##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q þ QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934 For the quarterly period ended March 31, 2005 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to ___________. Commission file number: 000-26887 Silicon Image, Inc.  Delaware
    
    77-0396307(State or other jurisdiction
ofincorporation 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) Yes þ No o and
(2) has been subject to such filing requirements for the past 90 days Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes þ No o The number of shares of the registrants Common Stock, $0.001 par value per share, outstanding
as of April 29, 2005 was 79,049,674 shares.




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##### Table of Contents



Silicon Image, Inc.
Quarterly Report on Form 10-Q
Three Months Ended
March 31, 2005 Table of Contents PagePart I Financial Information (Unaudited)Item 1
    
    Financial Statements (Unaudited)Condensed Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004
    
    
    1Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    
    2Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004
    
    
    3Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    4Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    49Item 4
    
    Controls and Procedures
    
    
    50Part II Other InformationItem 1
    
    Legal Proceedings
    
    
    51Item 2
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    53Item 3
    
    Defaults Upon Senior Securities
    
    
    53Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    53Item 5
    
    Other Information
    
    
    53Item 6
    
    Exhibits
    
    
    54SignaturesCertificationsEXHIBIT 10.01EXHIBIT 10.02EXHIBIT 31.01EXHIBIT 31.02EXHIBIT 32.01EXHIBIT 32.02




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##### Table of Contents



Part I. Financial Information (Unaudited) 
 Item 1. Financial Statements Silicon Image, Inc. 
 Condensed Consolidated Statements of Operations
 (in thousands, except
per share amounts)
(unaudited)
 Three Months EndedMarch 31,2005
    
    
    2004Revenue:Product
    
    $
    40,808
    
    
    $
    32,050Development, licensing and royalties
    
    
    3,512
    
    
    
    3,808Total revenue
    
    
    44,320
    
    
    
    35,858Cost and operating expenses:Cost of revenue (1)
    
    
    15,505
    
    
    
    14,515Research and development (2)
    
    
    8,122
    
    
    
    16,798Selling, general and administrative (3)
    
    
    3,904
    
    
    
    11,650Amortization of intangible assets
    
    
    274
    
    
    
    357Patent assertion costs
    
    
    49
    
    
    
    165Total cost and operating expenses
    
    
    27,854
    
    
    
    43,485Income (loss) from operations
    
    
    16,466
    
    
    
    (7,627
    )Interest income and other, net
    
    
    498
    
    
    
    84Income (loss) before provision for income taxes
    
    
    16,964
    
    
    
    (7,543
    )Provision for income taxes
    
    
    331
    
    
    
    317Net income (loss)
    
    $
    16,633
    
    
    $
    (7,860
    )Net income
(loss) per share - basic
    
    $
    0.21
    
    
    $
    (0.11
    )Net income
(loss) per share - diluted
    
    $
    0.19
    
    
    $
    (0.11
    )Weighted
average shares - basic
    
    
    78,307
    
    
    
    72,328Weighted
average shares - diluted
    
    
    87,376
    
    
    
    72,328
   (1)
    
    Includes stock compensation (benefit) expense of $(1.2) million and $1.2
million for the three months ended March 31, 2005 and 2004, respectively.(2)
    
    Includes stock compensation (benefit) expense of $ (4.4) million and $6.2
million for the three months ended March 31, 2005 and 2004, respectively.(3)
    
    Includes stock compensation (benefit) expense of $(3.7) million and $4.7
million for the three months ended March 31, 2005 and 2004, respectively. See accompanying Notes to Unaudited Condensed Consolidated Financial Statements 1




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Silicon Image, Inc. 
 Condensed Consolidated Balance Sheets
 (in thousands, except
share amounts)
(unaudited)
 March 31,
    
    
    Dec. 31,2005
    
    
    2004AssetsCurrent Assets:Cash and cash equivalents
    
    $
    15,499
    
    
    $
    23,280Short-term investments
    
    
    84,908
    
    
    
    70,240Accounts receivable, net of allowance for doubtful
accounts of $745 at March 31 and December 31
    
    
    22,080
    
    
    
    19,417Inventories
    
    
    12,144
    
    
    
    13,926Prepaid expenses and other current assets
    
    
    3,420
    
    
    
    3,073Total current assets
    
    
    138,051
    
    
    
    129,936Property and equipment, net
    
    
    9,108
    
    
    
    9,494Goodwill
    
    
    13,021
    
    
    
    13,021Intangible assets, net
    
    
    1,409
    
    
    
    1,683Other assets
    
    
    731
    
    
    
    774Total assets
    
    $
    162,320
    
    
    $
    154,908Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable
    
    $
    7,218
    
    
    $
    6,833Accrued liabilities
    
    
    9,812
    
    
    
    13,418Deferred license revenue
    
    
    3,009
    
    
    
    2,127Debt obligations and capital leases
    
    
    435
    
    
    
    489Deferred margin on sales to distributors
    
    
    10,032
    
    
    
    9,962Total liabilities
    
    
    30,506
    
    
    
    32,829Stockholders Equity:Common stock, par value $0.001; shares authorized:150,000,000  March 31 and December
31; shares issued and outstanding: 78,948,196
March
31 and 78,131,604  December 31
    
    
    80
    
    
    
    78Additional paid-in capital
    
    
    294,450
    
    
    
    299,744Unearned compensation
    
    
    (7,432
    )
    
    
    (7,632
    )Accumulated deficit
    
    
    (156,344
    )
    
    
    (172,978
    )Accumulated other comprehensive income
    
    
    1,060
    
    
    
    2,867Total stockholders equity
    
    
    131,814
    
    
    
    122,079Total liabilities and stockholders equity
    
    $
    162,320
    
    
    $
    154,908
 See accompanying Notes to Unaudited Condensed Consolidated Financial Statements 2




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Silicon Image, Inc. 
 Condensed Consolidated Statements of Cash Flows
 (in thousands)
(unaudited)
 Three Months EndedMarch 31,2005
    
    

2004Cash flows from operating activities:Net income (loss)
    
    $
    16,633
    
    
    $
    (7,860
    )Adjustments to reconcile net income (loss) to cash
provided by operating activities:Depreciation and amortization
    
    
    1,524
    
    
    
    1,150Provision for doubtful accounts receivable
    
    
    
    
    
    
    52Stock
compensation (benefit) expense
    
    
    (9,327
    )
    
    
    12,068Amortization of intangible assets
    
    
    274
    
    
    
    357Changes in assets and liabilities:Accounts receivable
    
    
    (2,663
    )
    
    
    (6,391
    )Inventories
    
    
    1,782
    
    
    
    694Prepaid expenses and other assets
    
    
    (304
    )
    
    
    472Accounts payable
    
    
    385
    
    
    
    2,769Accrued liabilities and deferred license revenue
    
    
    (2,724
    )
    
    
    3,828Deferred margin on sales to distributors
    
    
    70
    
    
    
    1,888Cash provided by operating activities
    
    
    5,650
    
    
    
    9,027Cash flows from investing activities:Proceeds from sales of short-term investments
    
    
    67
    
    
    
    12,281Purchases of short-term investments
    
    
    (16,541
    )
    
    
    (10,595
    )Purchases of property and equipment
    
    
    (1,138
    )
    
    
    (1,178
    )Cash provided by (used in) investing activities
    
    
    (17,612
    )
    
    
    508Cash flows from financing activities:Proceeds from issuances of common stock, net
    
    
    4,235
    
    
    
    5,053Repayments of debt obligations
    
    
    (54
    )
    
    
    (498
    )Cash provided by financing activities
    
    
    4,181
    
    
    
    4,555Net increase (decrease) in cash and cash equivalents
    
    
    (7,781
    )
    
    
    14,090Cash and cash equivalents  beginning of period
    
    
    23,280
    
    
    
    17,934Cash and cash equivalents  end of period
    
    $
    15,499
    
    
    $
    32,024Supplemental cash flows information:Cash payments for interest
    
    $
    2
    
    
    $
    Cash payments for taxes
    
    $
    
    
    
    $
    217
 See accompanying Notes to Unaudited Condensed Consolidated Financial Statements 3




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Silicon Image, Inc. 
 Notes to Unaudited Condensed Consolidated Financial Statements
March 31, 2005
 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements include those of
Silicon Image, Inc. and our subsidiaries (collectively, the Company), after elimination of all
significant intercompany accounts and transactions. The Company has prepared the accompanying unaudited
condensed consolidated financial statements in conformity with accounting principles generally
accepted in the United States of America, consistent in all material respects with those applied in
our Annual Report on Form 10-K for the year ended December 31, 2004. The interim financial
information is unaudited but reflects all adjustments, normal and recurring in nature, and which are, in the opinion of management,
necessary to fairly state the condensed consolidated balance sheets, and condensed consolidated
statements of income and cash flows for the interim periods presented. The Condensed Consolidated Balance Sheet as of December 31, 2004 is
derived from the December 31, 2004 audited financial statements. You should read these interim
condensed consolidated financial statements in conjunction with the audited consolidated financial
statements in our Annual Report on Form 10-K for the year ended December 31, 2004. 2. Recent Accounting Pronouncements In December 2004, the FASB issued SFAS 123 (revised 2004), Shared Based Payment,SFAS 123R.
The Statement is a revision of FASB 123 and supersedes APB No. 25. The Statement establishes
standards for the accounting for transactions in which an entity exchanges its equity instruments
for goods or services or incurs liabilities in exchange of goods or services that are based on the
fair value of the entitys equity instruments. It focuses primarily on accounting for transactions
in which an entity obtains employee services in share-based payment transactions. The Statement
requires an entity to measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award over the period during which an
employee is required to provide service for the award. The grant-date fair value of employee share
options and similar instruments must be estimated using option-pricing models adjusted for the
unique characteristics of those instruments unless observable market prices for the same of similar
instruments are available. In addition, the Statement requires a
public entity to measure the cost of
employee services received in exchange for an award of liability instruments based on its current
fair value and that the fair value of that award will be remeasured subsequently at each reporting
date through the settlement date. On April 14, 2005, the U.S. Securities and Exchange Commission
adopted a new rule amending the compliance dates for FAS 123R. In accordance with the new rule, the
accounting provisions of FAS 123R will be effective for the Company at the beginning of fiscal
2006. We have not determined the impact of this Statement on our financial statements at this time. In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 (FAS 109-1),
Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (AJCA). The
AJCA introduces a special 9% tax deduction on qualified production activities. FAS 109-1 clarifies
that this tax deduction should be accounted for as a special tax deduction in accordance with
Statement 109. We do not expect the adoption of these new tax provisions to have a material impact
on our consolidated financial position, results of operations or cash flows. In December 2004, the FASB issued FASB Staff Position No. FAS 109-2 (FAS 109-2), Accounting
and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs
Creations Act of 2004. The AJCA introduces a limited time 85% dividends received deduction on the
repatriation of certain foreign 4




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##### Table of Contents



earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. We do not
expect the adoption of these new tax provisions to have a material impact on our consolidated
financial position, results of operations or cash flows. Stock-Based Compensation We account for stock-based awards to employees and directors using the intrinsic value method
of accounting in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25). Under the intrinsic value method, if the exercise price of our
employee stock options equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized. Had we recorded compensation expense for our stock options based on the grant-date fair value
as prescribed by SFAS No. 123 and SFAS No. 148, our net income (loss) would have been as follows
(in thousands, except per share amounts): Three months endedMarch 31,2005
    
    
    2004Net income (loss) as reported
    
    $
    16,633
    
    
    $
    (7,860
    )Stock-based employee compensation expense determined using
fair value method
    
    
    (6,655
    )
    
    
    (5,137
    )Stock-based employee compensation cost (benefit)
included in the determination of net income (loss) as reported
    
    
    (10,266
    )
    
    
    9,286Pro forma net loss
    
    $
    (288
    )
    
    $
    (3,711
    )Basic net
income (loss) per share - pro forma
    
    $
    (0.00
    )
    
    $
    (0.05
    )Basic net
income (loss) per share - as reported
    
    $
    0.21
    
    
    $
    (0.11
    )Diluted net
income (loss) per share - pro forma
    
    $
    (0.00
    )
    
    $
    (0.05
    )Diluted net
income (loss) per share - as reported
    
    $
    0.19
    
    
    $
    (0.11
    )
 The weighted average grant-date fair value was estimated using the Black-Scholes pricing model
with the following assumptions: Three Months EndedMarch 312005
    
    
    2004Expected life (years)
    
    
    5.0
    
    
    
    5.0Interest rate
    
    
    4.3
    %
    
    
    3.0
    %Volatility
    
    
    90
    %
    
    
    90
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Weight-average fair value
    
    $
    10.28
    
    
    $
    6.65
 The weighted average grant-date fair value of stock purchase rights granted under our Employee
Stock Purchase Plan was estimated using the Black-Scholes pricing model with the following
assumptions: 5




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Three Months EndedMarch 312005
    
    
    2004Expected life (years)
    
    
    1.7
    
    
    
    1.5Interest rate
    
    
    3.8
    %
    
    
    1.2
    %Volatility
    
    
    85
    %
    
    
    90
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Weighted average fair value
    
    $
    4.75
    
    
    $
    2.69
 The components of comprehensive income (loss) were as follows (in thousands): Three Months EndedMarch 312005
    
    
    2004Net income (loss)
    
    $
    16,633
    
    
    $
    (7,860
    )Change in
net unrealized gain on investments
    
    
    (1,807
    )
    
    
    Comprehensive income (loss)
    
    $
    14,826
    
    
    $
    (7,860
    )
 The only component of accumulated other comprehensive income is the change in the net unrealized
gain on our available for sale investments. For the three-months ended March 31, 2004,
comprehensive loss approximated reported net loss. Cumulative translation adjustments are
immaterial for all periods presented. 3. Net Income (Loss) Per Share Basic net income (loss) per share is computed using the weighted-average number of common
shares outstanding during the period, excluding shares subject to repurchase, and diluted net
income (loss) 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 (loss) per share (in
thousands, except per share amounts): Three Months Ended March 31,2005
    
