes
recognized in earnings; 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 Company does not
believe that the implementation of these standards will have a material impact
on its condensed consolidated financial statements.
 
 In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities, Including an Amendment to FASB No.
115” (“SFAS 159”). Under SFAS 159, entities may elect to measure specified
financial instruments as well as warranty and insurance contracts at fair value
on a contract-by-contract basis, with changes in fair value recognized in
earnings each reporting period. The election, called the fair value option, will
enable entities to achieve an offset accounting effect for changes in fair value
of certain related assets and liabilities without having to apply complex hedge
accounting provisions. SFAS 159 is effective as of the beginning of a company’s
first fiscal year that begins after November 15, 2007. The Company did not adopt
the fair value option for any of its financial instruments.
  -6-
 Table of Contents
  3.
Significant Accounting Policies
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles requires us 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, 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.
 
 For a
discussion of the significant accounting policies, see Significant Accounting
Policies in our Annual Report on Form 10-K for the year ended December 31,
2007.
 
 Financial
Instruments
 
 The
Company accounts for its investments in debt securities under Statement of
Financial Accounting Standards, or 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 re evaluates 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
condensed consolidated statements of operations. 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.
 
 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 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 Statement of Financial
Accounting Standards 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 and was adopted by the company as of January 1, 2008. The adoption
of SFAS 157 on our assets and liabilities did not have a significant impact on
our financial statements.
 
 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.  Further information about
the application of SFAS 157 may be found in Note 13
below.
  -7-
 Table of Contents
  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 Activities and 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.
 
 Further information about the Company’s derivative instruments may be found in
Note 14 below.
 
 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, grants of restricted stock units (RSUs) and
an automatic grant program for non-employee board members pursuant to which
non-employee board members will receive option grants at designated intervals
over their period of board service. Stock option grants to employees and
officers 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, the Company has 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 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 employee stock options, employee stock purchase plan
and employee RSU grants.
 
 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 September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Employee
      stock option plans:Expected
      life in years
                
                
                4.8
                
                
                
                4.9
                
                
                
                4.8
                
                
                
                4.9Expected
      volatility
                
                
                62.0
                %
                
                
                68.0
                %
                
                
                64.5
                %
                
                
                73.4
                %Risk-free
      interest rate
                
                
                3.2
                %
                
                
                4.4
                %
                
                
                2.8
                %
                
                
                4.6
                %Expected
      dividends
                
                none
                
                
                none
                
                
                none
                
                
                noneWeighted
      average fair value
                
                $
                3.19
                
                
                $
                3.18
                
                
                $
                2.82
                
                
                $
                5.73Employee
      Stock Purchase Plan:Expected
      life in years
                
                
                0.5
                
                
                
                0.5
                
                
                
                0.5
                
                
                
                0.5Expected
      volatility
                
                
                45.7
                %
                
                
                51.4
                %
                
                
                65.8
                %
                
                
                51.3
                %Risk-free
      interest rate
                
                
                2.1
                %
                
                
                5.1
                %
                
                
                3.0
                %
                
                
                5.1
                %Expected
      dividends
                
                none
                
                
                none
                
                
                none
                
                
                noneWeighted
      average fair value
                
                $
                2.01
                
                
                $
                2.08
                
                
                $
                1.77
                
                
                $
                2.62
 
 For the three months ended September 30, 2008, 358,311 shares were purchased
under the ESPP program.
  -8-
 Table of Contents
  
 Stock-based
Compensation Expense
 
 The
following table shows total stock-based compensation expense included in the
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2008 and 2007 (in thousands):
 Three
      months ended September 30,
                  
                  
                  Nine
      months ended September 30,2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Cost
      of sales
                  
                  $
                  351
                  
                  
                  
                  421
                  
                  
                  $
                  1,132
                  
                  
                  
                  1,210Research
      and development
                  
                  
                  1,753
                  
                  
                  
                  2,181
                  
                  
                  
                  5,200
                  
                  
                  
                  6,545Selling,
      general and administrative
                  
                  
                  2,004
                  
                  
                  
                  2,731
                  
                  
                  
                  8,057
                  
                  
                  
                  6,796$
                  4,108
                  
                  
                  $
                  5,333
                  
                  
                  $
                  14,389
                  
                  
                  $
                  14,551
  Stock
Option Activity
 
 The
following is a summary of option activity for our Stock Option Plans excluding
RSUs (in thousands, except weighted average exercise price):
 
 Number
      of Options
              
              
              Weighted
      Average Exercise Price
              
              
              Weighted
      Average Remaining Contractual Term in Years
              
              
              Aggregate
      Intrinsic ValueOutstanding
      at January 1, 2008
              
              
              14,030
              
              
              $
              8.92
              
              
              
              6.75
              
              
              $
              3,576Granted
              
              
              1,366
              
              
              
              5.12Exercised
              
              
              (480
              )
              
              
              3.55Cancellations
              
              
              (805
              )
              
              
              10.08Outstanding
      at September 30, 2008
              
              
              14,111
              
              
              $
              8.66
              
              
              
              6.42
              
              
              $
              5,166Vested
      and expected to vest at September 30, 2008
              
              
              13,184
              
              
              $
              8.74
              
              
              
              6.28
              
              
              $
              4,950Exercisable
      at September 30, 2008
              
              
              9,371
              
              
              $
              8.95
              
              
              
              5.54
              
              
              $
              4,293
 
 At
September 30, 2008, the total compensation cost related to options granted to
employees under our share-based compensation plans but not yet recognized was
approximately $25.4 million, net of estimated forfeitures. The unamortized
compensation expense will be amortized on a straight-line basis, and the
weighted average period of this expense is approximately 2.5 years.
 
 Restricted
Stock Units
 
 RSUs
granted to non-executive employees vest over a period of four years subject to
the employee’s continuing service to the Company over that period. Vesting of
RSUs to executives is dependent on continuing service over a period of one to
two years as well as achieving certain performance conditions. 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 the RSUs outstanding as of September 30, 2008 is as follows: (in
thousands):
  Number
      of RSUs
              
              
              Aggregate
      Intrinsic ValueOutstanding
      at January 1, 2008
              
              
              -
              
              
              
              -Granted
              
              
              3,777
              
              
              
              -Cancellations
              
              
              (54
              )
              
              
              -Outstanding
      at September 30, 2008
              
              
              3,723
              
              
              $
              19,880Expected
      to vest at September 30, 2008
              
              
              1,338
              
              
              $
              7,145
  As of
September 30, 2008, the Company had $4.9 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 2.5 years.
 
  -9-
 Table of Contents
  5.
Stock Repurchase Program
 
 In
February 2007, our Board of Directors authorized a stock repurchase program
under which we were authorized to purchase up to $100.0 million of common stock,
on the open market, or in negotiated or block transactions, over a 36 month
period. As of December 31, 2007, we had repurchased a total of 5.0 million
shares at a total cost of $38.1 million. In February 2008, our Board of
Directors authorized an additional $100 million stock repurchase program, under
which shares may be repurchased over a period of three years, to commence
following completion of our accelerated stock repurchase plan (“ASR”) (see
below). Purchases under this program may be increased, decreased or discontinued
at any time without prior notice.
 
 In
February 2008, we entered into an accelerated stock repurchase agreement (ASR)
with Credit Suisse International (Credit Suisse), to purchase shares of common
stock for an aggregate purchase price of approximately $62 million paid in
February 2008.  We received 11.5 million shares under the agreement,
based on a predetermined price, which was subject to an adjustment based on the
volume weighted average price during the term of the ASR. In accordance with the
ASR agreement, on June 25, 2008, we chose to settle the arrangement in cash
(rather than shares) and made a final payment of approximately $6.2 million for
the purchase of shares.  The ASR terminated on June 30, 2008
(‘termination date’) with final settlement taking place in July 2008
(“settlement date”). On the settlement date, Credit Suisse returned
approximately $1 million based on the volume weighted average share price during
the period. In accordance with the relevant accounting guidance, we reflected
the 11.5 million shares repurchased and the $68.2 million paid to Credit Suisse
as treasury stock and recorded the $1 million received as part of other income
in the statement of operations in the second and third quarters of
2008.
 
 With the
above repurchase, the Company completed its original stock repurchase program of
February 2007 and additionally repurchased approximately $5 million of its stock
under the current $100 million stock repurchase program approved by the Board of
Directors in February 2008.
 
 6.
Comprehensive income
 
 The
components of comprehensive income, net of related taxes, were as follows (in
thousands):
 Three
      months ended September 30,
                    
                    
                    Nine
      months ended September 30,2008
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2007Net
      income
                    
                    $
                    6,074
                    
                    
                    $
                    4,110
                    
                    
                    $
                    5,050
                    
                    
                    $
                    11,398Change
      in unrealized value of investments
                    
                    
                    (371
                    )
                    
                    
                    28
                    
                    
                    
                    (400
                    )
                    
                    
                    163Effective
      portion of cash flow hedges
                    
                    
                    (284
                    )
                    
                    
                    -
                    
                    
                    
                    (284
                    )
                    
                    
                    -Foreign
      currency translation adjustments
                    
                    
                    (409
                    )
                    
                    
                    49
                    
                    
                    
                    (276
                    )
                    
                    
                    (76
                    )Total
      comprehensive income
                    
                    $
                    5,010
                    
                    
                    $
                    4,187
                    
                    
                    $
                    4,090
                    
                    
                    $
                    11,485
  7.
Net Income Per Share
 
 Basic net
income per share is computed using the weighted-average number of common shares
outstanding during the period and diluted net income per share is computed
using the weighted-average number of common shares and diluted equivalents
outstanding during the period, if any, determined using the treasury stock
method. The following table sets forth the computation of basic and diluted net
income per share (in thousands, except per share amounts):
 Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Net
      income
                
                $
                6,074
                
                
                $
                4,110
                
                
                $
                5,050
                
                
                $
                11,398Weighted
      average shares – basic
                
                
                73,861
                
                
                
                84,489
                
                
                
                76,088
                
                
                
                86,008Weighted
      average shares – diluted
                
                
                75,334
                
                
                
                85,937
                
                
                
                77,185
                
                
                
                88,063Net
      income per share – basic and diluted
                
                $
                0.08
                
                
                $
                0.05
                
                
                $
                0.07
                
                
                $
                0.13
  The
following is a reconciliation of the weighted-average common shares used to
calculate basic net income per share to the weighted-average common shares used
to calculate diluted net income per share (in thousands):
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Weighted-average
      common shares for basic net income per share
                
                
                73,861
                
                
                
                84,489
                
                
                
                76,088
                
                
                
                86,008Weighted-average
      dilutive stock options and restricted stock units outstanding under the
      treasury stock method
                
                
                1,473
                
                
                
                1,448
                
                
                
                1,097
                
                
                
                2,055Total
                
                
                75,334
                
                
                
                85,937
                
                
                
                77,185
                
                
                
                88,063
  For the
three and nine months ended September 30, 2008, approximately
11.0 million and 12.3 million, outstanding stock options
were excluded from the calculation of diluted net income per share,
respectively, because their inclusion would have been anti-dilutive. For
the three and nine months ended September 30, 2007, approximately
11.7 million and 11.2 million, outstanding stock options
were excluded from the calculation of diluted net income per share,
respectively.
  8.
Balance Sheet Components
 
 September
      30, 2008
              
              
              December
      31, 2007(in
      thousands)Inventories:Raw
      materials
              
              $
              3,173
              
              
              $
              3,132Work
      in process
              
              
              2,346
              
              
              
              2,719Finished
      goods
              
              
              10,984
              
              
              
              14,347Total
      inventories
              
              $
              16,503
              
              
              $
              20,198Property
      and equipmentComputers
      and software
              
              $
              24,929
              
              
              $
              29,950Equipment
              
              
              24,681
              
              
              
              28,188Furniture
      and fixtures
              
              
              3,357
              
              
              
              4,06152,967
              
              
              
              62,199Less:
      accumulated depreciation
              
              
              (31,361
              )
              
              
              (38,008
              )Total
      property and equipment, net
              
              $
              21,606
              
              
              $
              24,191Accrued
      and other liabilities:Accrued
      payroll and related expenses
              
              $
              5,078
              
              
              $
              5,586Payable
      related to intangibles acquired
              
              
              2,500
              
              
              
              17,500Restructuring
      Accrual
              
              
              882
              
              
              
              -Accrued
      legal fees
              
              
              1,009
              
              
              
              970Other
      accrued liabilities
              
              
              8,564
              
              
              
              12,940Total
      accrued and other current liabilities
              
              $
              18,033
              
              
              $
              36,996
 
 9.
Commitments and Contingencies
 
 Legal
Proceedings
 
 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. 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, we, 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. The court has not yet decided the class
certification motion. 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 on March 8, 2008.
 
 On July
31, 2007, we received a demand on behalf of alleged shareholder Vanessa Simmonds
that our board of directors prosecute a claim against the underwriters of our
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
our 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
  -10-
 Table of Contents
  from the
underwriters. On February 25, 2008, Ms. Simmonds filed an amended complaint. The
suit names us as a nominal defendant, contains no claims against us and seeks no
relief from us.  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 we are not required to answer or otherwise
respond to the amended complaint.  Accordingly, we did not join the
motion to dismiss filed by certain issuers.  The court has yet to rule
on either motion to dismiss.
 
 In
January 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 we and certain of our 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
our responsive pleading was filed April 14, 2008. Appellants filed a reply brief
on May 16, 2008. The court has not yet set a date for a hearing on the
appeal.
 
 On
January 31, 2007, we filed a lawsuit in the United States District Court for the
Northern District of California against Analogix Semiconductor, Inc.
(“Analogix”). The complaint charges Analogix with copyright infringement,
misappropriation of trade secrets and unfair competition under California law.
The lawsuit alleges that Analogix, without authorization and in violation of our
intellectual property rights, copied and used our proprietary register maps by
gaining unauthorized access to our proprietary and confidential information,
violated our copyright protection and unfairly competed with Silicon Image in
the marketplace.  In addition to seeking monetary damages in an amount
to be determined at trial, we seek an injunction barring Analogix from the
misappropriation of Silicon Image’s trade secrets.  On June 18, 2007,
Analogix filed a counterclaim alleging that we breached a confidentiality
agreement by purportedly disclosing Analogix’s confidential information within
Silicon Image. The court has set a trial date for January 26, 2009.
 
 On June
11, 2008, Analogix filed a lawsuit in the United States District Court for the
Northern District of California against us alleging violations of the Sherman
Act Sections 1 and 2, Cartwright Act, and Section 17200 of the California
Business and Professions Code.  The complaint seeks monetary damages
and injunctive relief.  The complaint alleges that Silicon Image, and
co-defendants HDMI Licensing, LLC and Simplay Labs, LLC, conspired with the
founders of the HDMI Consortium in violation of the antitrust
laws.  Specifically, the complaint claims that the defendants and the
founders of the HDMI Consortium have created certain structural advantages and
engaged in anti-competitive conduct for the purpose of monopolizing the markets
for HDMI Solutions and Discrete HDMI Solutions.  Silicon Image
believes the HDMI Consortium is pro-competitive, bringing critical technology to
the market and enabling hundreds of adopters to supply HDMI-enabled
products.  We intend to vigorously contest Analogix’s claims. 
The court has yet to set a trial date.
 
 On
January 14, 2005, we received a preliminary notification that the Securities and
Exchange Commission had commenced a formal investigation involving trading in
our securities. On February 14, 2005, through our legal counsel, we received a
formal notification of that investigation and associated subpoenas. On January
18, 2006, the SEC announced that it filed a civil complaint (Case No. CV 06-0256
DSF, C.D. Cal.) for insider trading against Deog Kyoon Jeong, a co-founder and
consultant to the Company, and that it was also entering into a consent judgment
with Mr. Jeong. The SEC stated that Mr. Jeong had agreed to pay a civil penalty
of $56,000 and to disgorge profits of $56,000, without admitting or denying the
allegations in the SEC complaint. We are not aware of any further actions taken
by the SEC in this matter. We intend to continue to fully cooperate with the SEC
in the event that any further actions are necessary.
 
 In
addition, we have been named as defendants in a number of judicial and
administrative proceedings incidental to our business and may be named again
from time to time, 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 our
results of operations, financial position or cash flows.
 
 Guarantees
 
 Certain
of our licensing agreements indemnify our customers for any expenses or
liabilities resulting from claimed infringements of third party patents,
trademarks or copyrights by 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,
we have not paid any such claims or been required to defend any lawsuits with
respect to any claim.
 
  -11-
 Table of Contents
  Contractual
Obligations and Off-Balance Sheet Arrangements
  The
following table represents our future minimum payments under our operating
leases, inventory and other non-inventory purchase outstanding at September 30,
2008 (in thousands):
 
 Contractual
      obligations
              
              Total
              
              
              Less
      than 1 year
              
              
              2-3
      years
              
              
              4-5
      years
              
              
              More
      than 5 yearsOperating
      lease obligations
              
              $
              7,872
              
              
              $
              3,735
              
              
              $
              4,078
              
              
              $
              59
              
              
              $
              -Intangibles
      purchase commitments
              
              
              6,823
              
              
              
              4,424
              
              
              
              2,399
              
              
              
              -
              
              
              
              -Total
      contractual obligations
              
              $
              14,695
              
              
              $
              8,159
              
              
              $
              6,477
              
              
              $
              59
              
              
              $
              -
 
 The
amounts above exclude liabilities under FASB Interpretation No. 48 “Accounting for Uncertainty in
Income Taxes”, as we are unable to reasonably estimate the ultimate
amount or timing of settlement.
 