    
    2004Net income (loss)
    
    $
    16,633
    
    
    $
    (7,860
    )Weighted average shares
    
    
    78,560
    
    
    
    73,108Unvested common shares subject to repurchase
    
    
    (253
    )
    
    
    (780
    )Weighted average common shares outstanding
    
    
    78,307
    
    
    
    72,328Weighted average common shares for diluted
net income (loss) per share
    
    
    87,376
    
    
    
    72,328Basic net income (loss) per share
    
    $
    0.21
    
    
    $
    (0.11
    )Diluted net income (loss) per share
    
    $
    0.19
    
    
    $
    (0.11
    )
 6




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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 for the three months ended March 31, 2005 (in thousands): Weighted-average common shares for basic net income per share
    
    
    78,307Weighted-average dilutive stock options outstanding under the
treasury stock method
    
    
    8,805Unvested common shares subject to repurchase
    
    
    264Weighted-average common shares for diluted net income per share
    
    
    87,376
 Had we generated net income for the three month period ended March 31, 2004, the number of
weighted average securities outstanding that would have been added to weighted average shares for
purposes of calculating diluted earnings per share would have been (in thousands): Unvested common stock subject to repurchase
    
    
    780Weighted-average dilutive stock
options
    
    
    10,307Total
    
    
    11,087
 As a result of our net loss for the three-months ended March 31, 2004, all common share
equivalents would have been anti-dilutive and therefore, have been excluded from the diluted net
loss per share calculation. The weighted average securities that were either out of the money or
anti-dilutive and excluded from our calculation of diluted net income (loss) per share were
approximately 5,277,000 and 20,411,000 for the three-month periods ended March 31, 2005 and 2004,
respectively. 4. Cash and cash equivalents and short-term investments We consider all highly liquid investments maturing within three months from the date of
purchase to be cash equivalents. All of our investments are categorized as available-for-sale at
the consolidated balance sheet dates, and have been presented at fair value. 7




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Cash and cash equivalents and short-term investments consisted of the following as of March
31, 2005 (in thousands): Gross
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueClassified as current assets:Cash
    
    $
    9,652
    
    
    $
    
    
    
    $
    
    
    
    $
    9,652Cash equivalents:Money market funds
    
    
    1,456
    
    
    
    
    
    
    
    
    
    
    
    1,456Commercial paper
    
    
    4,391
    
    
    
    
    
    
    
    
    
    
    
    4,391Total cash equivalents
    
    
    5,847
    
    
    
    
    
    
    
    
    
    
    
    5,847Total cash and cash equivalents
    
    
    15,499
    
    
    
    
    
    
    
    
    
    
    
    15,499Short-term investments:Corporate notes and bonds
    
    
    33,547
    
    
    
    
    
    
    
    (160
    )
    
    
    33,387Asset-backed securities
    
    
    18,183
    
    
    
    
    
    
    
    (77
    )
    
    
    18,106United States government agencies
    
    
    31,486
    
    
    
    
    
    
    
    (168
    )
    
    
    31,318Marketable equity securities *
    
    
    
    
    
    
    2,097
    
    
    
    
    
    
    
    2,097Total short-term investments
    
    
    83,216
    
    
    
    2,097
    
    
    
    (405
    )
    
    
    84,908Total cash and cash equivalents and
short-term investments
    
    $
    98,715
    
    
    $
    2,097
    
    
    $
    (405
    )
    
    $
    100,407
 Cash and cash equivalents and short-term investments consisted of the following as of December
31, 2004 (in thousands): Gross
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueClassified as current assets:Cash
    
    $
    9,592
    
    
    $
    
    
    
    $
    
    
    
    $
    9,592Cash equivalents:Money market funds
    
    
    6,201
    
    
    
    
    
    
    
    
    
    
    
    6,201Commercial paper
    
    
    7,486
    
    
    
    1
    
    
    
    
    
    
    
    7,487Total cash equivalents
    
    
    13,687
    
    
    
    1
    
    
    
    
    
    
    
    13,688Total cash and cash equivalents
    
    
    23,279
    
    
    
    1
    
    
    
    
    
    
    
    23,280Short-term investments:Corporate notes and bonds
    
    
    29,824
    
    
    
    
    
    
    
    (106
    )
    
    
    29,718Asset-backed securities
    
    
    5,250
    
    
    
    
    
    
    
    (11
    )
    
    
    5,239United States government agencies
    
    
    31,374
    
    
    
    1
    
    
    
    (79
    )
    
    
    31,296Marketable equity securities *
    
    
    
    
    
    
    3,987
    
    
    
    
    
    
    
    3,987Total short-term investments
    
    
    66,448
    
    
    
    3,988
    
    
    
    (196
    )
    
    
    70,240Total cash and cash equivalents and
short-term investments
    
    $
    89,727
    
    
    $
    3,989
    
    
    $
    (196
    )
    
    $
    93,520
   *
    
    Unrealized gain on marketable equity security represents our investment in Leadis, Inc., as
more fully described in Note 14. Market values were determined for each individual security in the investment portfolio. The
declines in value of these investments are primarily related to changes in interest rates and are
considered to be temporary in nature. With respect to our marketable equity securities, our policy
is to review our equity holdings on a regular basis to evaluate whether or not such securities has
experienced an other than temporary decline in fair value. Our policy 8




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includes, but is not limited to, reviewing the Companys cash position, earnings/revenue
outlook, stock price performance over the past six months, liquidity and management/ownership. If
we believe that an other-than-temporary decline in value exists, it is our policy to write down
these investments to the market value and record the related write-down in our consolidated
statement of operations. As of March 31, 2005, the average maturity period of our debt securities was approximately 278
days. 5. Balance Sheet Components March 31,
    
    
    Dec. 31,2005
    
    
    2004(in thousands)Inventories:Raw materials
    
    $
    2,239
    
    
    $
    3,089Work in process
    
    
    2,035
    
    
    
    2,372Finished goods
    
    
    7,870
    
    
    
    8,465$
    12,144
    
    
    $
    13,926Accrued liabilities:Accrued payroll and related expenses
    
    $
    3,312
    
    
    $
    3,351Restructuring accrual (see Note 7)
    
    
    835
    
    
    
    1,036Accrued legal fees
    
    
    715
    
    
    
    910Warranty accrual
    
    
    352
    
    
    
    351Bonus accrual
    
    
    727
    
    
    
    3,122Other accrued liabilities
    
    
    3,871
    
    
    
    4,648$
    9,812
    
    
    $
    13,418
 9




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Warranty Accrual At the time of revenue recognition, we provide an accrual for estimated costs to be incurred
pursuant to our warranty obligation. Our estimate is based primarily on historical experience.
Warranty accrual activity for the three months ended March 31, 2005 and 2004 was as follows (in
thousands): Three Months EndedMarch 31,2005
    
    
    2004Balance at January 1
    
    $
    351
    
    
    $
    271Provision for warranties issued during the period
    
    
    81
    
    
    
    130Cash and other settlements made during the period
    
    
    (80
    )
    
    
    (50
    )Balance at March 31
    
    $
    352
    
    
    $
    351
 6. Stock-Based Compensation Pro forma Net Income (Loss) We account for stock-based compensation arrangements in accordance with the provisions of
Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees,
and related interpretations, and comply with the disclosure provisions of Statement of Financial
Accounting Standard No. 148 (SFAS No. 148), Accounting for Stock-Based CompensationTransition and
Disclosure (an amendment of FASB Statement No. 123). Expense associated with stock-based
compensation is amortized over the vesting period of the individual award using an accelerated
method, as described in Financial Accounting Standards Board Interpretation No. 28. The Company is required under SFAS 148 to disclose pro forma information regarding option
grants made to its employees based on specified valuation techniques that produce estimated
compensation charges. We provide pro forma net income (loss) and pro forma net income (loss) per
share disclosures for stock-based awards made during the three-month period ended March 31, 2005
and March 31, 2004, as if the fair-value-based method defined in SFAS 123 had been applied. The
fair value of the stock-based awards was estimated using the Black-Scholes model. We are required to determine the fair value of stock option grants to non-employees and to
record the amount as an expense over the period during which services are provided to us.
Management calculates the fair value of these stock option grants using the Black-Scholes model,
which requires us to estimate the life of the stock option, the volatility of our stock, an
appropriate risk-free interest rate, and our dividend yield. The calculation of fair value is
highly sensitive to the expected life of the stock option and the volatility of our stock, both of
which we estimate based primarily on historical experience. The following table summarizes the components of our stock compensation expense (benefit) for
the three months ended March 31, 2005 and 2004 (in thousands): Three Months Ended March 31,2005
    
    
    2004Options granted to employees
    
    $
    188
    
    
    $
    31Options granted to non-employees
    
    
    939
    
    
    
    1,503Option repricings (benefit)
    
    
    (10,634
    )
    
    
    10,121Options assumed in connection with acquisitions
    
    
    180
    
    
    
    413Stock compensation expense (benefit)
    
    $
    (9,327
    )
    
    $
    12,068
 10




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Option repricing resulted in a benefit for the three months ended March 31, 2005 as opposed to
an expense in the three-month period ended March 31, 2004, as our average stock price during the
three months ended March 31, 2005 was lower compared to an increase in the three months ended March
31, 2004. 7. Asset impairment and restructuring activities During the third quarter of 2001, we began a program to focus our business on products and
technology, including those obtained through acquisitions, in which we have, or believe we can
achieve, a market leadership position. As part of this program, we decided to cancel numerous
products under development, to remove certain projects from our development plan, to phase out or
de-emphasize certain existing products and to integrate the operations of two acquired
companiesCMD Technology (CMD) and Silicon Communication Lab (SCL). In connection with this program, during the third quarter of 2001 through the first quarter of
2003, we recorded restructuring expenses as a result of four workforce reductions by eliminating
approximately 136 positions which consisted of both cash severance-related costs and non-cash
severance-related costs representing the intrinsic value of modified stock options. In addition,
restructuring expenses during this period were also a result of expected losses on leased
facilities, fixed asset write-downs, impairment of goodwill, intangible assets and acquired
technology offset by reversals of unearned compensation, a component of stockholders equity for
unvested stock options that were cancelled in connection with employee terminations. Severance and benefits payments are substantially complete. Lease payments will be made in the
form of cash through the end of the related lease term of November 2005. The following table
presents restructuring activity for the three-month periods ended March 31, 2005 and 2004 (in
thousands): 2005
    
    
    2004Severance and
    
    
    Leased
    
    
    
    
    
    
    Severance and
    
    
    LeasedBenefits
    
    
    Facilities
    
    
    Total
    
    
    Benefits
    
    
    Facilities
    
    
    TotalBalance as of January 1
    
    $
    32
    
    
    $
    1,004
    
    
    $
    1,036
    
    
    $
    37
    
    
    $
    1,838
    
    
    $
    1,875Cash payments
    
    
    
    
    
    
    (201
    )
    
    
    (201
    )
    
    
    (4
    )
    
    
    (223
    )
    
    
    (227
    )Balance as of March 31
    
    $
    32
    
    
    $
    803
    
    
    $
    835
    
    
    $
    33
    
    
    $
    1,615
    
    
    $
    1,648
 8. Debt Facility In October 2002, we entered into a $3.6 million term loan to refinance $3.1 million of debt
acquired in connection with our acquisition of CMD and $500,000 of other bank debt. This loan bore
interest at prime plus 0.25% and required monthly payments through its maturity of October 1, 2004.
This loan was repaid in full in 2004. During the three months ended March 31, 2003, we borrowed
$383,000 to finance certain capital equipment. This term loan bore interest at 5% and required
monthly payments through its maturity in February 2005. During the three-months ended March 31,
2005, this remaining balance on this loan was repaid in full. During the period ended March 31,
2004, we entered into an agreement to extend this debt facility by way of a revolving line of
credit with an availability of up to $10.0 million, and an equipment line of credit of up to $3.0
million. Borrowings under the revolving line are limited to the lesser of $10.0 million or 80% of
eligible accounts receivable as defined in the loan agreement. This revolving line of credit
expires in May 2005 and bears interest at either prime plus 0.25% or LIBOR plus 2.75%, at our
option. We are working actively to replace this existing line of credit. Quarterly and annual
financial covenants are contained within this revised agreement. No amounts have been drawn down
against this line of credit as of March 31,2005. As of March 31, 2005, we were in compliance with
all covenants. 11