 10.
Customer and Geographic Information
 
 We
operate in one reportable operating segment, semiconductors and IP solutions for
the secure storage, distribution and presentation of high-definition content.
Our Chief Executive Officer, who is considered to be our chief operating
decision maker, reviews financial information presented on one operating segment
basis for purposes of making operating decisions and assessing financial
performance.
 
 Revenue
by geographic area was as follows (in thousands):
 
 Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Japan
                
                $
                12,516
                
                
                $
                31,787
                
                
                $
                52,697
                
                
                $
                83,515Taiwan
                
                
                13,878
                
                
                
                11,232
                
                
                
                39,715
                
                
                
                39,380United
      States
                
                
                13,461
                
                
                
                20,374
                
                
                
                38,443
                
                
                
                48,994Hong
      Kong
                
                
                12,364
                
                
                
                6,486
                
                
                
                25,340
                
                
                
                14,611Europe
                
                
                5,470
                
                
                
                5,718
                
                
                
                22,367
                
                
                
                18,789Korea
                
                
                3,300
                
                
                
                4,682
                
                
                
                10,307
                
                
                
                13,430Other
                
                
                16,787
                
                
                
                6,003
                
                
                
                26,103
                
                
                
                16,453Total
      revenue
                
                $
                77,776
                
                
                $
                86,282
                
                
                $
                214,972
                
                
                $
                235,172
  Revenue
by product line was as follows (in thousands):
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Consumer
      Electronics (1)
                
                $
                55,883
                
                
                $
                68,219
                
                
                $
                155,728
                
                
                $
                181,553Personal
      Computer (1)
                
                
                11,713
                
                
                
                9,362
                
                
                
                34,640
                
                
                
                28,659Storage
      (1)
                
                
                10,180
                
                
                
                8,701
                
                
                
                24,604
                
                
                
                24,960Total
      revenue
                
                $
                77,776
                
                
                $
                86,282
                
                
                $
                214,972
                
                
                $
                235,172
 ____________
 (1)
              Includes
      licensing revenue
 
 Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Consumer
      Electronics
                
                $
                46,157
                
                
                $
                60,928
                
                
                $
                133,222
                
                
                $
                155,444Personal
      Computer
                
                
                9,704
                
                
                
                7,696
                
                
                
                30,681
                
                
                
                24,663Storage
                
                
                9,113
                
                
                
                6,203
                
                
                
                20,094
                
                
                
                17,591Licensing
      revenue
                
                
                12,802
                
                
                
                11,455
                
                
                
                30,975
                
                
                
                37,474Total
      revenue
                
                $
                77,776
                
                
                $
                86,282
                
                
                $
                214,972
                
                
                $
                235,172
 
 For the
three months ended September 30, 2008, shipments to Innotech Corporation, World
Peace Industrial, Weikeng Industrial Co.  Ltd, and Microtek, Inc. generated
12.4%, 12.0%, 11.0% and 10.2% of our revenue, respectively. For the nine months
ended September 30, 2008, shipments to World Peace Industrial, Innotech
Corporation, Microtek, Inc. and Weikeng Industrial Co. Ltd. generated 13.8%,
11.9% 11.5% and 10.0% of our revenue, respectively.
  For the
three months ended September 30, 2007, shipments to Innotech, Microtek, World
Peace and Samsung Electronics, generated 15.3%, 15.9% 13.5% and 10%,
respectively, of our revenue. For the nine months ended September 30, 2007,
shipments to Microtek, Innotech and World Peace, generated 14.2%, 16.1% and
11.6%, respectively, of our revenue.
 
  -12-
 Table of Contents
 
 Location
of long lived assets comprising of property plant and equipment are as follows
(in thousands):
  September
      30, 2008
                  
                  
                  December
      31, 2007Long-lived
      assets US
                  
                  $
                  17,656
                  
                  
                  $
                  20,927Germany
                  
                  
                  1,803
                  
                  
                  
                  1,500Other
      foreign countries
                  
                  
                  2,147
                  
                  
                  
                  1,764Total
                  
                  $
                  21,606
                  
                  
                  $
                  24,191
  11.
Provision (benefit) for Income Taxes
 
 For the
three and nine months ended September 30, 2008, we recorded a provision for
income taxes of $114,000 and a benefit of ($13,000), respectively. The effective
tax rate for the three and nine months ended September 30, 2008 was 1.8% and
(0.3%) respectively. The effective tax rate is based on projected taxable income
for 2008.
 
 For
the three and nine months ended September 30, 2007, we recorded a provision for
income taxes of $9.1 million and $17.7 million, respectively. The effective tax
rate for the three and nine months ended September 30, 2007 was 68.9% and 60.8%
respectively and was based on our projected taxable income for 2007. The
effective tax rate for the three months ended September 30, 2007 of 68.9% was
comprised of 53.8% Federal, 1.2% State and 13.9% foreign,
respectively.
 
 We
adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” (FIN
48) on January 1, 2007. As a result of the adoption of FIN 48, we recorded a
reduction to opening retained earnings as of January 1, 2007 of approximately
$5.1 million related primarily to our measurement of certain tax credits based
on the requirements of FIN 48. We have historically classified accruals for tax
uncertainties in current taxes payable and, where appropriate, as a reduction to
deferred tax assets. As a result of the adoption of FIN 48, we reclassified $5.6
million from current taxes payable to other long term liabilities. In addition,
we further increased other long term liabilities by $4.0 million, decreased
current deferred tax assets by $2.3 million and increased non-current deferred
tax assets by $1.3 million. As of the adoption date, we had gross tax effected
unrecognized tax benefits of approximately $14.4 million of which $11.5 million,
if recognized, would have affected the effective tax rate.
 
 Our
policy is to include interest and penalties related to unrecognized tax benefits
within the provision for income taxes. The provision for income taxes for the
three and nine months ended September 30, 2008 included approximately $141,000
and $339,000 of accrued interest related to unrecognized tax benefits,
respectively. We conduct business globally and, as a result, we and our
subsidiaries file income tax returns in various jurisdictions throughout the
world including the U.S. federal and various U.S. state jurisdictions as well as
various foreign jurisdictions. In the normal course of business we are subject
to examination by taxing authorities throughout the world. We remain subject to
federal and state examination for all years from 1996 and forward by virtue of
the tax attributes carrying forward from those years. We also remain subject to
examination in most foreign jurisdictions for all years since 2002 or the year
we began operations in those countries if later. We are not aware of any
material income tax examinations in progress at this time.
 
 12.
Investment in Intellectual Property
 
 In
February 2007, we entered into an agreement with Sunplus Technology Co., Ltd.
(Sunplus) to license certain technology (Sunplus IP) from Sunplus for $40.0
million, as described below, and to
license certain of our intellectual property (Silicon Image IP) to Sunplus for
$5.0 million.The purpose of this licensing agreement is to obtain
advanced technology for development of our future products. The agreement
provides for us 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 September 30, 2008, we have paid
Sunplus $24.4 million of the consideration for the licensed technology and
related deliverables and support. We are required to pay the remaining $15.6
million as follows: (a) $5 million is due upon the determination that the
delivered technology meets certain functionality tests; (b) $7.5 million is due
on September 30, 2008; and (c) $3.1 million is due quarterly over a two-year
period ending in the second quarter of 2009. In accordance with SFAS No. 142
Goodwill and Other
Intangibles, we will evaluate the Sunplus IP for impairment whenever
indicators of impairment exist.
 
 13.
Fair Value Measurements
 
 Our
financial assets measured at fair value on a recurring basis are cash
equivalents and short term investments. Our 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.
 
  -13-
 Table of Contents
  The types
of instruments valued based on quoted prices in markets that are not active,
broker or dealer quotations, or
 
 The
following table sets forth our cash and cash equivalents and short-term
investments as of September 30, 2008, 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
              
              $
              23,940
              
              
              $
              153,509
              
              
              
              
              
              $
              177,449Total
      Assets
              
              $
              23,940
              
              
              $
              153,509
              
              
              $
              -
              
              
              $
              177,449
  Cash and
cash equivalents and short term investments in the above table excludes $23.1
million in cash held by us or in our accounts with investment fund managers as
of September 30, 2008. During the three months ended September 30, 2008, we held
no direct investments in auction rate securities, collateralized debt
obligations, structured investment vehicles or mortgage-backed
securities.
  Our
foreign currency forward contracts discussed in Note 14 below are measured at
Level 1 fair value. As of September 30, 2008, the outstanding foreign exchange
contracts had a notional value of $3.7 million and had a unrealized loss of
$284,000 recorded in accumulated other comprehensive income as part of
stockholders' equity in the condensed consolidated balance sheet as of September
30, 2008.
 
 14.
Derivative Instruments
 
 Effective
Q3 2008, we began using derivative instruments primarily to manage exposures to
foreign currency fluctuations on forecasted cash flows and balances primarily
denominated in Euro, British Pound and Japanese Yen. Our primary objective in
holding derivatives is to reduce the volatility of earnings and cash flows
associated with changes in foreign currency exchange rates. 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 its 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.
  Foreign
Currency Derivatives
  As of
September 30, 2008, the outstanding foreign exchange contracts had a notional
value of $3.7 million and had a unrealized loss of $284,000 recorded in
accumulated other comprehensive income as part of stockholders' equity in the
condensed consolidated balance sheet as of September 30, 2008.
 
 15.
Restructuring and asset impairment charges
  In
July 2008, management approved a restructuring plan to improve the
effectiveness and efficiency of our operating model as part of our program to
pursue continuous improvement. A portion of this program involves other actions
which do not result in restructuring charges, such as better utilization of
assets, reduced spending, and organizational efficiencies. During the quarter
ended September 30, 2008, we incurred $1.8 million in restructuring
charges. These charges include $1.4 million related to employee severance and
benefit arrangements due to termination of 20 employees and a charge of $459,000
to accelerate the depreciation of certain long-lived assets as a result of our
decision to discontinue the use of such assets. Our restructuring is
substantially complete and we expect to complete the payouts under the
restructuring program by July 2009.
  The
following table presents restructuring activity for the quarter ended September
30, 2008 (in thousands):
  Employee
      Severance and benefits
              
              
              Fixed
      Assets
              
              
              TotalAccrued
      restructuring balance as of July 1, 2008
              
              $
              -
              
              
              $
              -
              
              
              $
              -Additional
      accruals
              
              
              1,417
              
              
              
              459
              
              
              
              1,876Cash
      payments
              
              
              (535
              )
              
              
              -
              
              
              
              (535
              )Non-cash
      settlements
              
              
              -
              
              
              
              (459
              )
              
              
              (459
              )Accrued
      restructuring balance as of September 30, 2008
              
              $
              882
              
              
              $
              -
              
              
              $
              882
  The
operating accruals have been reflected as restructuring expenses on the
consolidated condensed statements of operations. The remaining accrual as of
September 30, 2008 relates to severance benefits we expects to pay in the next
12 months.
  -14-
 Table of Contents
  16.
Goodwill
 
 We
conducted our annual impairment test for goodwill on the last day of the third
quarter of 2008 and concluded that goodwill was not impaired as of that
date.
 
 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 theUnited
Statesand 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 discrete and various levels of integrated 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 ecosystem 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,
  -15-
 Table of Contents
  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.
 
 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 high speed serial digital
interconnect core technology for the mobile device market, including digital
still cameras, HD camcorders, portable media players and smart phones, as well
as the DRAM memory and home networking markets.
 
 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 or the
Annual Report on Form 10-K. 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.
 
 Strategy
and Core Technologies
  Our goal
is to enable the access and presentation of high-definition digital content
anytime, anywhere, on any device. Our business strategy is to grow the available
market for our products and IP solutions through the development, introduction
and promotion of industry standards such as HDMI, DVI and Serial Advanced
Technology Attachment (SATA) in our core technology areas, which are as
follows:
 
 Transition
Minimized Differential Signaling (TMDS)
 
 TMDS is a
technology for transmitting high-speed serial data. It is used by the DVI and
HDMI video interfaces, as well as other digital communication
interfaces. TMDS devices are based on a transmitter/receiver pair. 
The transmitter incorporates an advanced coding algorithm which has reduced
electromagnetic interference over copper cables and enables robust clock
recovery at the receiver to achieve high skew tolerance for driving longer cable
lengths as well as shorter low cost/quality cables.
 
 Internal
TMDS (iTMDS)
 
 iTMDS
defines a video-only link, using a protocol that is a superset of DVI, for
connecting video paths within a DTV.  This protocol handles not only
standard 8-bit DVI, but also 10-, 12-, and 16-bit color depths.  The
protocol embeds an indicator of the current color depth within the TMDS stream
allowing the iTMDS receiver to automatically switch to the correct format
without any support microcontroller or software.
 
 Serial
Advanced Technology Attachment (SATA)
 
 SATA is a
computer bus primarily designed for transfer of data between a computer and mass
storage devices such as hard disk drives and optical drives. The main
advantages over the older parallel ATA interface are faster data transfer,
ability to remove or add devices while operating (hot swapping), thinner cables
that let air cooling work more efficiently, and more reliable operation with
tighter data integrity checks.
 
 SATA was designed as a successor to the Advanced Technology Attachment standard
(ATA), and is expected to eventually replace the older technology (retroactively
renamed Parallel ATA or PATA). Serial ATA adapters and devices communicate over
a high-speed serial cable. The current SATA specification supports data
transfer rates as high as 3.0 Gbit/s per device. SATA uses only 4 signal
lines; cables are more compact and cheaper than PATA. SATA supports hot-swapping
and NCQ. There is a special connector (eSATA) specified for external devices,
and an optionally implemented provision for clips to hold internal connectors
firmly in place.
 
 SATA
Software
 
 The
preferred interface for SATA host controllers is Advanced Host Controller
Interface (AHCI), which allows advanced features of SATA such as hot plug and
Native Command Queueing (NCQ). If AHCI is not enabled by the motherboard and
chipset, SATA controllers typically operate in  “IDE emulation”
mode.  Windows device drivers that are labeled as SATA are usually running
in IDE emulation mode unless they explicitly state that they are AHCI. While the
drivers included with Windows XP do not support AHCI, we have implemented
proprietary AHCI drivers to support the features of our advanced host
controllers.  Windows Vista and the current versions of Mac OS X and Linux
have native support for AHCI.
 
  -16-
 Table of Contents
  
 Personal
Entertainment Network (PEN)
 
 PEN is a
set of ultra light weight protocols designed to network consumer electronic
equipment.  The protocol suite is comprised of resource discovery, control
messaging, streaming media and remote user interface components.  The
protocols are designed to be implemented 100% in silicon without the need for
general purpose microprocessors thus allowing extremely cost effective IC
implementations.  PEN protocols incorporate a content protection scheme
suitable for distribution of entertainment content and provide auto federation
and interoperability for networked CE devices.
 
 Because
PEN protocols are designed to operate over IP networks they are suitable for any
physical layer with sufficient speed and latency characteristics including MoCA,
Ethernet, WiFi and power line.  Using these protocols it is possible to
stream media and data without the need for complex software (XML, HTML, Web
Browsers, Java, etc.) in the receiver device.
 
 Consumer
Electronics Control (CEC)
 
 CEC
defines a control channel and protocol for controlling consumer electronic
devices.  The channel wiring is mandatory within the HDMI specification,
although implementation of CEC in a product is optional. The CEC channel uses an
industry standard protocol for remote control functions and is implemented as a
one-wire bidirectional serial bus.  CEC is used to allow a single remote
control to command and control multiple CEC-enabled devices with a single remote
control and individual CEC-enabled devices to command and control each other
without user intervention.
 
 An
example of the latter is to allow the DVD player, when the drawer closes with a
disk, to command the TV and the intervening A/V receiver (all with CEC) to
power-up, select the appropriate HDMI ports, and auto-negotiate the proper video
mode and audio mode. Similarly, the equipment can be commanded by the DVD player
to return to sleep mode when the movie ends.
 
 Mobile
High Definition Link (MHL Technology)
 
 Our MHL
technology is a low pin count HD audio and video serial link specifically
defined for connecting mobile devices to high definition TVs. MHL is based on
the same technology used in DVI and HDMI but only requires single TMDS data pair
to transmit video to MHL enabled TVs at resolutions up to 1080p. MHL uses 5
signal pins that can be used with a small low pin count standard MHL connector
or a proprietary connector in mobile devices. Reduced pin count connectors are
critical in small mobile devices because the available connector real estate is
greatly limited compared to standard consumer electronic devices such as Blu-Ray
players and set top boxes.  The MHL specification also includes provision
to have sink devices to provide power to the mobile device when connected thus
preserving battery life.
 
 Serial Port
Memory Technology (SPMT)
 
 SPMT
is a new memory interface architecture that Silicon Image and other leading
semiconductor companies are currently developing. SPMT is initially targeted for
Dynamic Random Access Memory (DRAM) chips, that employs a serial interface
architecture rather than a parallel interface architecture as commonly found in
current memory offerings. This new architecture will enable greater bandwidth
flexibility, significantly reduced pin count, lower power demand and savings on
overall system cost. As consumers demand more rich features, mobile device
manufacturers are faced with the challenge and expense of adding more processors
to deliver this functionality – and that requires faster and denser memory. By
shifting from parallel to serial interface technology, you can:
 
 
 ·
              Reduce
      pin count by a minimum of 40
percent
 ·
              Provide
      a bandwidth range from 3.2-6.4GB/s and
higher
 ·
              Reduce
      input/output power by 50 percent or more over other currently available
      DRAM offerings
 ·
              Provide
      the ability to use either a single port or multiple ports into a single
      SPMT-enabled memory chip
 
  All of the above directly translate into lowering overall system
cost.
 
 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 52.4% and 54.7% of our total revenue for the
three and nine months ended September 30, 2008, respectively, compared to 60.5%
and 56.1%of our
total revenue for the same periods of 2007, respectively. 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 nine months
ended September 30, 2008, 47.4% and 50.7% of our revenue, respectively, was
generated through distributors, compared to 50.9% and 45.6% in the comparable
periods of 2007, respectively.
 