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In November 2004, we leased certain capital equipment and as of March 31, 2005, the future
capital lease obligations were approximately $355,000. In January 2005, we acquired certain capital equipment under a debt arrangement and as of
March 31, 2005, the future debt obligations under this arrangement were approximately $80,000. 9. Legal Proceedings On April 24, 2001, we filed suit in the U.S. District Court for the Eastern District of
Virginia against Genesis Microchip Corp. and Genesis Microchip, Inc. (collectively, Genesis) for
infringement of our U.S. patent number 5,905,769 (USDC E.D. Virginia Civil Action No.: CA-01-266-R)
(the Federal Suit). On April 24, 2001, we also filed a complaint against Genesis with the
International Trade Commission of the United States government (ITC) for unlawful trade practices
related to the importation of articles infringing our patent (the ITC investigation). The actions
sought injunctions to halt the importation, sale, manufacture and use of Genesis DVI receiver chips
that infringe our patent, and monetary damages. We voluntarily moved to dismiss the ITC
investigation, with notice that we would proceed directly in the Federal Suit. Our motion to
dismiss was granted on February 7, 2002. We filed an amended complaint in the Federal Suit as of
February 28, 2002, adding a claim for infringement of our U.S. patent number 5,974,464. In April
2002, Genesis answered and made counterclaims against us for non-infringement, license, patent
invalidity, fraud, antitrust, unfair competition and patent misuse. Also in April 2002, we filed a
motion to dismiss certain of Genesiss counterclaims. In addition, we filed a motion to bifurcate
trial of the counterclaims to the extent the court does not dismiss them. In May 2002, the Court
granted our motion to dismiss certain of the counterclaims, with leave to amend. Genesis re-filed
counterclaims against us for fraud and patent misuse. We filed another motion to dismiss these
counterclaims, which the Court granted with prejudice on August 6, 2002. In December 2002, the
parties entered into a memorandum of understanding (MOU) to settle the case. When the parties
failed to reach agreement on a final, definitive agreement as required by the MOU, in January 2003,
the parties filed motions with the Court to enforce their respective interpretations of the MOU. On
July 15, 2003, the Court granted our motion to interpret the MOU in the manner we requested, and
ruled that Genesis had engaged in efforts to avoid its obligations under the MOU. On August 6,
2003, the Court entered a final judgment based on its July 15, 2003 ruling. Under the final
judgment order, Genesis was ordered to make a substantial cash payment, and to make royalty
payments; although Genesis has made a cash payment to the Court, it has not made all the payments
that are required under the final judgment order. We filed motions for reimbursement of some of our
expenses, including some of our legal fees, and for modification and/or clarification of certain
items of the judgment, and to hold Genesis in contempt of Court for breaching the protective order
in the case by disclosing secret information to at least one of our competitors. On December 19,
2003, the Court granted our motions in part and denied them in part: the court issued an amended
judgment, and held Genesis in contempt of Court for breaching the protective order. Under the
amended judgment, Genesis was ordered to make a substantial cash payment, royalty payments, and
interest; although Genesis has made and continues to make cash payments to the Court, it may not
have made all the payments that are required under the amended judgment. On January 16, 2004,
Genesis filed a notice of appeal to the U.S. Court of Appeals for the Federal Circuit. On August
26, 2004, the parties completed the filing of their respective appeal briefs. On October 26, 2004,
the Court of Appeals for the Federal Circuit issued an order setting an oral argument for the
appeal on December 7, 2004. The hearing took place as scheduled. At the end of the hearing, the
panel of Federal Circuit judges hearing the case stated that they believed that no final order had
been issued by the trial court, and that therefore the Federal Circuit did not have jurisdiction to
hear the appeal. The Federal Circuit issued its opinion on January 28, 2005 and, as expected, the
Federal Circuit dismissed Genesis appeal for lack of jurisdiction. The Federal Circuit held that
the lower courts order, which was based on the parties agreement to settle the case, was not
final and appealable. The case was remanded by the Federal Circuit back to the lower court. The
parties have been engaged in negotiating a stipulation by which the lower court can issue a new
final judgment and such action is expected shortly. To date, we have not received any cash payments nor have we recognized any revenue associated
with the matter. If the MOU is upheld in its present form after all appeals have been exhausted,
Genesis will be granted a royalty-bearing license for the right to use certain non-necessary patent
claims referred to in the DVI Adopters Agreement. In addition, upon Genesiss becoming a signatory
to the HDMI Adopters Agreement, Genesis will be granted a royalty-bearing license for the right to
use these claims as part of their HDMI implementation. Genesis 12




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will also be granted a royalty-bearing license to expand use of certain DVI- related patent
claims to the consumer electronics marketplace. We expect that an amended final, appealable order
will be entered in the second quarter of 2005. We further expect that Genesis will refile its appeal. Through March
31, 2005, we have spent approximately $11.0 million on this matter and expect to continue to incur
significant legal costs until the matter is resolved. Silicon Image, certain officers and directors, and Silicon Images underwriters have been
named as defendants in a securities class action lawsuit captioned Gonzales v. Silicon Image, et
al., No. 01 CV 10903 (SDNY 2001) pending in Federal District Court for the Southern District of New
York. The lawsuit alleges that all defendants were part of a scheme to manipulate the price of
Silicon Images stock in the aftermarket following Silicon Images initial public offering in
October 1999. Response to the complaint and discovery in this action on behalf of Silicon Image and
individual defendants has been stayed by order of the court. The lawsuit is proceeding as part of a
coordinated action of over 300 such cases brought by plaintiffs in the Southern District of New
York. Pursuant to a tolling agreement, individual defendants have been dropped from the suit for
the time being. In February 2003, the Court denied motions to dismiss brought by the underwriters
and certain issuers and ordered that the case may proceed against certain issuers including against
Silicon Image. A proposed settlement has been negotiated and has received preliminary approval by
the Court. In the event that the settlement is granted final approval, we do not expect it to have
a material effect on our results of operations or financial position. In the event that the
settlement is not finally approved, we could not accurately predict the outcome the litigation, but
we intend to defend this matter vigorously. In May 2003, Silicon Image, certain officers and directors, and Silicon Images underwriters
were named as defendants in a securities class action lawsuit captioned Liu v. Credit Suisse First
Boston Corp., et al., No. 03-20459 (S.D. Fla. 2003) and filed in Federal District Court for the
Southern District of Florida. The action was filed on behalf of a putative class of shareholders
who purchased stock from some or all of approximately 50 issuers whose public offerings were
underwritten by Credit Suisse First Boston. The initial complaint alleged that Silicon Image and
certain officers were part of a scheme by Credit Suisse First Boston to artificially inflate the
price of Silicon Images stock through the dissemination of allegedly false analysts reports.
Silicon Image was never served with a copy of the complaint. In June 2003, the action was
transferred to the Federal District Court for the Southern District of New York. The plaintiff in
this matter filed an amended complaint shortly thereafter, from which Silicon Image, and the named
officers, were dropped as defendants. Plaintiffs have not amended their complaint or otherwise
indicated that they intend to name Silicon Image or its officers or directors as defendants in the
action since that time. We believe that these claims were without merit and, if revived, we would
defend this matter vigorously. Silicon Image and certain of its officers were named as defendants in a securities class
action litigation captioned Curry v. Silicon Image, Inc., Steve Tirado, and Robert Gargus, No. C05
00456 MMC, commenced on January 31, 2005 and pending in the United States District Court for the
Northern District of California. Plaintiffs filed the action on behalf of a putative class of
shareholders who purchased Silicon Image stock between October 19, 2004 and January 24, 2005. The
lawsuit alleges that the Company and certain of its officers and directors made alleged
misstatements of material facts and violated certain provisions of Sections 20(a) and 10(b) of the
Exchange Act of 1934 and Rule 10b-5 promulgated there under. Two individuals, not including named
plaintiff Curry, have filed a motion to be designated by the court as lead plaintiffs. The Company
intends to defend itself vigorously in this matter. On
January 14, 2005, the Company received a notification that the
Securities and Exchange
Commission had commenced a formal, private investigation involving trading in the Companys
securities. The Company is fully cooperating with the investigation. 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. We intend to
defend such matters vigorously, and although adverse decisions or settlements may occur in one or
more of such cases, the final resolution of these matters, individually or in the aggregate, is not
expected to have a material adverse effect on our results of operations or financial position. 13




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10. Customer and Geographic Information Revenue by geographic area was as follows (in thousands): Three Months EndedMarch 31,2005
    
    
    2004Taiwan
    
    $
    11,368
    
    
    $
    9,457Japan
    
    
    7,541
    
    
    
    7,540United States
    
    
    12,158
    
    
    
    9,569Hong Kong
    
    
    1,218
    
    
    
    1,489Korea
    
    
    4,694
    
    
    
    1,730Other
    
    
    7,341
    
    
    
    6,073$
    44,320
    
    
    $
    35,858
 Revenue by product line was as follows (in thousands): Three Months EndedMarch 31,2005
    
    
    2004PC
    
    $
    10,920
    
    
    $
    9,667Consumer Electronics
    
    
    19,471
    
    
    
    11,367Storage products
    
    
    10,417
    
    
    
    11,016Development, licensing and royalties
    
    
    3,512
    
    
    
    3,808$
    44,320
    
    
    $
    35,858
 Revenue by product line, including development, licensing and royalties, was as follows (in
thousands): Three Months EndedMarch 31,2005
    
    
    2004PC
    
    $
    11,105
    
    
    $
    9,680Consumer Electronics
    
    
    21,232
    
    
    
    12,282Storage products
    
    
    11,983
    
    
    
    13,896$
    44,320
    
    
    $
    35,858
 For each period presented, substantially all long-lived assets were located within the United
States. For the three months ended March 31, 2005, one distributor generated 18% of our revenue and
another distributor generated 10% of our revenue, and as of March 31, 2005, two distributors represent
13% and 11% of gross accounts receivable. For the three months ended March 31, 2004, one
distributor generated 15% of our revenue and another distributor generated 11% of our revenue. 11. Guarantees and Indemnifications Certain of our licensing agreements indemnify our customers for any expenses or liabilities
resulting from claimed infringements of patent, trademark or copyright by third parties related to
the intellectual property content of our products. Certain of these indemnification provisions are
perpetual from execution of the agreement and, in some instances, the maximum amount of potential
future indemnification is not limited. To date, we have not paid any such claims or been required
to defend any lawsuits with respect to any claim. However, there can be no assurance that such
claims will not be filed in the future. 14




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12. Intangible Assets, net Components of intangible assets are as follows (in thousands): March 31, 2005
    
    
    December 31, 2004Gross
    
    
    
    
    
    
    GrossCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    Amount
    
    
    AmortizationIntangible assets subject
to amortization:Acquired technology
    
    $
    1,780
    
    
    $
    (984
    )
    
    $
    1,780
    
    
    $
    (863
    )Non-compete agreement
    
    
    1,849
    
    
    
    (1,236
    )
    
    
    1,849
    
    
    
    (1,083
    )Assembled workforce
    
    
    502
    
    
    
    (502
    )
    
    
    502
    
    
    
    (502
    )$
    4,131
    
    
    $
    (2,722
    )
    
    $
    4,131
    
    
    $
    (2,448
    )Intangible assets not
subject to amortization:Goodwill
    
    $
    13,021
    
    
    $
    
    
    
    $
    13,021
    
    
    $
    
 Estimated future amortization expense for our intangible assets is as follows for fiscal years
ending December 31 (in thousands): 2005
    
    $
    8232006
    
    
    5082007
    
    
    78$
    1,409
 Amortization of intangible assets for the three months ended March 31, 2005 and 2004 was
$274,000 and $357,000, respectively. 13. Income taxes For the quarter ended March 31, 2005, we have recorded a provision for income taxes of
$331,000. This primarily includes an estimated provision for U.S. alternative minimum taxes for the
fiscal year ending December 31, 2005 and a provision relating to taxes in foreign jurisdictions
where we operate based on expected annual estimated tax rates. At December 31, 2004, we had a net
operating loss carry-forward for federal income tax purposes of approximately $99.7 million that
expires in various years through 2024. These future tax benefits have not been recognized as an
asset on our balance sheet due to uncertainties surrounding our ability to generate sufficient
taxable income in future periods to realize these tax benefits. Under the Tax Reform Act of 1986,
the amounts of, and benefits from, net operating loss carry-forwards may be restricted or limited
in certain circumstances. 14. Unrealized gain on equity investments In October 2000, as consideration for the transfer of certain technology, we received from
Leadis Technology Inc. (Leadis), a development stage privately controlled enterprise, 300,000
shares of preferred stock and a derivative warrant to purchase 75,000 shares of the Companys
common stock. Initially these shares were valued at zero due to the early stage of Leadis
development and other uncertainties as to the realization of this investment. During the quarter
ended June 30, 2004, Leadis completed an initial public offering of its stock. In connection with
the initial public offering the preferred stock was converted into common stock on a 1:1 basis. In
connection with the initial public offering, we were subject to a lock-up agreement whereby we were
restricted from selling the stock and the common stock underlying the warrant for a period of six
months ending December 2004, (for the duration of the lock-up period we were also restricted from
engaging in hedging or other transactions which would result in or lead to the sale or disposition
of the shares underlying the derivative warrant). For the three and six month periods ended 15




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June 30, 2004, we valued the warrant using the Black-Scholes model and recorded a gain of
approximately $990,000. On September 16, 2004, we net exercised the derivative warrant for
equivalent shares of common stock (74,397 shares), and based on the price of the stock at that
date, recorded a loss of $64,000 on these shares. As of March 31, 2005, we hold approximately 351,000 Leadis common shares that were marked to
market (as an available for sale security, down from approximately 374,000 shares at December 31,
2004 as noted below), with any resulting gain/loss recorded as other comprehensive income (loss)
until sold or considered impaired on other than a temporary basis. Our typical practice has been
not to hold shares for investment purposes. In February 2005, we sold approximately 23,600 shares
at a price range from $7.40 to $7.50. These shares related to the warrant shares and consequently
in connection with this sale, we recorded a realized loss of approximately $120,000 for the
three-month period ended March 31, 2005. The value of our common stock holding in Leadis was
determined to be approximately $2.1 million as of March 31, 2005, based on Leadiss closing market
price of $5.98 at that date. This amount is classified as short-term investments. 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations This Form 10-Q contains forward-looking statements within the meaning of Section 21E of the
Securities and Exchange Act of 1934 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, may, will, can, should, could,
estimate, based on, intended, would, projected, forecasted 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 updates or 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. 16