  -17-
 Table of Contents
  A
significant portion of our revenue is generated from products sold overseas.
Sales to customers in Asia, including
 
 Critical
Accounting Policies
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles (GAAP) requires management to make estimates and
assumptions that affect amounts reported in our condensed 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
following accounting policies 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. Our critical accounting estimates include those regarding (1) revenue
recognition, (2) allowance for doubtful accounts receivable, (3) inventories,
(4) goodwill and intangible assets, (5) income taxes, (6) accrued liabilities,
(7) stock-based compensation expense, and (8) legal matters. For a discussion of
the critical accounting estimates, see “Item 7. Management’s Discussion and
Analysis of Financial Condition and Results of Operations — Critical Accounting
Policies” in our Annual Report on Form 10-K for the year ended December 31,
2007.
 
 Results
of Operations
 
 REVENUE
  Three
      months ended September 30,
                  
                  
                  Nine
      months ended September 30,2008
                  
                  
                  2007
                  
                  
                  Change
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  Change(dollars
      in thousands)
                  
                  
                  
                  
                  
                  (dollars
      in thousands)Product
      revenue
                  
                  $
                  64,974
                  
                  
                  $
                  74,827
                  
                  
                  
                  -13.2
                  %
                  
                  $
                  183,997
                  
                  
                  $
                  197,698
                  
                  
                  
                  -6.9
                  %Licensing
      revenue
                  
                  
                  12,802
                  
                  
                  
                  11,455
                  
                  
                  
                  11.8
                  %
                  
                  
                  30,975
                  
                  
                  
                  37,474
                  
                  
                  
                  -17.3
                  %Total
      revenue
                  
                  $
                  77,776
                  
                  
                  $
                  86,282
                  
                  
                  
                  -9.9
                  %
                  
                  $
                  214,972
                  
                  
                  $
                  235,172
                  
                  
                  
                  -8.6
                  %
 Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change
                
                
                2008
                
                
                2007
                
                
                Change(dollars
      in thousands)
                
                
                
                
                
                (dollars
      in thousands)Consumer
      Electronics (1)
                
                $
                55,883
                
                
                $
                68,219
                
                
                
                -18.1
                %
                
                $
                155,728
                
                
                $
                181,553
                
                
                
                -14.2
                %Personal
      Computers (1)
                
                
                11,713
                
                
                
                9,362
                
                
                
                25.1
                %
                
                
                34,640
                
                
                
                28,659
                
                
                
                20.9
                %Storage
      (1)
                
                
                10,180
                
                
                
                8,701
                
                
                
                17.0
                %
                
                
                24,604
                
                
                
                24,960
                
                
                
                -1.4
                %Total
      revenue
                
                $
                77,776
                
                
                $
                86,282
                
                
                
                -9.9
                %
                
                $
                214,972
                
                
                $
                235,172
                
                
                
                -8.6
                %
 ____________
 
 (1)
              Includes
      licensing revenue
  Three
      months ended September 30,
                  
                  
                  Nine
      months ended September 30,2008
                  
                  
                  2007
                  
                  
                  Change
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  Change(dollars
      in thousands)
                  
                  
                  
                  
                  
                  (dollars
      in thousands)Consumer
      Electronics
                  
                  $
                  46,157
                  
                  
                  $
                  60,928
                  
                  
                  
                  -24.2
                  %
                  
                  $
                  133,222
                  
                  
                  $
                  155,444
                  
                  
                  
                  -14.3
                  %Personal
      Computers
                  
                  
                  9,704
                  
                  
                  
                  7,696
                  
                  
                  
                  26.1
                  %
                  
                  
                  30,681
                  
                  
                  
                  24,663
                  
                  
                  
                  24.4
                  %Storage
                  
                  
                  9,113
                  
                  
                  
                  6,203
                  
                  
                  
                  46.9
                  %
                  
                  
                  20,094
                  
                  
                  
                  17,591
                  
                  
                  
                  14.2
                  %Licensing
      revenue
                  
                  
                  12,802
                  
                  
                  
                  11,455
                  
                  
                  
                  11.8
                  %
                  
                  
                  30,975
                  
                  
                  
                  37,474
                  
                  
                  
                  -17.3
                  %Total
      revenue
                  
                  $
                  77,776
                  
                  
                  $
                  86,282
                  
                  
                  
                  -9.9
                  %
                  
                  $
                  214,972
                  
                  
                  $
                  235,172
                  
                  
                  
                  -8.6
                  %
  The
decrease in product revenues for the three months as well as the nine months
ended September 30, 2008, respectively, is primarily due to declines in sales of
our Consumer Electronics (“CE”) products partially offset by increase in
revenues from our Personal Computers (“PC”) products. The decrease in CE product
revenues compared to comparable periods in 2007 is primarily due to lower
revenues as a result of our previously announced product transition and lower
revenues from our discrete receiver chips and input processors from
DTV’s in our CE business, and due to increased competition of discrete and
integrated solutions from other companies.We believe
the weakening consumer demand due to concerns about the economy, also had a
negative impact on our revenue for the current quarter. Revenue from our HDMI
1.3 products increased for the three months ended September 30, 2008 as compared
to three months ending September 30, 2007. However, the decrease in overall CE
revenues reflects a product transition wherein sales of our HDMI 1.1 and 1.2
products are decreasing, partially offset by increased sales of HDMI
1.3 products. We expect our CE business to follow normal seasonal
patterns declining in the fourth quarter as compared to the third
quarter of 2008.
  -18-
 Table of Contents
   There was an increase in PC revenues for three and nine months ended September
30, 2008 over the comparable periods in 2007 primarily due to transition from
DVI to HDMI in PC’s. Average selling prices ("ASPs") in the PC business
decreased in the quarter and for the nine months ended September 30, 2008 as
compared to the corresponding period 2007. This decline was in line with our
expectations. We expect revenues from our PC business to decline in the
fourth quarter due to increased integration pressures to our discrete
chips.
 
 The
increase in storage revenue for the three months ended September 30, 2008, over
the comparable periods in 2007, was primarily due to growth in sales of our
Steelvine processor chips offset by a slight decline in the storage ASP’s.
We have seen a significant increase in Steel Vine processor adoption on high end
and midrange PC motherboards. We believe that revenue from our storage
business will remain flat in the fourth quarter as compared
to the third quarter.
 
 Licensing
revenues increased for the three months and decreased for the nine months ended
September 30, 2008 as compared to comparable periods in 2007 due to the timing
of execution of development and licensing arrangements.
 
 COST
OF REVENUE AND GROSS PROFIT
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change
                
                
                2008
                
                
                2007
                
                
                Change(dollars
      in thousands)
                
                
                
                
                
                (dollars
      in thousands)Product
      cost of revenue (1)
                
                $
                31,518
                
                
                $
                36,858
                
                
                
                -14.5
                %
                
                $
                87,921
                
                
                $
                100,543
                
                
                
                -12.6
                %Licensing
      cost of revenue
                
                
                223
                
                
                
                642
                
                
                
                -65.3
                %
                
                
                1,064
                
                
                
                4,653
                
                
                
                -77.1
                %Total
      Cost of revenue (1)
                
                
                31,741
                
                
                
                37,500
                
                
                
                -15.4
                %
                
                
                88,985
                
                
                
                105,196
                
                
                
                -15.4
                %Total
      gross profit
                
                
                46,035
                
                
                
                48,782
                
                
                
                -5.6
                %
                
                
                125,987
                
                
                
                129,976
                
                
                
                -3.1
                %Gross
      profit margin
                
                
                59.2
                %
                
                
                56.5
                %
                
                
                
                
                
                
                58.6
                %
                
                
                55.3
                %(1)
      Includes stock-based compensation expense
                
                $
                351
                
                
                $
                421
                
                
                
                
                
                
                $
                1,132
                
                
                $
                1,210
 
 Cost of
revenue consists primarily of costs incurred to manufacture, assemble and test
our products, license development costs, as well as overhead
costs including stock-based compensation expense. The $5.8 million and
$16.2 million decreases in cost of revenue for three months and nine months
ended September 30, 2008, respectively, over the comparable periods in 2007
was primarily due to decreases in revenues, lower manufacturing and outside
processing costs through negotiation and improved supply chain efficiencies, use
of vendors offering lower pricing, increasing use of company-owned testing
equipment, better inventory control, offset by higher shipping and
warehousing fees as a result of increase in fuel prices. Stock-based
compensation expense was relatively flat for the three and nine months ended
September 30, 2008 over the comparable periods of 2007.
 
 Total
gross profit decreased by $2.7 million and $4.0 million for the three and nine
months ended September 30, 2008, respectively, compared to the same
periods in 2007. Our gross profit margins of 59.2% and 58.6% for the three
and nine months ended September 30, 2008 increased from 56.5% and 55.3% for the
same periods in 2007, primarily due to product mix and operational
efficiencies as described above. For the fourth quarter of 2008, we expect the
gross margin percentage to be lower than the third quarter of 2008, as a result
of seasonality in revenue and cost of revenue and changes in product
mix.
 
 OPERATING
EXPENSES
 
 Research
and Development (“R&D”).
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change
                
                
                2008
                
                
                2007
                
                
                Change(dollars
      in thousands)
                
                
                
                
                
                (dollars
      in thousands)Research
      and development (1)
                
                $
                20,714
                
                
                $
                20,489
                
                
                
                1.1
                %
                
                $
                64,554
                
                
                $
                56,709
                
                
                
                13.8
                %Percentage
      of total revenue
                
                
                26.6
                %
                
                
                23.7
                %
                
                
                
                
                
                
                30.0
                %
                
                
                24.1
                %(1)
      Includes stock-based compensation expense
                
                $
                1,753
                
                
                $
                2,181
                
                
                
                
                
                
                $
                5,200
                
                
                $
                6,545
  R&D
expense consists primarily of employee compensation, including stock-based
compensation expense, and other related costs, fees for independent contractors,
the cost of software tools used for designing and testing our products, and
costs associated with prototype materials. R&D expenses increased $225,000
and $7.8 million for the three and nine months ended September 30, 2008 as
compared to the comparable periods in 2007, due to the higher compensation
expenses caused by increased staffing and higher tape-out expenses, higher
depreciation expenses, offset partially by a decline in stock based compensation
expense.
 
  -19-
 Table of Contents
  Selling, General and Administrative (“SG&A”).
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change
                
                
                2008
                
                
                2007
                
                
                Change(dollars
      in thousands)
                
                
                
                
                
                (dollars
      in thousands)Selling,
      general and administrative (1)
                
                $
                17,468
                
                
                $
                16,827
                
                
                
                3.8
                %
                
                $
                54,853
                
                
                $
                51,122
                
                
                
                7.3
                %Percentage
      of total revenue
                
                
                22.5
                %
                
                
                19.5
                %
                
                
                
                
                
                
                25.5
                %
                
                
                21.7
                %(1)
      Includes stock-based compensation expense
                
                $
                2,004
                
                
                $
                2,731
                
                
                
                
                
                
                $
                8,057
                
                
                $
                6,796
  SG&A
expense consists primarily of employee compensation, including stock-based
compensation expense, sales commissions, professional fees, marketing and
promotional expenses. The increase in SG&A expenses of $641,000 for the
three months ended September 30, 2008 as compared to corresponding period in
2007 is primarily due to increase in compensation expense as a result
of  increase in head count in the sales department. Increase in
SG&A expenses for the nine months ended September 30, 2008 as compared to
corresponding period in 2007 of $3.7 million, is primarily due to increased
compensation expenses as a result of higher head count as stated above, increase
in legal expenses related to the Analogix litigation as described in Note 9 to
the condensed consolidated financial statements above, and an increase in stock
based compensation expense as a result of grant of RSUs to employees and
executives as discussed in Note 4 to the Condensed Consolidated Financial
statements.
 
 Amortization
of Intangible Assets.
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change
                
                
                2008
                
                
                2007
                
                
                Change(dollars
      in thousands)Amortization
      of intangible assets
                
                $
                1,587
                
                
                $
                540
                
                
                
                193.9
                %
                
                $
                4,761
                
                
                $
                1,692
                
                
                
                181.4
                %Percentage
      of total revenue
                
                
                2.0
                %
                
                
                0.6
                %
                
                
                
                
                
                
                2.2
                %
                
                
                0.7
                %
 
 The
increase in the amortization of intangible assets was primarily caused by the
commencement of amortization of the acquired Sunplus technology in the fourth
quarter of 2007.  See further discussion in Note 12 to the Condensed
Consolidated Financial Statements.
 
 Restructuring.
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change
                
                
                2008
                
                
                2007
                
                
                Change(dollars
      in thousands)
                
                
                
                
                
                (dollars
      in thousands)Restructuring
      expense
                
                $
                1,876
                
                
                $
                -
                
                
                
                100.0
                %
                
                $
                1,876
                
                
                $
                -
                
                
                
                100.0
                %Percentage
      of total revenue
                
                
                2.4
                %
                
                
                0.0
                %
                
                
                
                
                
                
                0.9
                %
                
                
                0.0
                %
 
 In
July 2008, we announced a restructuring plan to improve the effectiveness
and efficiency of our operating model as part of our
program to pursue continuous improvement. The restructuring expense for the
three and nine months ended September 30, 2008, consists primarily of $1.4
million related to employee severance and benefit arrangements due to
termination of 20 employees and a charge of $459,000 relating to retirement
of certain assets. We did not have any restructuring charges in the prior fiscal
year.
 
 Interest
Income and other, net.
  Three
      months ended September 30,
                  
                  
                  Nine
      months ended September 30,2008
                  
                  
                  2007
                  
                  
                  Change
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  Change(dollars
      in thousands)Interest
      income and other, net
                  
                  $
                  1,798
                  
                  
                  $
                  2,302
                  
                  
                  
                  -21.9
                  %
                  
                  $
                  5,094
                  
                  
                  $
                  8,618
                  
                  
                  
                  -40.9
                  %Percentage
      of total revenue
                  
                  
                  2.3
                  %
                  
                  
                  2.7
                  %
                  
                  
                  
                  
                  
                  
                  2.4
                  %
                  
                  
                  3.7
                  %
 
 The
interest income and other, net, which principally includes interest
income, decreased for the three and nine months ended September 30, 2008,
respectively, compared to the same periods of 2007. The decrease was
primarily due to a lower average total cash balances as a result of the stock
repurchases made during the first nine months of  2008, a lower
interest rate environment, and a switch to investments in tax exempt securities
in 2008, which generally carry lower interest rates than similar taxable
securities. The decrease in interest income and other, net for the three and
nine months ending September 30, 2008 was partially offset by $620,000 and $1.0
million, respectively, gain recorded on the ASR transaction as described in Note
5 to the condensed consolidated financial statements under Part 1 Item 1
above.
 
  -20-
 Table of Contents
  Provision
(benefit) for income taxes.
  Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change
                
                
                2008
                
                
                2007
                
                
                Change(dollars
      in thousands)Provision
      (benefit) for income taxes
                
                $
                114
                
                
                $
                9,118
                
                
                
                -98.7
                %
                
                $
                (13
                )
                
                $
                17,673
                
                
                
                -100.1
                %Percentage
      of total revenue
                
                
                0.1
                %
                
                
                10.6
                %
                
                
                
                
                
                
                0.0
                %
                
                
                7.5
                %
  Provision (benefit) for Income
Taxes.For the three and nine months ended September 30, 2008, we
recorded a provision for income taxes of $114,000 and a benefit of ($13,000),
respectively. The effective tax rate for the three and nine months ended
September 30, 2008 was 1.8% and (0.3%), respectively and was based on our
projected taxable income for 2008, plus certain discrete items recorded during
the quarter.
 
 The
difference between the provision (benefit) 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. We currently expect an effective tax rate of 0-5%, for the full
year 2008.
 
 For the
three and nine months ended September 30, 2007, we recorded a provision for
income taxes of $9.1 million and $17.7 million, respectively. The
effective tax rate for the three and nine months ended September 30, 2007
was 68.9% and 60.8%, respectively. The effective tax rate was based on projected
taxable income for 2007. The effective tax rate for the three months ended
September 30, 2007 of 68.9% comprised of 53.8%, 1.2% and 13.9% for federal,
state and foreign, respectively.
 
 The
Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes – an interpretation of FASB Statement No. 109” (FIN 48) as of January 1,
2007. See “Note 11: Provision (benefit) for income taxes” in the Notes to
Condensed Consolidated Financial Statements under Part I Item I of this report
for further discussion.
 
 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 and
Investments.
  Nine
      months ended September 30,2008
                
                
                2007
                
                
                Change(dollars
      in thousands)Total
      cash, cash equivalents and
    short-term  investments
                
                $
                200,539
                
                
                $
                225,689
                
                
                
                -11.1
                %Cash
      provided by operating activities
                
                $
                27,251
                
                
                $
                37,001
                
                
                
                -26.4
                %Cash
      provided by (used in) investing activities
                
                
                (23,240
                )
                
                
                35,251
                
                
                
                -165.9
                %Cash
      used in financing activities
                
                
                (69,058
                )
                
                
                (23,439
                )
                
                
                194.6
                %Effect
      of exchange rate changes on cash & cash equivalents
                
                
                (407
                )
                
                
                (76
                )
                
                
                435.5
                %Net
      increase (decrease) in cash and cash equivalents
                
                $
                (65,454
                )
                
                $
                48,737
                
                
                
                -234.3
                %
 
 The
decrease in cash and cash equivalents of $65.4 million for the nine months ended
September 30, 2008, was primarily due to payment of $68.2 million in
connection with our accelerated stock repurchase program, payment of $6.2
million to Sunplus and Oracle in connection with the investment in
intangibles and software and $6.0 million investments in property, plant and
equipment, net purchases of investments of $17.2 million, partially offset by
cash received on exercise of stock options and for purchases of stock by
employees under the ESPP of $4.7 million, and cash generated from operations of
$27.3 million.
  -21-
 Table of Contents
 
 Accounts
Receivable, Net.
  September
      30,
                
                
                December
      31,2008
                
                
                2007
                
                
                Change(dollars
      in thousands)Accounts
      receivable, net
                
                $
                23,603
                
                
                $
                21,254
                
                
                
                11.1
                %
  Net
accounts receivable as of September 30, 2008 represents 27 days of sales
outstanding. This compares to 22 days of sales outstanding on December 31, 2007.
The accounts receivable balance as of December 31, 2007 was lower due to a high
level of collections at year end. The increase in accounts receivable of $2.3
million was in line with our expectations.
 