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Overview Silicon Image is a leader in multi-gigabit semiconductor solutions for the secure
transmission, storage and display of rich digital media. The Companys mission is to be the leader
in defining the architectures, intellectual property (IP) and semiconductor technology required to
build secure digital content delivery systems. To ensure that rich digital content is available
across devices, consumer electronics (CE), personal computers and displays (PC) and storage devices
must be architected for content compatibility and interoperability. Silicon Images strategy entails establishing industry-standard, high-speed digital interfaces
and building market momentum and leadership through its first-to-market, standards-based IC
products. Further leveraging its IP portfolio, the Company broadens market adoption of the Digital
Visual Interface (DVI), High-Definition Multimedia Interface (HDMI) and Serial ATA (SATA)
interfaces by licensing its proven IP cores to companies providing advanced system-on-a-chip
solutions incorporating these interfaces. Licensing, in addition to creating revenue and return on
engineering investment in market segments we choose not to address, creates products complementary
and in some cases competitive to our own that expand the markets for our products and help to
improve industry wide interoperability. Silicon Image is a leader in the global PC and digital display arena with its innovative
PanelLink®-branded digital interconnect technology, which enables an all-digital connection
between PC host systems, such as PC motherboards, graphics add-in boards, notebook PCs and digital
displays such as LCD monitors, plasma displays and projectors. Silicon Images PanelLink technology
serves as the basis for both the DVI standard as well as for the popular HDMI standard, designed
for CE applications. Together, Silicon Images PanelLink DVI and HDMI solutions are the most
popular DVI and HDMI implementation in the market with more than 80 million units shipped to date. In 2000, our PC business represented 96.1% of total revenue. We embarked upon a plan to
diversify into the CE and storage markets for growth opportunities as well as to decrease our
dependence on the PC business. Products sold into the PC market generated 24.6% and 27.0% of our
revenue in the first three months of 2005 and 2004, respectively. If we include licensing revenues,
these percentages were 25.0% and 27.0% for the first three months of 2005 and 2004, respectively. Leveraging our core technology and standards-setting expertise, Silicon Image is a leading
force in advancing the adoption of HDMI, the digital audio and video interface standard for the
consumer electronics market. Introduced in 2002 by founders Hitachi Ltd. (Hitachi), Matsushita
Electric Industrial Co. (MEI or Panasonic), Philips Consumer Electronics International B.V.
(Philips), Silicon Image, Sony Corporation (Sony), Thomson Multimedia, S.A. (Thomson or Thomson
RCA) and Toshiba Corporation (Toshiba). HDMI enables the distribution of uncompressed,
high-definition video and multi-channel audio in a single, all-digital interface that dramatically
improves quality and simplifies cabling. Based on the same core technology used by the DVI
standard, Silicon Images HDMI technology is also marketed under the PanelLink brand and includes
High-bandwidth Digital Content Protection (HDCP), which is supported by Hollywood studios as the
technology of choice for the secure distribution of premium content over uncompressed digital
connections. Silicon Image shipped the first HDMI-compliant silicon to the market and currently
remains the market leader for HDMI functionality. Products sold into the CE market have been increasing as a percentage of our total revenues
and generated 43.9% and 31.7% of our total revenues for the first three months of 2005 and 2004,
respectively. If we include licensing revenues, these numbers were 47.9% and 34.3% for the first
three months of 2005 and 2004, respectively. Our CE products offer a secure interface for
transmission of digital video and audio to consumer devices, such as digital TVs, HDTVs, A/V
receivers, STBs, and DVD players. Demand for our products will be driven primarily by the adoption
rate of the HDMI standard within these product categories. In the storage market, Silicon Image has assumed a leadership role in SATA, the new
high-bandwidth, point-to-point interface that is replacing parallel ATA in desktop storage and
making inroads in the enterprise arena due to its improved price/performance. Silicon Image is a
leading supplier of discrete SATA devices with multiple motherboard and add-in-card design wins.
Silicon Images SATALink-branded solutions are fully SATA-compliant and offer advanced features
and capabilities such as Native Command Queuing, port multiplier capability 17




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##### Table of Contents



and ATAPI support. Silicon Image also supplies high-performance, low-power Fibre Channel
Serializer/Deserializer (SerDes) to leading switch manufacturers. In September 2004, Silicon Image introduced its first products based on its SteelVine
storage architecture that is expected to serve the storage needs of the SMB and consumer
electronics markets with a system-on-a-chip implementation that includes a high-speed five-port
switch, two micro-processors, firmware and the SATA interface, among other features. Products sold
into the storage market, as a percentage of our total revenues, generated 23.5% and 30.7% of our
revenue for the first three months of 2005 and 2004, respectively. If we include licensing
revenues, these numbers were 27.0% and 38.8% for the first three months of 2005 and 2004,
respectively. Demand for our storage semiconductor products is dependent upon the rate at which
interface technology transitions from parallel to serial, market acceptance of our SteelVine
architecture, and the extent to which SATA and Fibre Channel functionality are integrated into
chipsets and controllers offered by other companies, which would make our discrete devices
unnecessary. In the second quarter of 2005, we expect our legacy storage semiconductor business
(Fibre Channel and parallel ATA) revenues to decrease and our Serial ATA and SteelVine revenues to
increase. License revenue is recognized when an agreement with a licensee exists, the price is fixed or
determinable, delivery or performance has occurred, and collection is reasonably assured.
Generally, we expect to meet these criteria and recognize revenue at the time we deliver the
agreed-upon items. However, we may defer recognition of revenue until cash is received if
collection is not reasonably assured at the time of delivery. A number of our license agreements
require customer acceptance of deliverables, in which case we would defer recognition of revenue
until the licensee has accepted the deliverables and either payment has been received or is
expected within approximately 90 days of acceptance. Certain licensing agreements provide for
royalty payments based on agreed upon royalty rates. Such rates can be fixed or variable depending
on the terms of the agreement. The amount of revenue we recognize is determined based on a time
period or on the agreed-upon royalty rate, extended by the number of units shipped by the customer.
To determine the number of units shipped, we rely upon actual royalty reports from our customers
when available and rely upon estimates in lieu of actual royalty reports when we have a sufficient
history base of receiving royalties from a specific customer to make an estimate based on available
information from the licensee such as quantities held, manufactured and other information. These
estimates for royalties necessarily involve the application of management judgment. As a result of
our use of estimates, period-to-period numbers are trued-up in the following period to reflect
actual units shipped. To date, such true-up adjustments have not been significant. In cases where
royalty reports and other information are not available to allow us to estimate royalty revenue, we
recognize revenue only when royalty payments are received. Development revenue is recognized when
project milestones have been completed and acknowledged by the other party to the development
agreement and collection is reasonably assured. In certain instances, we recognize development
revenue using the lesser of non-refundable cash received or the results of using a proportional
performance measure. Our licensing activity is complementary to our product sales and it helps us to monetize our
intellectual property and accelerate market adoption curves associated with our technology. Most of
our licenses include a field of use restriction that prevents the licensee from building a chip in
direct competition with those market segments we have chosen to pursue. Revenue from development
for licensees, licensing and royalties accounted for 7.9% and 10.6% of our revenues for the first
three months in 2005 and 2004, respectively. Licensing contracts are complex and depend upon many
factors including completion of milestones, allocation of values to delivered items, and customer
acceptances Although we attempt to make these factors predictable, many of these factors require
significant judgment. License revenue has been lumpy over time, and is expected to continue to be
lumpy for the foreseeable future, resulting in considerable fluctuation in the amount of revenue
recognized in a particular quarter. Outlook We expect a 12-16% sequential growth in overall revenues in the second quarter of 2005. In our
storage business, we expect that storage IC revenues will be flat to up five percent. In addition,
we expect that revenue from our new SteelVine system products will grow significantly during the
second quarter of 2005. These products contributed $0.2 million to our revenue in the first quarter
of 2005, and we anticipate that they will contribute total revenues in 2005 of $8-$10 million.
Furthermore, we expect SteelVine chip sales to grow throughout the year and to make a meaningful
contribution to our storage IC revenue. We expect our PC revenues to decline sequentially by 5- 18




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15% during the second quarter of 2005. We expect the CE business to strengthen in the second
quarter of 2005 and expect revenue growth of 25-35% sequentially. In the first quarter of 2005, we achieved licensing revenues of $3.5 million. We expect
licensing revenues to be approximately $4.0 million for the second quarter of 2005. We expect overall gross margins to be flat as a percentage of revenue, in the second quarter
of 2005, assuming that we do not experience any significant expense or benefit from stock compensation. We are
unable to predict any such expense or benefit, as they are dependent on changes in our stock price
and volatility. We anticipate that cost improvements already in inventory, combined with planned
second quarter improvements, will offset the effect of ASP erosion and product mix. We cannot forecast operating expenses in the second quarter of 2005, due to the substantial
impact of stock compensation, which fluctuates from quarter to quarter with changes in our stock
price. Stock compensation provided a benefit in the first quarter of 2005, reducing operating
expenses by $9.3 million. In addition to the effect of any changes resulting from stock
compensation which is unknown, we expect our operating expenses in the second quarter of 2005 to
reflect an increase of $1.2 to $2.0 million as a result of head count increases, lower
non-recurring engineering credits, higher commissions and higher project related expenses without
taking into account stock compensation expense. We expect to incur substantial non-cash stock compensation expense in 2005 and future periods
as a result of previous stock option repricings, stock options assumed in connection with our prior
acquisitions, the issuance of stock options to consultants, and modifications to stock options. We
may also incur non-cash stock compensation expense in connection with future acquisitions. The
amount of stock compensation expense as well as any potential benefit will fluctuate each period
with changes in our stock price and volatility. We will also incur legal fees in 2005 in conjunction with our patent infringement lawsuit
against Genesis, and other outstanding litigation, including those items noted in our subsequent
events to our footnotes and related to Item 4. The amount of legal fees incurred will depend on the
duration of the litigation, as well as the nature and extent of the litigation activities. We are
not able to accurately estimate the amount of legal fees we will incur with respect to this matter;
however, we do expect to incur substantial amounts through at least the fourth quarter of 2005. Commitments, Contingencies and 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 49% of our revenue in the first quarter of 2005 and 47% of our revenue in 2004.
Additionally, the percentage of revenue generated through distributors tends to be significant,
since many OEMs rely upon third party manufacturers or distributors to provide purchasing and
inventory management functions. In the first quarter of 2005, 48% of our revenue was generated
through distributors, compared to 45% in 2004. Our licensing revenue is not generated through
distributors, and to the extent licensing revenue increases faster than product revenues, we would
expect a decrease in the percentage of our total revenues generated through distributors. A significant portion of our revenue is generated from products sold overseas. Sales to
customers in Asia, including distributors, generated 68% and 71% of our revenue in the first
quarter of 2005 and 2004, respectively. The reason for our geographical concentration in Asia is
that most of our products are part of flat panel displays, graphic cards and motherboards, the
majority of which are manufactured in Asia. The percentage of our revenue derived from any country
is dependent upon where our end customers choose to manufacture their products. Accordingly,
variability in our geographic revenue is not necessarily indicative of any geographic trends, but
rather is the combined effect of new design wins and changes in customer manufacturing locations.
All revenue to date has been denominated in U.S. dollars. In September 1998, we entered into an agreement with Intel to develop and promote the adoption
of a digital display interface specification. In connection with this agreement, we granted Intel a
warrant to purchase 285,714 shares of our common stock at $1.75 per share. Under the same
agreement, we granted Intel a warrant to purchase 285,714 shares of our common stock at $0.18 per
share upon achievement of a specified milestone that was reached during the first quarter of 1999.
Both of these warrants were exercised in May 2001. Additionally, if a second specified milestone is
achieved, which we do not believe is likely, we would be required to grant Intel a third 19




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warrant to purchase 285,714 shares of our common stock at $0.18 per share. The estimated fair value
of this warrant at March 31, 2005 would be $2.8 million. Critical Accounting Policies The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect amounts reported in
our consolidated financial statements and accompanying notes. We base our estimates on historical
experience and all known facts and circumstances that we believe are relevant. Actual results may
differ materially from our estimates. We believe the 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) long-lived assets, (5) goodwill,
(6) deferred tax assets, (7) accrued liabilities, (8) stock-based compensation expense, and (9)
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, 2004. 20




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Results of Operations for the Three Months Ended March 31, 2005 as compared to Results of
Operations for the Three Months Ended March 31, 2004 REVENUE (dollars in thousands): Three months ended March 31,2005
    
    
    2004
    
    
    ChangePersonal Computers
    
    $
    10,920
    
    
    $
    9,667
    
    
    
    13.0
    %Consumer Electronics
    
    
    19,471
    
    
    
    11,367
    
    
    
    71.3
    %Storage Products
    
    
    10,417
    
    
    
    11,016
    
    
    
    (5.4
    )%Product Revenue
    
    $
    40,808
    
    
    $
    32,050
    
    
    
    27.3
    %Percentage of total revenue
    
    
    92.1
    %
    
    
    89.4
    %
    
    2.7
    ptsDevelopment, licensing and royalties
    
    $
    3,512
    
    
    $
    3,808
    
    
    
    (7.8
    )%Percentage of total revenue
    
    
    7.9
    %
    
    
    10.6
    %
    
    (2.7
    )ptsTotal revenue
    
    $
    44,320
    
    
    $
    35,858
    
    
    
    23.6
    %
 REVENUE (with development, licensing and royalty revenues by product line, dollars in thousands): Three months ended March 31,2005
    
    
    2004
    
    
    ChangePersonal Computers
    
    $
    11,105
    
    
    $
    9,680
    
    
    
    14.7
    %Consumer Electronics
    
    
    21,232
    
    
    
    12,282
    
    
    
    72.9
    %Storage Products
    
    
    11,983
    
    
    
    13,896
    
    
    
    (13.8
    )%Total revenue
    
    $
    44,320
    
    
    $
    35,858
    
    
    