 Inventory.
  September
      30,
                
                
                December
      31,2008
                
                
                2007
                
                
                Change(dollars
      in thousands)Inventory
                
                $
                16,503
                
                
                $
                20,198
                
                
                
                -18.3
                %
 Our
inventories are accounted for at the lower of cost or market. Inventory is
written down based on 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 is charged to the provision for inventory, which is a
component of our cost of sales. Inventory decreased primarily due to lower
manufacturing and outside processing costs through negotiation, use of vendors
offering better pricing, increasing use of company-owned testing equipments,
implementation of enhanced tools enabling better inventory control, all
resulting in a lower inventory balance.
 
 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 licensing 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.
 
  -22-
 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 September
30, 2008. 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%$436,000
              $872,000
              $1,308,000
 
 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. The
effect of any adverse changes in foreign currency exchange rates may impact our
future operating results or cash flows as any such changes in our currency
exchange rate may result in increased ongoing research and development or sales
and marketing costs in our foreign operations. Additionally, some 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.
  Derivative
Instruments
  Foreign
Currency Derivatives
  As of
September 30, 2008, the outstanding foreign exchange contracts had a notional
value of $3.7 million and had a unrealized loss of $284,000 recorded in
accumulated other comprehensive income as part of equity the condensed
consolidated balance sheet as of September 30, 2008.
  Effective
Q3 2008, we began using derivative instruments, primarily to manage exposures to
foreign currency. We enter into foreign exchange forward contracts to reduce the
short-term effects of foreign currency fluctuations on operating expenses
denominated in Euros, Japanese Yen and British Pounds. Our market risks
associated with our foreign currency operating expenses relate primarily to
variances from our forecasted foreign currency transactions and balances. The
effect of foreign currency fluctuations on sales has not been material because
our sales are primarily denominated in U.S. dollars. Approximately 94.0% of our
operating expenses are U.S.-dollar denominated. To reduce variability in
operating expenses caused by the remaining non-U.S.-dollar denominated operating
expenses, we hedge certain foreign currency forecasted transactions with forward
contracts with maturities up to six months. These hedging programs are not
designed to provide foreign currency protection over longer time horizons. In
designing a specific hedging approach, we consider several factors, including
offsetting exposures, significance of exposures, costs associated with entering
into a particular hedge instrument, and potential effectiveness of the hedge.
The gains and losses on foreign exchange contracts mitigate the variability in
operating expenses associated with currency movements. We do not enter into
foreign exchange forward contracts for trading purposes. We do not expect gains
or losses on these derivative instruments to have a material effect on our
financial results. See Note 14 to the Consolidated Financial
Statements.
 
 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 2008 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
 
  -23-
 Table of Contents
  
 Part II. Other Information
 
 Item 1. Legal Proceedings
 
 Please
refer to Note 9 to our 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.
 
 Our
annual and quarterly operating results are likely to vary significantly in the
future based on a number of factors over 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.
 
 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.
 
 Our future annual
and quarterly operating results are highly dependent upon how well we
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;
  -24-
 Table of Contents
  
 •
              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 may be significantly impacted by a downturn in the
economy.
 
 Our CE
product revenue, which comprised of approximately 59.3% and 62.0% of total
revenue for the three and nine months ended September 30, 2008 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. If the US economy or other economies around the world move
into recession, we expect that the demand for overall consumer electronics will
be adversely affected and therefore, demand for our CE, PC and storage products
and our operating results will be adversely affected as well.
 
 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 these virtual products 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 sales of these virtual products 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
  -25-
 Table of Contents
  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 DVI and HDMI 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 Instaport products and MHL
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, such as our Personal Entertainment Network (PEN) products
under development. Moreover, there is no assurance that our new or future
products will achieve the desired level of market acceptance in the anticipated
time frames 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.
 
 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 (“AVA”) 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. Also, the user
experience associated with audiovisual transmissions over HDMI with HDCP is
unproven and users may reject products incorporating these technologies or they
may require more customer support than expected. 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 Digital Visual Interface (DVI) or High-Definition Multimedia
Interface (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 the following
interfaces 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
  -26-
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  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 receives 100% of the HDMI adopter royalty
revenues.
  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.
 
  -27-
 Table of Contents
  While our
sales cycles are typically long, our average product life cycles tend to be
short as a result of the rapidly changing
 
 Our customer may
not purchase anticipated levels of products, which can result in increased
inventory levels
 
 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 significantly
reduce our revenue.
 
 Historically,
a relatively small number of customers and distributors have generated a
significant portion of our revenue. For the three months ended September 30,
2008, shipments to Innotech Corporation, World Peace Industrial, Weikeng
Industrial Co.  Ltd, and Microtek, Inc. generated 12.4%, 12.0%, 11.0% and
10.2% of our revenue, respectively. For the nine months ended September 30,
2008, shipments to World Peace Industrial, Innotech Corporation, Microtek, Inc.
and Weikeng Industrial Co. Ltd. generated 13.8%, 11.9% 11.5% and 10.0% of our
revenue, respectively. For the three months ended September 30, 2007, shipments
to Innotech, Microtek, and World Peace, generated 15.3%, 15.9% and 13.5% f our
revenue, respectively. For the nine months ended September 30, 2007, shipments
to Microtek, Innotech and World Peace, generated 14.2%, 16.1% 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.
 
 We sell our
products through distributors, which limits our direct
interaction with our end
customers, therefore reducing our ability to forecast sales
and increasing the
complexity of our business.
 
 Many
original equipment manufacturers (“OEM”) rely on third-party manufacturers or
distributors to provide inventory management and purchasing functions.
Distributors generated 47.4% and 50.7% of our revenue for the three and nine
months ended September 30, 2008, respectively. Distributors generated 50.9% and
45.6% of our revenue for the three and nine months ended September 30, 2007,
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.
  -28-
 Table of Contents
   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,
      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.
 
 There
are risks to our global strategy.
 
 In 2006,
we implemented a global strategy that involves maintaining operations in various
countries around the world. We believe that, in the long run, we will realize
certain operational benefits from this global strategy as well as achieve an
overall lower tax rate. However, the effectiveness of the strategy requires, in
addition to maintaining and increasing profitability, 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
the these compliance requirements or fail to maintain supportive processes, our
ability to realize the expected benefits of our global strategy may be
jeopardized, which may adversely affect our business, operating results or
financial condition.
 
  -29-
 Table of Contents
   We have made
acquisitions in the past and may make acquisitions in the
future, if advisable, 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.
 
 Our
acquisition of sci-worx GmbH exposes us to a variety of risks.
 
 We
acquired sci-worx, now Silicon Image, GmbH, a limited liability company based in
Germany, in January 2007. In addition to the acquisition-related risks described
in the risk factor above, this acquisition exposes us to complexities of
operating in Germany, a country in which we had not previously had significant
operations and whose regulatory framework with which we have only recently
become familiar and of difficulties in managing and integrating approximately
172 employees, as of the date of
 acquisition,
based in Germany. In addition, the technologies acquired from sci-worx may
require significant additional development before they can be marketed and may
not generate sufficient revenue to offset expenses associated with the
acquisition. Any of these problems or factors with respect to this acquisition
could adversely affect our business, financial condition or results of
operations.
 
 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 our foundry, 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.
  -30-
 Table of Contents
   We depend on
third-party sub-contractors to manufacture, assemble and test nearly all of our
products, which reduce our control over the production process.
 
 We do not
own or operate a semiconductor fabrication facility. We rely on third party
semiconductor manufacturing companies overseas to produce the vast majority 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.
 In
addition, our semiconductor products are assembled and tested by several
independent subcontractors. 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 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 to other customers 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
contractors, which would be time-consuming, costly and difficult. 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 prevent
identification 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.
 
 We face foreign
business, political and economic risks because a majority of our products and
our customers’ products are manufactured and sold outside of theUnited
States.
 
 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 nine months ended September 30, 2008, approximately 82.7% and
82.1% 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
  -31-
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  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
our intellectual
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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 Our participation
in working groups for the development and promotion of industry
standards in our target markets, including the Digital Visual Interface and
HDMI specifications, requires us to license some of our intellectual
property for free or under specified terms and conditions,
which may make it
easier for others to compete with 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. We no
longer receive 100% of these royalties.
 
 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 strategic
partners.
 
 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 will enhance 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.
 
 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;
  -33-
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 •
              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 could allow Intel
to develop products that compete with ours or otherwise reduce the value
of 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.
 
 We may become
engaged in additional intellectual property litigation that could be
time-consuming, may be expensive to prosecute or defend and
could adversely affect
our 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.
 
 On
January 31, 2007, we filed a lawsuit in the United States District Court for the
Northern District of California against Analogix Semiconductor, Inc.
(“Analogix”). The complaint charges Analogix with copyright infringement,
misappropriation of trade secrets and unfair competition under California law.
The lawsuit alleges that Analogix, without authorization and in violation of our
intellectual property rights, copied and used our proprietary register maps by
gaining unauthorized access to our proprietary and confidential information,
violated our copyright protection and unfairly competed with Silicon Image in
the marketplace.  In addition to seeking monetary damages in an amount
to be determined at trial, we seek an injunction barring Analogix from the
misappropriation of Silicon Image’s trade secrets.  On June 18, 2007,
Analogix filed a counterclaim alleging that we breached a confidentiality
agreement by purportedly disclosing Analogix’s confidential information within
Silicon Image. The court has set a trial date for January 26,
2009.
  -34-
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  On June
11, 2008, Analogix filed a lawsuit in the United States District Court for the
Northern District of California against us alleging violations of the Sherman
Act Sections 1 and 2, Cartwright Act, and Section 17200 of the California
Business and Professions Code.  The complaint seeks monetary damages
and injunctive relief.  The complaint alleges that Silicon Image, and
co-defendants HDMI Licensing, LLC and Simplay Labs, LLC, conspired with the
founders of the HDMI Consortium in violation of the antitrust
laws.  Specifically, the complaint claims that the defendants and the
founders of the HDMI Consortium have created certain structural advantages and
engaged in anti-competitive conduct for the purpose of monopolizing the markets
for HDMI Solutions and Discrete HDMI Solutions.  Silicon Image
believes the HDMI Consortium is pro-competitive, bringing critical technology to
the market and enabling hundreds of adopters to supply HDMI-enabled
products.  We intend to vigorously contest Analogix’s claims. 
The court has yet to set a trial date.
 
 This
and other litigation initiated by us may be expensive and time-consuming and may
divert our resources and the attention of our executives.
 
 Any
potential intellectual property litigation against us or in which we become
involved 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 other intellectual
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 for
qualified 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
  -35-
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  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.
 
 We had a material
weakness in internal control over financial reporting in 2005 which was
remediated in 2006. We cannot assure you that additional material
weaknesses will not be identified in the future. If our
internal control over
financial reporting or disclosure controls and procedures are
not effective, there
may be errors in our financial statements that could require a restatement or
our filings may not be timely and investors may lose confidence in our
reported financial information, which could lead to a decline in our
stock price.
 
 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. In addition, we may
reassess the implementation or testing of certain of our current controls as a
result of the 2007 release of Public Company Accounting Oversight Board Auditing
Standard No. 5, which may lead to modifications in such controls. These
modifications could affect the overall effectiveness or evaluation of the
control system in the future by us or our independent registered public
accounting firm. 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 and our
independent registered public accounting firm in the past and
may continue to do so
in the future.
 
 We have
experienced a number of transitions with respect to our board of directors,
executive officers and our independent registered public accounting firm in
recent quarters, including the following:
 
 •
              In
      January 2005, Steve Laub (who replaced David Lee in November 2004)
      resigned from the positions of chief executive officer and president and
      from the board of directors, Steve Tirado was appointed as chief executive
      officer and president and to the board as well and Chris Paisley was
      appointed chairman of the board of
directors.
 
 •
              In
      February 2005, Jaime Garcia-Meza was appointed as vice president of our
      storage business.
 
 •
              In
      April 2005, Robert C. Gargus retired from the position of chief financial
      officer and Darrel Slack was appointed as his
  successor.
 
 •
              In
      April 2005, four of our then independent outside directors, David Courtney
      (chairman of the audit committee), Keith McAuliffe, Chris Paisley
      (chairman of the board) and Richard Sanquini, resigned from our board of
      directors and board committees.
 
 •
              In
      April 2005, Darrel Slack, our then chief financial officer, was elected to
      our board of directors.
 
 •
              In
      May 2005, Masood Jabbar and Peter Hanelt were elected to our board of
      directors.
 
 •
              In
      June 2005, David Lee did not stand for re-election as a director at our
      annual meeting of stockholders and accordingly, Dr. Lee resigned from our
      board of directors.
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 •
              In
      June 2005, PricewaterhouseCoopers LLP resigned as our independent
      registered public accounting firm. In July 2005, we appointed Deloitte
      & Touche LLP as our new independent registered public accounting
      firm.
 
 •
              In
      August 2005, Darrel Slack began a personal leave of
    absence.
 
 •
              In
      August 2005, Dale Brown resigned from the positions of chief accounting
      officer and corporate controller.
 
 •
              In
      August 2005, Robert Freeman was appointed as interim chief financial
      officer and chief accounting
officer.
 
 •
              In
      September 2005, Darrel Slack resigned from the position of chief financial
      officer and from our board of directors and the board of directors of HDMI
      Licensing, LLC, our wholly-owned
subsidiary.
 
 •
              In
      October 2005, William George was elected to our board of
      directors.
 
 •
              In
      October 2005, Robert Bagheri resigned from the position of executive vice
      president of operations.
 
 •
              In
      October 2005, John LeMoncheck, then vice president, consumer electronics
      and PC/display, left Silicon Image.
 
 •
              In
      October 2005, John Shin was appointed as interim vice president, consumer
      electronics and PC/display businesses and served in that position until
      February 2006. Mr. Shin serves as vice president of engineering and has
      held that position since October
2003.
 
 •
              In
      November 2005, Robert Freeman’s position changed from interim chief
      financial officer to chief financial
officer.
 
 •
              In
      December 2005, William Raduchel was elected to our board of
      directors.
 
 •
              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 and Harold Covert was appointed as his
  successor.
 
 •
              In
      October 2007, Harold L. Covert. was appointed as Chief financial
      Officer
 
 Such past
and future transitions may continue to result in disruptions in our operations
and require additional costs.
 
 We have been and
may continue to become the target of securities class action suits and
derivative suits which could result in substantial costs and
divert management
attention 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. 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, we, 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
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  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. The court has not yet
decided the class certification motion. 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 on March 8, 2008.
 
 We and
certain of our officers have also been named as defendants in a securities class
action captioned “Curry v. Silicon Image, Inc., Steve Tirado and Robert Gargus,”
commenced on January 31, 2005. 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 our officers and directors violated securities laws and made alleged
misstatements of material facts. For more information, please see Part I, Item I
of this report. Uncertainties inherent in litigation prevent us from predicting
the outcome of this litigation and while it remains pending it may divert
management attention, cause us to incur unanticipated expenses and consume other
resources.
 
 Our operations
and the operations of our significant customers, third-party wafer foundries
and third-party assembly and test subcontractors are located in areas
susceptible 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 (“SPIL”), Advanced Semiconductor Engineering, or ASE, one of the
subcontractors that assemble and test our semiconductor products, is also
located in Taiwan. For the three and nine months ended September 30, 2008,
customers and distributors located in Japan generated 16.1% and 25.3% of our
revenue, respectively and customers and distributors located in Taiwan generated
17.8% and 19.2% of our revenue, respectively. For the three and nine months
ended September 30, 2007, customers and distributors located in Japan generated
36.8% and 35.5%, of our revenue respectively, in each period and customers and
distributors located in Taiwan generated 13.0% and 16.7% 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 our
operations, 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
nuclear arms crises 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 reduce our
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.
 
  -38-
 Table of Contents
  
 Provisions of our
charter documents andDelawarelaw could
prevent or delay a change in 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.
 
 Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds
  Not applicable.
 Item 3. Defaults Upon Senior Securities
 
 Not
applicable.
 
 Item 4. Submission of Matters to a Vote of Security
Holders
 
 Not
applicable.
 
 Item 5. Other Information
 
 Not
applicable.
 
  -39-
 Table of Contents
  
 Item 6. Exhibits
 
 (a)
Exhibits
 
 31.01
              Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.02
              Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.01*
              Certification
      of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906
                of
      the Sarbanes-Oxley Act of 2002.32.02*
              Certification
      of Principal 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.
 
 
  -40-
 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:
      October 24, 2008
              /s/
      Harold L. CovertHarold
      L. Covert
                Chief
      Financial Officer
                (Principal
      Financial Officer)
 
 
 
 
  -41-
 Table of Contents
  Exhibit
Index
 
 31.01
              Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.02
              Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.01*
              Certification
      of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906
                of
      the Sarbanes-Oxley Act of 2002.32.02*
              Certification
      of Principal 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.
  -42-