    23.6
    %
 Revenue was $44.3 million for the first quarter of 2005, an increase of 23.6 % from the first
quarter of 2004. The increase in revenues is due to increased sales of our consumer electronics and
personal computer products, which contributed an additional $8.1 million ($ 9.0 million including
licensing), and $1.3 million ($1.4 million including licensing) of revenue, respectively, offset
by a decrease in sales of storage products in the amount of $0.6 million ($1.9 million including
licensing). Our overall licensing revenue also declined by approximately $0.3 million. The increase
in the CE product line is primarily attributable to the transition of these markets to
high-definition and consequently, an increased demand for our HDMI based products. CE product
sales declined sequentially, reflecting seasonal patterns. The increase in the PC product line is
primarily attributable to the increased demand of DVI receiver sales offset by a decline in
transmitter sales. The decrease in our storage business is primarily attributable to the expected
decline in revenues from our fibre-channel and parallel ATA product lines offset by an increase in
revenues from our storage IC business which are primarily driven by the demand for our serial ATA
controllers. We license our technology in each of our areas of business, but usually limit the
scope of the license to market areas that are complementary to our products sales and that do not
directly compete with our direct product offerings. Development, licensing and royalty revenues
declined as a percentage of total revenues from 10.6% in the first quarter of 2004 to 7.9% in the
first quarter of 2005, reflecting the inherently uneven nature of our licensing 21




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revenues, as a small number of transactions can represent a large portion of licensing revenues and
changes in the number or timing of these transactions can have a significant impact on licensing
revenues. License revenue has been lumpy over time, and is expected to continue to be lumpy for the
foreseeable future, resulting in considerable fluctuation in the amount of revenue recognized in a
particular quarter. Overall, we expect a sequential growth in revenues in the range of 12-16%
during the second quarter of 2005. COST OF REVENUE AND GROSS MARGIN Three months ended March 31,2005
    
    
    2004
    
    
    Change(Dollars in thousands)Product gross margin (excluding licensing revenue)*
    
    $
    25,303
    
    
    $
    17,535Percentage of product revenue
    
    
    62.0
    %
    
    
    54.7
    %
    
    7.3ptsLicensing revenue margin
    
    $
    3,512
    
    
    $
    3,808Total gross margin*
    
    $
    28,815
    
    
    $
    21,343Percentage of total revenue
    
    
    65.0
    %
    
    
    59.5
    %
    
    5.5pts*Stock compensation (benefit) expense (included in above)
    
    $
    (1,196
    )
    
    $
    1,152
 Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our
products, as well as related overhead costs. Gross margin (revenue minus cost of revenue, as a
percentage of revenue) was 65.0% and 59.5% for the three month periods ended March 31, 2005 and
2004, respectively, and includes non-cash stock compensation expense (benefit) of ($1.2) million
and $1.2 million, respectively. Overall, gross margin increased substantially due to the effect of
the stock benefit year over year ($2.4 million effect or 5.9%), offset in part by a marginal
decline of 0.4% attributable to the effect of lower average selling prices and slightly lower
licensing revenues. Relative to the first quarter, gross margins are expected to remain flat during the second
quarter, assuming that we do not experience any expense or benefit from stock compensation. We are
unable to predict any such expense or benefit, as they are dependent on changes in our stock price
and volatility. OPERATING EXPENSES Three months ended March 31,2005
    
    
    2004
    
    
    Change(Dollars in thousands)Research and development (1)
    
    $
    8,122
    
    
    $
    16,798
    
    
    
    (51.6
    )%Percentage of total revenue
    
    
    18.3
    %
    
    
    46.8
    %
    
    (28.5
    )ptsSelling, general and administrative (2)
    
    $
    3,904
    
    
    $
    11,650
    
    
    
    (66.5
    )%Percentage of total revenue
    
    
    8.8
    %
    
    
    32.5
    %
    
    (23.7
    )ptsAmortization of intangible assets
    
    $
    274
    
    
    $
    357
    
    
    
    (23.2
    )%Percentage of total revenue
    
    
    0.6
    %
    
    
    1.0
    %
    
    0.4
    )ptsPatent assertion costs
    
    $
    49
    
    
    $
    165
    
    
    
    (70.3
    )%Interest income and other, net
    
    $
    498
    
    
    $
    84
    
    
    
    492.9
    %
   (1)
    
    Includes non-cash stock compensation (benefit) expense of $(4.4) million and $6.2 million for
the three month periods ended March 31, 2005 and 2004, respectively. 22




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(2)
    
    Includes non-cash stock compensation (benefit) expense of $(3.7) million and $4.7 million for
the three month periods ended March 31, 2005 and 2004, respectively. Research and Development.R&D expense consists primarily of compensation and related costs for
employees, fees for independent contractors, the cost of software tools used for designing and
testing our products, and costs associated with prototype materials. Our R&D expense decreased
51.6% from the first quarter of 2004, as a result of non-cash stock compensation which provided a
$4.4 million benefit to our research and development expense in the first quarter of 2005 as
compared to a $6.2 million stock compensation expense in the first quarter of 2004. The effect of
this change was partially offset by a $2.0 million increase in other research and development
expenditures primarily due to an increase in the number of R&D projects to support the multiple
markets in which we operate. Selling, General and Administrative.SG&A expense consists primarily of employee compensation
and benefits, sales commissions, and marketing and promotional expenses. Our SG&A expense
decreased 66.5% from the first quarter of 2004, as a result of non-cash stock compensation which
provided a $3.7 million benefit to our SG&A expense in the first quarter of 2005 compared to a $4.7
million stock compensation expense in the first quarter of 2004. The effect of this change was
partially offset by a $0.6 million increase in compensation included in our SG&A resulting from
increased headcount to support the increased rate of growth of the Company. Stock Compensation.Stock compensation expense (benefit) included in the functional expense
amounts was ($9.3) million or (21.0)% of revenue for the first quarter of 2005 and $12.1 million or
33.7% of revenue for the three month period ended March 31, 2004. The decrease in total stock
compensation can be primarily attributed to the effect of a lower stock price during the first
quarter of 2005, compared to the fourth quarter of 2004, relative to our repriced options offset by
a charge relating to other options subject to variable accounting. These expenses are included in
cost of sales, research and development and selling and general administrative costs, and are shown
here for the reader to better understand the composition of these expenses and reasons these
expenses change from period to period. We may incur substantial non-cash stock compensation expense in future periods as a result of
(1) the issuance of, or modifications to, restricted stock awards and stock option grants to
employees and consultants, (2) the stock option repricing programs we implemented in 2000 and 2001,
(3) amortization of our existing unearned compensation balance, and (4) the impact on the adoption
of SFAS 123R. Since the expense associated with our stock option repricings and stock options
issued to non-employee consultants is dependent on our stock price and volatility, stock
compensation expense (or benefit) may fluctuate significantly from period to period. To date, we
have recognized over $23 million of expense in connection with our stock option repricings, and
this may become an even more significant component of our stock compensation expense in future
periods depending on our weighted average stock price and the number of such repriced options that
continue to remain outstanding. Approximately 1.7 million stock options were outstanding as of
March 31, 2005 that were repriced in 2001 and 2000. For these repriced options, the Company will
continue to mark-to-market options that are vested and outstanding, until they are exercised,
cancelled or are forfeited. In future periods, to the extent that the market price of our stock
exceeds or is lower than the market price as of March 31, 2005, we could incur an expense or a
benefit, respectively, pertaining to these outstanding options and an incremental charge for
options that vest and become outstanding in those periods. Amortization of Intangible Assets.Amortization of intangible assets was $274,000 and $357,000
for the first quarters of 2005 and 2004, respectively, relating to intangible assets on our balance
sheets, pursuant to our acquisition of Transwarp Netwoks, Inc. during the second quarter of 2003. Restructuring.During the third quarter of 2001, we began a program to focus our business on
products and technology, including those obtained through acquisitions, in which we have, or
believe we can achieve, a market leadership position. As part of this program, we decided to cancel
numerous products under development, to remove certain projects from our development plan, to phase
out or de-emphasize certain existing products and to integrate the operations of two acquired
companiesCMD Technology (CMD) and Silicon Communication Lab (SCL). In connection with this program, during the third quarter of 2001 through the first quarter of
2003, we recorded restructuring expenses as a result of four workforce reductions by eliminating
approximately 136 positions which consisted of both cash severance-related costs and non-cash
severance-related costs representing the intrinsic value of modified stock options. In addition,
restructuring expenses during this period were also a result of expected loss on leased facilities,
fixed asset write-downs, impairment of goodwill, intangible assets and acquired technology, 23




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offset by reversals of unearned compensation, a component of stockholders equity for unvested
stock options that were cancelled in connection with employee terminations. Severance and benefits payments are substantially complete. Lease payments will be made in the
form of cash through the end of the related lease term of November 2005. The following table
presents restructuring activity for the three-month periods ended March 31, 2005 and 2004 (in
thousands): 2005
    
    
    2004Severance and
    
    
    Leased
    
    
    
    
    
    
    Severance and
    
    
    LeasedBenefits
    
    
    Facilities
    
    
    Total
    
    
    Benefits
    
    
    Facilities
    
    
    TotalBalance as of January 1
    
    $
    32
    
    
    $
    1,004
    
    
    $
    1,036
    
    
    $
    37
    
    
    $
    1,838
    
    
    $
    1,875Cash payments
    
    
    
    
    
    
    (201
    )
    
    
    (201
    )
    
    
    (4
    )
    
    
    (223
    )
    
    
    (227
    )Balance as of March 31
    
    $
    32
    
    
    $
    803
    
    
    $
    835
    
    
    $
    33
    
    
    $
    1,615
    
    
    $
    1,648
 Patent Assertion Costs.Patent assertion costs which are included in selling, general and
administration expenses were $0.1 million for the first quarter of 2005 as compared to $0.2 million
during the same period in 2004. Patent assertion costs are related to the lawsuit we filed against
Genesis in April 2001. The decrease in 2005 compared to 2004 is attributable to a lower level of
activity during the first quarter of 2005. However, we expect to incur significant patent assertion
costs through at least the fourth quarter of 2005. The amount of legal fees incurred will depend on
the duration of the litigation, as well as the nature and extent of the litigation activities. We
are not able to accurately estimate the amount of legal fees we will incur. Interest Income and Other, Net.This principally includes interest income and interest
expense. The net amount was $498,000 for the first quarter of 2005, compared to $84,000 for the
first quarter of 2004. The increase is principally due to substantially higher cash balances and
higher interest rates. Provision for Income Taxes.For the quarter ended March 31, 2005, we have recorded a provision
for income taxes of $331,000. This primarily includes an estimated provision for U.S. alternative
minimum taxes for the fiscal year ending December 31, 2005 and a provision relating to taxes in
foreign jurisdictions where we operate based on expected annual estimated tax rates. At December
31, 2004, we had a net operating loss carry forward for federal income tax purposes of
approximately $99.7 million that expires in various years through 2024. These future tax benefits
have not been recognized as an asset on our balance sheets due to uncertainties surrounding our
ability to generate sufficient taxable income in future periods to realize these tax benefits.
Under the Tax Reform Act of 1986, the amounts of, and benefits from, net operating loss carry
forwards may be restricted or limited in certain circumstances. 24




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LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION March 31,
    
    
    December 31,2005
    
    
    2004
    
    
    Change(Dollars in thousands)Cash and cash equivalents
    
    $
    15,499
    
    
    $
    23,280
    
    
    $
    (7,781
    )Short-term investments
    
    
    84,908
    
    
    
    70,240
    
    
    
    14,668Total cash,
cash equivalents and short-term
investments
    
    $
    100,407
    
    
    $
    93,520
    
    
    $
    6,887% of total assets
    
    
    61.9
    %
    
    
    60.4
    %
    
    1.5
    ptsTotal current assets
    
    $
    138,051
    
    
    $
    129,936
    
    
    $
    8,115Total current liabilities
    
    
    30,506
    
    
    
    32,829
    
    
    
    (2,323
    )Working capital
    
    $
    107,545
    
    
    $
    97,107
    
    
    $
    10,438
 Three months ended March 31,2005
    
    

2004
    
    
    ChangeCash provided by operating activities
    
    $
    5,650
    
    
    $
    9,027
    
    
    $
    (3,377
    )Cash provided by (used in) investing activities
    
    
    (17,612
    )
    
    
    508
    
    
    
    (18,120
    )Cash provided by financing activities
    
    $
    4,181
    
    
    $
    4,555
    
    
    $
    (374
    )
 Since our inception, we have financed our operations through a combination of private sales of
convertible preferred stock, our initial public offering, lines of credit, capital lease financing
and cash flows from operations. At March 31, 2005, we had $107.5 million of working capital and
$100.4 million of cash and cash equivalents and short-term investments. If we are not able to generate
cash from operating activities, stock option exercises, and proceeds from sales of shares under our
employee stock purchase plan, we will liquidate short-term investments or, to the extent available,
utilize credit arrangements to meet our cash needs. Working Capital Net accounts receivable increased to $22.1 million at March 31, 2005 from $19.4 million at
December 31, 2004. The increase is primarily due to the timing of the receivables. Our days sales
outstanding (DSO) was 45 days at March 31, 2005, compared to 38 days at December 31, 2004. The
increase in DSO is consistent with the timing of shipments near the end of the quarter. We expect
the DSO days to be in the 43-47 days range during the second quarter of 2005. Inventories decreased to $12.1 million at March 31, 2005 from $13.9 million at December 31,
2004. The decrease is attributable to increased business volume and an effort to reduce overall
inventory, especially wafer starts. Our inventory turn rate increased to 5.5 as at March 31, 2005
from 4.8 as at December 31, 2004. Inventory turns are computed on an annualized basis, and are a
measure of the number of times inventory is replenished during the year. Our inventory turns
increased primarily due to higher business volume during the first
quarter of 2005 and lower inventory balances as at March 31, 2005. We expect this measure to be at the 5.3 to 5.6
level during the second quarter of 2005. Accounts payable increased to $7.2 million and accrued liabilities decreased to $9.8 million,
respectively, at March 31, 2005 from $6.8 million and $13.4 million, respectively, at December 31,
2004. The increase in accounts payable was due to the timing associated with internal check
processing, and the decrease in accrued liabilities is primarily from payments made in this quarter
for year-end bonuses and commissions offset by quarterly accruals. Deferred license revenue increased to $3.0 million at March 31, 2005 from $2.1 million at
December 31, 2004. The increase is principally due to the timing of when the deferred license
revenue will be recognized as revenue. Operating Activities Operating activities generated $5.7 million of cash during the first quarter of 2005. For the
first quarter of 2005, our net income excluding non-cash items for depreciation and amortization,
stock compensation expense (benefit), amortization of intangible assets was $9.1 million. Decreases
in inventories, accrued liabilities and other assets, offset by increases in accounts receivable,
prepaid expenses, accounts payable, deferred revenue and deferred margin on sales to distributors
was a net use of cash of $3.4 million. Operating activities contributed $9.0 million of cash
during the first quarter of 2004. During the first quarter of 2004, our net income excluding
non-cash items for depreciation, stock compensation expense, and amortization of intangible assets
was $5.7 million, which accounts for some of the cash provided by operating activities. Decreases
in inventories, prepaid expenses, and other assets offset by increases in accounts receivable,
accounts payable, accrued liabilities and deferred license revenue and deferred margin on sales to
distributors contributed $3.2 million. 25




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##### Table of Contents



Investing and Financing Activities Investing activities used $17.6 million and provided $0.5 million of cash during the three
months ended March 31, 2005 and 2004, respectively. For the three-months ended March 31, 2005, the
application of cash related to the purchases of short-term investments and capital expenditures.
For the three-month period ended March 31, 2004, the source of cash was net proceeds from sales of
short-term investments, partially offset by capital expenditures. We generated $4.2 million and $4.6 million from financing activities during the three months
ended March 31, 2005 and 2004. Cash provided by financing activities in both periods was primarily
from stock option exercises and proceeds from sales of shares under our employee stock purchase
plan, partially offset by repayments of our capital leases and other obligations. Debt and Lease Obligations In October 2002, we entered into a $3.6 million term loan to refinance $3.1 million of debt
acquired in connection with our acquisition of CMD and $500,000 of other bank debt. This loan bore
interest at prime plus 0.25% and required monthly payments through its maturity of October 1, 2004.
This loan was repaid in full in 2004. During the three months ended March 31, 2003, we borrowed
$383,000 to finance certain capital equipment. This term loan bore interest at 5% and required
monthly payments through its maturity in February 2005. During the three-months ended March 31,
2005, this remaining balance on this loan was repaid in full. During the period ended March 31,
2004, we entered into an agreement to extend this debt facility by way of a revolving line of
credit with an availability of up to $10.0 million, and an equipment line of credit of up to $3.0
million. Borrowings under the revolving line are limited to the lesser of $10.0 million or 80% of
eligible accounts receivable as defined in the loan agreement. This revolving line of credit
expires in May 2005 and bears interest at either prime plus 0.25% or LIBOR plus 2.75%, at our
option. We are working to put in place a new line of credit to replace the existing line that
expires in May 2005. Quarterly and annual financial covenants are contained within this revised
agreement. No amounts have been drawn down against this line of credit as at March 31,2005. As of
March 31, 2005, we were in compliance with all covenants. In November 2004, we leased certain capital equipment and as of March 31, 2005, the future
capital lease obligations were approximately $355,000. In January 2005, we acquired certain capital equipment under a debt arrangement and as of
March 31, 2005, the future debt obligations under this arrangement were approximately $80,000. Future minimum payments for our operating leases, debt and inventory related purchase
obligations outstanding at March 31, 2005 are as follows (in thousands): Payments due inContractual obligations
    
    Total
    
    
    Less than 1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    More than 5 yearsDebt obligations
    
    $
    435
    
    
    $
    261
    
    
    $
    174
    
    
    $
    
    
    
    $
    Operating lease obligations
    
    
    9,017
    
    
    
    2,793
    
    
    
    2,804
    
    
    
    2,922
    
    
    
    498Inventory purchase obligations
    
    
    6,658
    
    
    
    6,658
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    16,110
    
    
    $
    9,712
    
    
    $
    2,978
    
    
    $
    2,922
    
    
    $
    498
 26




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Future minimum lease payments under operating leases have not been reduced by expected
sublease rental income or by the amount of our restructuring accrual that relates to leased
facilities. We plan to spend approximately $8.5 to $9.5 million during the remainder of the 2005 fiscal
year for equipment, furniture and software. Based on our estimated cash flows, we believe our existing cash and short-term investments are
sufficient to meet our capital and operating requirements for at least the next 12 months. Our
future operating and capital requirements depend on many factors, including the levels at which we
generate product revenue and related margins, the extent to which we generate cash through stock
option exercises and proceeds from sales of shares under our employee stock purchase plan, the
timing and extent of development, licensing and royalty revenues, 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. Factors Affecting Future Results 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. We operate in rapidly evolving markets, which makes it difficult to evaluate our future prospects. The revenue and income potential of our business and the markets we serve are early in their
lifecycle and are difficult to predict. The Digital Visual Interface (DVI) specification, which is
based on technology developed by us and used in many of our products, was first published in April
1999. We completed our first generation of consumer electronics and storage IC products in
mid-to-late 2001. In addition, the preliminary serial ATA specification was first published in
August 2001 and the High Definition Multimedia Interface (HDMI) specification was first released in
December 2002. 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. We have a history of losses and may not become profitable. For the three months ended March 31, 2005, we have a net income of $16.6 million. However, prior
to this quarter, we have incurred net losses in each fiscal year since our inception. We incurred
losses of $0.3 million and $12.8 million for the years ended December 31, 2004 and 2003,
respectively. While our operations were profitable in the three months ended March 31, 2005, we may
not sustain profitability. Our quarterly operating results may fluctuate significantly and are difficult to predict. Our 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: 27




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
    the growth, evolution and rate of adoption of industry standards for our key markets,
including digital-ready PCs and displays, consumer electronics 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 lumpy over time, and is expected to
continue to be lumpy 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;
    the cost of components for our products and prices charged by the third parties who
manufacture, assemble and test our products;
    fluctuations in the price of our common stock, which drive a substantial portion of our
non-cash stock compensation expense; and
    the nature and extent of litigation activities, particularly relating to our patent
infringement suit against Genesis Microchip, and any subsequent legal proceedings related
to the matters raised in that suit; and class action lawsuits against us that were
initiated in early 2005; 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. 28




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Our future quarterly operating results are highly dependent upon how well we manage our business. Our 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 PC, storage
and CE; which may involve additional research and development, marketing or other costs and
expenses;
    our ability to close licensing deals when expected and make timely deliverables and
milestones on which recognition of revenue often depends;
    our ability to engineer customer solutions that adhere to industry standards in a
timely, and cost-effective manner;
    our ability to achieve acceptable manufacturing yields and develop automated test
programs within a reasonable time frame for our new products;
    our ability to manage joint ventures and projects, design services, and our supply
chain partners;
    our ability to monitor the activities of our licensees to ensure compliance with
license restrictions and remittance of royalties;
    our ability to structure our organization to enable achievement of our operating
objectives and to meet the needs of our customers and markets;
    the success of the distribution and partner channels through which we choose to sell our products; and
    our ability to manage expenses and inventory levels. If we fail to effectively manage our business, this could adversely affect our results of
operations. The licensing component of our business strategy increases business risk and volatility. Part of our business strategy is to license certain of our Companys technology to companies
that address markets in which we do not want to directly participate. We signed our first license
contract in December 2001 and have limited experience marketing and selling our technology on a
licensing basis. There can be no assurance that additional companies will be interested in
licensing our technology on commercially favorable terms or at all. We also cannot ensure that
companies who license 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. Licensing contracts 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
revenues could fluctuate significantly from period to period because they are heavily dependent on
a few key deals being completed in a particular period, the timing of which is difficult to
predict. Because of their high margin content, licensing revenues can have a disproportionate
impact on gross margins and profitability. Also, generating revenue from licensing 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. In addition, in any
period, our expectation of licensing revenue is or may be dependent on one or a few licenses being
completed. 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 licensing transactions are increasingly
complex and subject to 29




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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 reduce revenue from sales of our
products and increased losses. The PC, CE 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. Our display products face competition from a number of sources, including
analog solutions, DVI-based solutions, dual (analog and DVI based) solutions and other digital
interface solutions. We expect competition in the display market to increase. For example, Analog
Devices, ATI, Broadcom, Chrontel, Genesis Microchip, Explore Tech, National Semiconductor, Novatek,
nVidia, Philips, Pixelworks, SIS, Smart ASIC, ST Microelectronics, Sunplus, Texas Instruments,
Thine, and Weltrend, are shipping products or have announced intentions to introduce products
and/or other digital interface solutions that we expect will compete with our PanelLink products.
Other companies have announced DVI-based solutions and we expect that additional companies are
likely to enter the market. Current or potential customers, including our own licensees, may also
develop solutions that could compete with us, directly or indirectly, such as the integration of a
DVI transmitter into a graphics processing chip or integration of a DVI receiver into a panel
monitor controller. In the CE market, our digital interface products are used to connect cable set-top boxes,
satellite set-top boxes and DVD players to digital televisions. These products incorporate DVI and
High-bandwidth Digital Content Protection (HDCP), or HDMI with or without HDCP support. Companies
that have announced or are shipping DVI-HDCP solutions include Texas Instruments (TI), Toshiba,
Panasonic, Mstar, Thine, Broadcom and Genesis Microchip (Genesis). In addition, our video
processing products face competition from products sold by AV Science, Broadcom, Focus
Enhancements, Genesis, Mediamatics, Micronas Semiconductor, Oplus, Philips, Pixelworks, Zoran, ATI
and Trident. We also compete, in some instances, against in-house developed solutions designed by
large original equipment manufacturers and or customers with captive in-house semiconductor
capabilities. We expect competition for HDMI products from the other HDMI founders and adopters,
including Hitachi, Matsushita, Philips, Sony, Thomson, Toshiba, MStar, and Analog Devices. Toshiba
and Matsushita have working HDMI solutions. Silicon Image has several other licensees and smaller partnerships of a similar nature. The
effect of these partnerships over time should accelerate growth and lower research and
development expenses. While the products developed in these partnerships may return lower gross
margins for Silicon Image, they will fuel higher revenues with less investment in development
expenses; thus these products are expected to contribute to the bottom line in a similar fashion to
the contribution we receive from higher gross margin, non- partnership related products. In the storage market, our Fibre Channel products face competition from companies selling
similar discrete products, including PMC Sierra, ServerWorks and Vitesse, from other Fibre Channel
Serializer-Deserializer (SerDes) providers who license their core technology, such as LSI Logic,
and from companies that sell Host Bus Adapters (HBA) controllers with integrated SerDes, such as
QLogic and Agilent. In the future, our current or potential customers may also develop their own
proprietary solutions that may include integration of SerDes. Our SATA products compete with similar products from Marvell and Promise. In addition, other
companies such as Adaptec, APT, ATI, Intel, LSI Logic, ServerWorks and Vitesse have developed or
announced intentions to develop SATA controllers. We also compete against Intel and other
motherboard chipset makers that have integrated SATA functionality into their chipsets. Our parallel ATA products compete with similar products from Promise and Highpoint. Our SteelVine products compete with similar products from Adaptec, IQStor and Xyratex. 30




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Some of these 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. In addition, some of our competitors could merge (for example, Genesis and Pixelworks
announced, and then terminated, such a merger), which may enhance their market presence. As a
result, they may be able to adapt more quickly to new or emerging technologies and customer
requirements, or devote more resources to the promotion and sale of their products. We cannot
assure you that we can compete successfully against current or potential competitors, or that
competition will not reduce our revenue and increase our losses. Demand for our consumer electronics products is dependent on the adoption and widespread use of
the HDMI specification. Our success in the consumer electronics market is largely dependent upon the rapid and
widespread adoption of the HDMI specification, which combines high-definition video and
multi-channel audio in one digital interface and uses our patented underlying transition minimized
differential signaling (TMDS® ) technology, and optionally Intels HDCP technology, as
the basis for the interface. Version 1.0 of the specification was published for adoption in
December 2002 and version 1.1 of the specification was published for adoption in May 2004. We
cannot predict the rate at which manufacturers will adopt the HDMI specification. Adoption of the
HDMI specification may be affected by the availability of consumer products, such as DVD players
and televisions, and of computer components that implement this new interface. Other competing
specifications may also emerge that could adversely affect the acceptance of the HDMI
specification. Delays in the widespread adoption of the HDMI specification could reduce acceptance
of our products, limit or reduce our revenue growth and increase our losses. We believe that the adoption of our CE products may be affected in part by U.S. and
international regulations relating to digital television, cable, satellite and over-the-air digital
transmissions, specifically regulations relating to the transition from analog to digital
television. The Federal Communications Commission (FCC) has adopted rules governing the transition
from analog to digital television, which include rules governing the requirements for television
sets sold in the United States designed to speed the transition to digital television. The FCC has
delayed such requirements and timetables for phasing in digital television in the past. We cannot
predict whether the FCC will further delay its rules relating to the digital television
requirements and timetables. In the event that additional regulatory activities, either in the
United States or internationally, delay or postpone the transition to digital television beyond the
anticipated time frame, that could reduce the demand for our CE products. In addition, we believe that the rate of HDMI adoption may be accelerated by FCC rules
requiring that after July 2005 high-definition STBs distributed by cable operators include a DVI or
HDMI interface and that as of certain phase-in dates televisions marketed or labeled as digital
cable ready include a DVI or HDMI interface. However, we cannot predict whether these rules will
be amended prior to phase in or that their phase-in dates will not be pushed back or otherwise
delayed. In the event that the phase-in dates are postponed or otherwise delayed the demand for our
products could be reduced, which would adversely affect our business. In the event that mandatory
use of a DVI or HDMI interface in STBs distributed by cable operators were to be delayed beyond the
currently anticipated time frame or not required at all, that could reduce the demand for our CE
products, which would adversely affect our business. 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. We believe that the adoption of HDMI may be affected by the availability of high-quality
digital content to devices equipped with HDMI or DVI interfaces. Typically high quality digital
content is made available to devices equipped with HDMI or DVI interfaces through high-definition
television or digital television distribution channels. To the extent that the availability of such
content is delayed or not made available by the content owners or broadcasters and distributors of
such content then demand for HDMI products could be delayed or reduced. Transmission of audio and video from source devices (such as a DVD player or STB) to sink
devices (such as an HDTV) over HDMI with HDCP represents a combination of new technologies
working in concert. Cable and satellite system operators are just beginning to require
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source and sink devices in consumer homes, and DVD players incorporating this technology have
only recently come to market. Complexities with these technologies and the variability in
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. Growth of the market for our PC products depends on the widespread adoption and use of the DVI
specification. Our success is largely dependent upon the rapid and widespread adoption of the DVI
specification, which defines a high-speed data communication link between computers and digital
displays. We cannot predict the rate at which manufacturers of computers and digital displays will
adopt the DVI specification. The adoption of DVI has been slower than we originally anticipated.
Reportedly, the 2004 DVI adoption rate in the PC market was approximately in the range of 45-50%.
The DVI adoption rate in the PC market was reported to be approximately 25% and 12% in 2003 and
2002, respectively. Adoption of the DVI specification may be affected by the availability of
computer components able to communicate DVI-compliant signals, such as transmitters, receivers,
connectors and cables necessary to implement the specification. Other specifications may also
emerge that could adversely affect the acceptance of the DVI specification. For example, a number
of companies have promoted alternatives to the DVI specification using other interface
technologies, such as low voltage differential signaling, or LVDS. Further delays in the widespread
adoption of the DVI specification could reduce acceptance of our products, limit or reduce our
revenue growth and increase our losses. Our success depends on the growth of the digital display market. Our PC business depends on the growth of the digital display market. The potential size of the
digital display market and its rate of development are uncertain and will depend on many factors,
including:  
    the number of digital-ready computers that are being produced and consumer demand for
these computers;
    the rate at which display manufacturers replace analog or non-compliant DVI interfaces
with fully DVI-compliant interfaces;
    the availability of cost-effective semiconductors that implement a fully DVI-compliant
interface; and
    improvements to analog technology, which may decrease consumer demand for our digital
display products. In order for the digital display market to grow, digital displays must be widely available and
affordable to consumers. In the past, the supply of digital displays, such as flat panels, has been
cyclical and consumers have been very price sensitive. Also, some manufacturers have implemented
DVI interfaces that are not fully DVI-compliant. These interfaces often interfere with the
operability of our products which function best with a fully DVI-compliant interface. Our ability
to sustain or increase our revenue may be limited should there not be an adequate supply of, or
demand for, affordable digital displays with DVI-compliant interfaces. A significant amount of our revenue is associated with the adoption of new or emerging
technologies within the PC industry. The PC industry has slowed and the adoption of these new
technologies may not occur as planned. A large portion of our revenue is directly or indirectly related to the PC industry and the
adoption of new or emerging technologies within the PC industry. Accordingly, we are highly
dependent on the adoption of new or emerging technologies within the PC industry, which experienced
a slowdown in growth during the second half of 2000 that has continued into the first quarter of
2005. We cannot predict the duration or severity of the downturn in the PC and display market, or
in the general economy, or its effect on our revenue and operating results, including 32




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the adoption of these new or emerging technologies. If the market for PCs and PC-related
displays continues to grow at a slow rate or contracts whether due to reduced demand from end
users, macroeconomic conditions or other factors, our business and results of operations could be
negatively affected. Although we have broadened our product offerings to include more products in the consumer
electronics and storage markets, there can be no guarantee that we will achieve long-term success
in these markets. To date, we have achieved reasonable success, but if we fail to consistently
achieve design wins in the consumer electronics and storage markets, we would become more dependent
on our PC related products for the PC industry. In general, the demand for our products in the PC market is highly dependent upon Intels
continued integration of SDVO and PCI-Express into its PC chipset platforms. Although Intel has
included SDVO and PCI-Express in its Grantsdale platform, there is no assurance that Intel will
continue to include DVI support in its future platforms. Our revenue generated from sales of DVI
transmitters and SATA host controllers is highly dependent upon the ability of such transmitters to
work with existing Intel PC chipset platforms. If Intel fails to integrate SDVO and PCI-Express or
some other convenient method to interface to our products in its future PC chipset platforms, then
the demand for our DVI transmitters could be adversely affected. Demand for our DVI receiver
products is also highly dependent upon Intels integration of serial interfaces into its PC chipset
platform because of Intels dominant market share in the PC business. If Intel were to discontinue
support for serial interfaces, then the number of available PCs with a DVI port could significantly
decrease, thus reducing demand for our DVI receivers. Our success depends in part on new strategic relationships. We have recently entered into several strategic partnerships with third
parties. Examples include our licensing arrangements with Sunplus, under which
Sunplus licenses our technology and we and Sunplus jointly develop products for manufacture and
supply, our licensing arrangements with MediaTek, under which we
licensed our HDMI transmitter technology to MediaTek for incorporation into their DVD player
chipsets. We have several other smaller licenses and partnerships of a similar nature. While these
arrangements 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 arrangements will be successful. Negotiating and performing under these
arrangements involves significant time and expense, we may not realize anticipated increases in
revenues, standards adoption or cost savings, and these arrangements may make it easier
for the third parties to compete with us, any of which may have a negative affect our business and
results of operations. Our success depends on the development and growth of markets for products based on new and
emerging storage technologies. Our product development efforts in the storage market are focused on the development of
products using new interface technologies such as Fibre Channel and SATA. The markets for these new
interface technologies are at an early stage of development, and there can be no assurance that
they will replace other storage interfaces that are now widely used, such as parallel ATA and SCSI.
The potential size and rate of development of these markets are uncertain and will depend on many
factors, including:  
    the rate at which manufacturers of storage subsystems adopt new interface technologies,
which may be more costly to implement than existing interface technologies until volumes
are sufficient to bring costs to competitive levels;
    the availability of cost-effective semiconductors and components for storage
subsystems, such as SATA-enabled hard drives and SATA-enabled optical drives (CD and DVD)
that implement new interface technologies for the storage market;
    whether and to the degree Intel or other motherboard manufacturers integrate the
functionality of our products, such as SATA, into their chips and chipsets; and 33




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
    improvement to existing storage interface technologies such as parallel ATA and SCSI,
or the introduction of other new storage interface technologies, either of which may
decrease consumer demand for our storage products. In particular, the rate of implementation of the SATA interface will depend on how quickly
drive (optical and hard disk) manufacturers, motherboard and PC providers and chipmakers are able
to resolve technical communication and functionality issues to enable a plug and play environment
in which a computer system is automatically able to recognize and configure storage devices.
Resolution of these issues could be time-consuming, and will depend in good measure on the ability
of chipmakers to incorporate the required high-speed serial data transfer capabilities into their
semiconductors without sacrificing manufacturing yields. Any delay in acceptance of new interface technologies, or a reduction in the growth or size of
the market for systems based on SATA or Fibre Channel technologies, would limit sales of our
storage products and reduce our revenue. Any delay in the availability of serial ATA compatible
drives or acceleration of serial ATA or Fibre Channel SerDes integration efforts by motherboard or
storage controller manufacturers may also reduce our revenue. We have promulgated a SATALite specification to which we have invited key industry members to
participate. This program includes certain licenses to our technology that we hope will increase
market acceptance of our serial ATA products. There can be no assurance that this program will
succeed, or that SATALite participants will not use our technology to compete against us. To date, we have achieved a number of design wins for our serial ATA and Fibre Channel storage
products. Even after we have achieved a design win from an Original Equipment Manufacturer (OEM),
we may not realize any revenue, or significant revenue, from that OEM since a design win is not a
binding commitment to purchase our products and the OEM may not achieve market acceptance for their
product. Further delay in serial ATA-enabled drive availability may lead OEMs to re-open their
designs and designs we have won may be subject to being lost, which could reduce our revenue and
increase our operating expenses in competing to re-win designs. With respect to our product offerings based upon the SteelVine architecture, there can be no
assurance such product offerings will achieve the desired level of market acceptance in the
anticipated timeframes or that such product offerings will be successful. Furthermore, there can be
no assurance that we will be able to introduce these products into the marketplace on a timely
basis or that we will be successful in achieving the necessary partners and channels to be
successful in the marketplace. Our inability to be timely in product introductions and or have
adequate partners and channels may adversely impact our ability to be successful with this line of
products and would adversely affect our business. It is anticipated that the products based upon
the SteelVine architecture will be sold into markets where we have limited experience. Furthermore,
there is no established market for these products. There can be no assurance that we will be able
to successfully market and sell the products based upon the SteelVine architecture and failure to
do so would adversely affect our business. We do not have long-term commitments from our customers and we allocate resources based on our
estimates of customer demand. Substantially all of our sales are made on the basis of purchase orders, rather than long-term
agreements. In addition, our customers may cancel or reschedule purchase orders. We purchase
inventory components and build our products according to our estimates of customer demand. This
process requires us to make multiple assumptions, including volume and timing of customer demand
for each product, manufacturing yields and product quality. If we overestimate customer demand or
product quality or under estimate manufacturing yields, we may build products that we may not be
able to sell at an acceptable price or at all. As a result, we would have excess inventory, which
would increase our losses. Additionally, if we underestimate customer demand or if sufficient
manufacturing capacity is unavailable, we will forego revenue opportunities or incur significant
costs for rapid increases in production, lose market share and damage our customer relationships. 34




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Our lengthy sales cycle can result in a delay between incurring expenses and generating revenue,
which could harm our operating results. Because our products are based on new technology and standards, a lengthy sales process,
typically requiring several months or more, is often required before potential customers begin the
technical evaluation of our products. This technical evaluation can exceed nine months before the
potential customer informs us whether we have achieved a design win, which is not a binding
commitment to purchase our products. After achieving a design win, it can then be an additional
nine months before a customer commences volume shipments of systems incorporating our products, if
at all. Given our lengthy sales cycle, we may experience a delay between the time we incur
expenditures and the time we generate revenue, if any. As a result, our operating results could be
seriously harmed if a significant customer reduces or delays orders, or chooses not to release
products incorporating our products. 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 March 31, 2005, shipments to World
Peace International, an Asian distributor, generated 18% of our revenue and shipments to Microtek,
a distributor, generated 10% of our revenue. For the year ended December 31, 2004, shipments to
World Peace International, generated 15% of our revenue, and shipments to Microtek generated 12% of
our revenue. In addition, an end-customer may buy 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; or
    one or more significant customers selects products manufactured by one of our
competitors for inclusion in their future product generations. Due to our participation in multiple markets, our customer base has broadened significantly
and we therefore anticipate being less dependent on a relatively small number of customers to
generate revenue. However, 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. 35




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We sell our products through distributors, which limits our direct interaction with our customers,
therefore reducing our ability to forecast sales and increasing the complexity of our business. Many original equipment manufacturers rely on third-party manufacturers or distributors to
provide inventory management and purchasing functions. Distributors generated 48% of our revenue
for the three months ended March 31, 2005, 45% of our revenue for the year ended December 31, 2004,
and 42% of our revenue for the year ended December 31, 2003. 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 retail channel, with
the OEM or the OEMs contract manufacturer. Such a buildup could result in a slowdown in
orders, requests for returns from customers, or requests to move out planned shipments.
This could adversely impact our revenues and profits. Any failure to manage these challenges could disrupt or reduce sales of our products and
unfavorably impact our financial results. Our success depends on the development and introduction of new products, which we may not be able
to do in a timely manner because the process of developing high-speed semiconductor products is
complex and costly. The development of new products is highly complex, and we have experienced delays, some of
which exceeded one year, in the development and introduction of new products on several occasions
in the past. We have recently introduced new storage products for the consumer and small to medium
business markets and we expect to introduce new consumer electronics, storage and PC 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 evolving standards, including
enhancements or modifications to existing standards such as DVI, HDCP, SATA I and SATA II,
and HDMI;
    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 and achievement of high manufacturing yields and
low cost testing; and 36




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
    market acceptance of new products. 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 limitations, the inability to license third-party technology or
other factors. Competitors and customers may integrate the functionality of our products into their
products that would reduce 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. We have
made acquisitions in the past and may make acquisitions in the
future, if advisable, as
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. One of the ways we develop new products and enter new
markets is through acquisitions. In 2001, we completed the acquisitions of CMD and SCL. In April
2003, we acquired TWN. We may acquire additional companies or technologies. 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. The cyclical nature of the semiconductor industry may create constrictions in our foundry, test
and assembly capacity. In the past, the semiconductor industry has been characterized by significant downturns and
wide fluctuations in supply and demand. For example, demand in the semiconductor industry rose to
record levels in 1999, and then declined until beginning to show signs of recovery during 2003 and
2004. The industry has also experienced significant fluctuations in anticipation of changes in
general economic conditions. This cyclicality has led to 37




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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. 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. 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 Taiwan Semiconductor
Manufacturing Company (TSMC), an outside foundry, to produce the vast majority all of our
semiconductor products. We also rely on Kawasaki, UMC and Atmel for outside foundry services, and
on Amkor and ASE to test certain 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;
    lack of availability of, or delayed access to, next-generation or key process technologies; and
    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 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. If a fire
occurs at any one of our third-party sub-contractors, this can
adversely affect our assembly and/or test capacity potentially
delaying product shipments to our customers. On
May 1, 2005, one of our sub-contractors packaging and test
facilities experienced damage from a fire. While none of our products
were directly affected by the fire, this sub-contractors
packaging and test capacity have been temporarily reduced. We are
working with this sub-contractor to determine the extent of the
potential impact we may experience as a result of their temporary
reduction in capacity. Since we use multiple packaging and testing
sub-contractors, we are currently exploring alternatives for
additional capacity should the affected sub-contractor be unable to
fill our assembly and test needs. 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 38




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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 the United 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, and for the three months ended March 31, 2005, 68% of
our revenue, and for the years ended December 31, 2004 and 2003, 72% and 74% 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. Accordingly, we are subject to
international risks, including, but not limited to:  
    difficulties in managing from afar;
    political and economic instability, including international tension in Iraq, Korea and
the China Strait and lack of normal diplomatic relationships between the United States and
Taiwan;
    less developed infrastructures in newly industrializing countries;
    susceptibility of foreign areas to terrorist attacks;
    susceptibility to interruptions of travel, including those due to international tensions
(including the war in and occupation of Iraq), medical issues such as the SARS and Avian Flu
epidemics (particularly affecting the Asian markets we serve), and the financial instability and
bankruptcy of major air carriers;
    bias against foreign, especially American, companies;
    difficulties in collecting accounts receivable;
    expense and difficulties in protecting our intellectual property in foreign jurisdictions;
    difficulties in complying with multiple, conflicting and changing laws and regulations, including
export requirements, tariffs, import duties, visa restrictions, environmental laws and other
barriers;
    exposure to possible litigation or claims in foreign jurisdictions; and
    competition from foreign-based suppliers and the existence of protectionist laws and business
practices that favor these suppliers, such as withholding taxes on payments made to us. These risks could adversely affect our business and our results of operations. 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. 39




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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. Our participation in the Digital Display Working Group requires us to license some of our
intellectual property for free, which may make it easier for others to compete with us in the DVI
PC market. We are a promoter of the DDWG, which published and promotes the DVI specification. Our
strategy includes establishing the DVI specification as the industry standard, promoting and
enhancing this specification and developing and marketing products based on this specification and
future enhancements. As a result:  
    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. Accordingly, companies that implement the DVI specification in their products can use specific
elements of our intellectual property for free to compete with us. Our participation as a founder in the working group developing HDMI requires us to license some of
our intellectual property, which may make it easier for others to compete with us in the market. In April 2002, together with Sony, Philips, Thomson, Toshiba, Matsushita and Hitachi, we
announced the formation of a working group to define the next-generation digital interface
specification for consumer electronics products. Version 1.0 of the specification was published for
adoption on December 9, 2002. The HDMI specification combines high-definition video and
multi-channel audio in one digital interface and uses Silicon Images patented underlying TMDS®
technology, optionally, along with Intels HDCP as the basis for the interface. The founders of the
working group have signed a founders agreement in which each commits to license certain
intellectual property to each other, and to adopters of the specification. Our strategy includes establishing the HDMI specification as the industry standard, promoting
and enhancing this specification and developing and marketing products based on this specification
and future enhancements. As a result: 40




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
    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, companies that implement the HDMI specification in their products can use
specific elements of our intellectual property to compete with us. Although there will be license
fees and royalties associated with the adopters agreements, there can be no assurance that such
license fees and royalties will adequately compensate us for having to license our intellectual
property. Fees and royalties received during the early years of adoption 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, the HDMI founders may reallocate the license fees and royalties
amongst themselves to reflect each founders relative contribution of intellectual property to the
HDMI specification. 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 has been an investor of ours;
    Intel and we have been parties to a business cooperation agreement;
    Intel and we are parties to a patent cross-license;
    Intel and we worked together to develop HDCP;
    an Intel subsidiary has the exclusive right to license HDCP, of which we are a licensee;
    Intel and we were two of the original founders of the Digital Display Working Group (DDWG);
    Intel is a promoter of the serial ATA 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 DVI and serial ATA
by making them 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 the technology or promulgating a competing standard, which could affect demand
for our products;
    Intel may potentially integrate the functionality of our products, including Fibre
Channel, Serial ATA, 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. 41




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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 have entered into a patent cross-license agreement with Intel in which each of us granted
the other a license to use the grantors patents, 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 are 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 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 merit less, can result in substantial costs to us and could divert the
attention of our management. We and certain of our officers and directors, together with certain
investment banks, have been named as defendants in a securities class action suit filed against us
on behalf of purchasers of our securities between October 5, 1999 and December 6, 2000. It is
alleged that the prospectus related to our initial public offering was misleading because it failed
to disclose that the underwriters of our initial public offering had solicited and received
excessive commissions from certain investors in exchange for agreements by investors to buy our
shares in the aftermarket for predetermined prices. Due to inherent uncertainties in litigation, we
cannot accurately predict the outcome of this litigation; however, a proposed settlement has been
negotiated and has received preliminary approval by the Court. In the event that the settlement is
not granted final approval, we believe that these claims are without merit and we intend to defend
vigorously against them. We and certain of our officers, together with certain investment banks and
their current or former employees, were named as defendants in a securities class action suit filed
against us on behalf of a putative class of shareholders who purchased stock from some or all of
approximately 50 issuers whose public offerings were underwritten by Credit Suisse First Boston.
The lawsuit alleges that Silicon Image and certain officers were part of a scheme by Credit Suisse
First Boston to artificially inflate the price of Silicon Images stock through the dissemination
of allegedly false analysts reports. The plaintiff in this matter has filed an amended complaint
in which Silicon Image, and the named officers, was dropped as defendants. We believe that the
settlement described above, if approved, would encompass the claims in this case. We believe that
these claims were without merit and, if revived, and not subject to the settlement, we intend to
defend vigorously against them. Silicon Image and certain of its officers were named as defendants in a securities class
action litigation captioned Curry v. Silicon Image, Inc., Steve Tirado, and Robert Gargus, No. C05
00456 MMC, commenced on January 31, 2005 and pending in the United States District Court for the
Northern District of California. Plaintiffs filed the action on behalf of a putative class of
shareholders who purchased Silicon Image stock between October 19, 2004 and January 24, 2005. The
lawsuit alleges that the Company and certain of its officers and directors made alleged
misstatements of material facts and violated certain provisions of Sections 20(a) and 10(b) of the
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Two individuals, not including named
plaintiff Curry, have filed a motion to be designated by the court as lead plaintiffs. The Company
intends to defend itself vigorously in this matter. We are currently engaged in intellectual property litigation that is time-consuming and expensive
to prosecute. 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, 42




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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 April 24, 2001, we filed suit in the U.S. District Court for the Eastern District of
Virginia against Genesis Microchip Corp, and Genesis Microchip, Inc. (collectively,Genesis) for
infringement of our U.S. patent number 5,905,769 (USDC E.D. Virginia Civil Action.: CA-01-266-R)
(the Federal Suit). On April 24, 2001, we also filed a complaint against Genesis with the
International Trade Commission of the United States government (ITC) for unlawful trade practices
related to the importation of articles infringing our patent (the ITC investigation). The
actions sought injunctions to halt the importation, sale, manufacture and use of Genesis DVI
receiver chips that infringe our patent, and monetary damages. We voluntarily moved to dismiss the
ITC investigation, with notice that we would proceed directly in the Federal Suit. Our motion to
dismiss was granted on February 7, 2002. We filed an amended complaint in the Federal Suit as of
February 28, 2002, adding a claim for infringement of our U.S. patent number 5,974,464. In April
2002, Genesis answered and made counterclaims against us for non-infringement, license, patent
invalidity, fraud, antitrust, unfair competition and patent misuse. Also in April 2002, we filed a
motion to dismiss certain of Genesiss counterclaims. In addition, we filed a motion to bifurcate
trial of the counterclaims to the extent the court does not dismiss them. In May 2002, the Court
granted our motion to dismiss certain of the counterclaims, with leave to amend. Genesis re-filed
counterclaims against us for fraud and patent misuse. We filed another motion to dismiss these
counterclaims, which the Court granted with prejudice on August 6, 2002. In December 2002, the
parties entered into a memorandum of understanding (MOU) to settle the case. When the parties
failed to reach agreement on a final, definitive agreement as required by the MOU, in January 2003,
the parties filed motions with the Court to enforce their respective interpretations of the MOU. On
July 15, 2003, the Court granted our motion to interpret the MOU in the manner we requested, and
ruled that Genesis had engaged in efforts to avoid its obligations under the MOU. On August 6,
2003, the Court entered a final judgment based on its July 15, 2003 ruling. Under the final
judgment order, Genesis was ordered to make a substantial cash payment, and to make royalty
payments; although Genesis has made a cash payment to the Court , it has not made all the payments
that are required under the final judgment order. We filed motions for reimbursement of some of our
expenses, including some of our legal fees, and for modification and/or clarification of certain
items of the judgment, and to hold Genesis in contempt of Court for breaching the protective order
in the case by disclosing secret information to at least one of our competitors. On December 19,
2003, the Court granted our motions in part and denied them in part: the court issued an amended
judgment, and held Genesis in contempt of Court for breaching the protective order. Under the
amended judgment, Genesis was ordered to make a substantial cash payment, royalty payments, and
interest; although Genesis has made cash payments to the Court, it may not have made all the
payments that are required under the amended judgment. On January 16, 2004, Genesis filed a notice
of appeal to the U.S. Court of Appeals for the Federal Circuit. On August 26, 2004, the parties
completed the filing of their respective appeal briefs. On October 26, 2004, the Court of Appeals
for the Federal Circuit issued an order setting an oral argument in the appeal on December 7, 2004.
The hearing took place as scheduled. At the end of the hearing, the panel of Federal Circuit judges
hearing the case stated that they believed that no final order had been issued by the trial court,
and that therefore the Federal Circuit did not have jurisdiction to hear the appeal. The Federal
Circuit issued its opinion on January 28, 2005 and as expected, the Federal Circuit dismissed
Genesis appeal for lack of jurisdiction. The Federal Circuit held that the parties agreement to
settle the case, as embodied in the MOU that was found by the lower court to be valid and
enforceable, requires that Genesis pay us a portion of the settlement as a condition to dismissing
the case. Because the lower court allowed Genesis to pay the amount into escrow instead of directly
to us, the Federal Circuit held that the underlying claims asserted below remain pending, and
therefore that the judgment below was not final and was not appealable. The case was remanded by
the 43




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Federal Circuit back to the lower court. The parties have negotiated a stipulation by which
the lower court can enter a new final judgment which is likely to result in a new appeal by Genesis
to the Federal Circuit by Genesis. There can be no assurance that Genesis will not undertake further efforts to avoid its
obligations under the MOU, and that further proceedings (lawsuits, contempt citations, etc.)
against Genesis, and certain of its executives, its counsel, and others may not be required to
obtain compliance or to obtain redress for non-compliance. There can be no assurance that an
appellate court will uphold the Courts rulings or the MOU. There can be no assurance that further
delays or noncompliance will not occur. The Courts rulings of July 15, 2003 and December 19, 2003
indicate that Genesis violated certain provisions of the MOU, and of the protective order in the
case, including disclosure of confidential information to Pixelworks. On August 5, 2003, Genesis
and Pixelworks issued a joint press release terminating their proposed merger. In that press
release, Genesis and Pixelworks jointly stated, Pixelworks has confirmed that prior to signing the
merger agreement, it reviewed the Memorandum of Understanding that purported to settle the lawsuit
between Genesis Microchip and Silicon Image, Inc. While this litigation, including the appeal or
any possible derivative proceedings, is pending, Genesis may use the technology covered by these
patents to develop products that might compete with ours. If we are unsuccessful in this
litigation, we could be unable to prevent Genesis or others from using the technology covered by
these patents. Even if we prevail in this litigation, uncertainties regarding the outcome prior to
that time may reduce demand for our products, or Genesiss use of our technology in products that
compete with our products may reduce demand or pricing for our products. In addition, even if the
MOU is upheld on appeal, future disputes may occur, including those regarding whether and what
intellectual property licenses were granted and the scope of any such licenses and the royalty
rates and payment terms for such licenses, whether the MOU was breached, whether consent was
fraudulently obtained, and whether a merger partner may succeed to the rights and/or the
obligations under the MOU. These disputes may result in additional costly and time-consuming
litigation or the license of additional elements of our intellectual property for free. Any potential intellectual property litigation against us 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. 44




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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. We do not have key person life insurance for any of our key
personnel. 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, new regulations adopted by The NASDAQ National Market requiring shareholder
approval for all stock option plans, as well as new 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. There have been several proposals on
whether and/or how to account for stock options. 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 use contractors to provide services to the Company, which often involves contractual
complexity, tax and employment law compliance, and being subject to audits and other governmental
actions. We have been audited for our contracting policies in the past, and may be in the future.
Burdening our ability to freely use contractors to provide services to the Company may increase the
expense of obtaining such services, and/or require us to discontinue using contractors and attempt
to find, interview, and hire employees to provide similar services. Such potential employees may
not be available in a reasonable time, or at all, or may not be hired without undue cost. We have
experienced management and director transitions in the past, which
disrupt our management, operations and controls, and may continue to
do so in the future. We have experienced a number of transitions with respect to our board of directors and
executive officers in recent quarters, including the following:  
    In April 2004, Steve Tirado moved from the position of president to division president
of storage group, Jaime Garcia-Meza moved from the position of vice president of worldwide
sales to vice president of sales and marketing for storage platforms, Rob Valiton was
appointed as vice president of worldwide sales, and Chris Paisley was appointed to the
board of directors
    In August 2004, the Company announced that Robert C. Gargus planned to retire from the
position of chief financial officer and Dale Brown, the controller of the Company, was
appointed as chief accounting officer.
    In September 2004, Parviz Khodi, the vice president, PC/display products of the
Company, passed away unexpectedly and his duties were subsequently assumed by John
LeMoncheck, the vice president, CE products and Patrick Reutens was appointed as chief
legal officer of the Company.
    In November 2004, David Lee resigned from the positions of chief executive officer and
president, Steve Laub was appointed as chief executive officer and president and to the
board of directors as well, and Andrew Rappaport and Douglas Spreng resigned from the board
of directors.
    In January 2005, Steve Laub 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 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. Past and future transitions with respect to our board and executives have resulted, and may
continue to result in disruptions in our management, internal
controls and operations and in additional costs. 45




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We face additional risks and costs, and potential delisting from Nasdaq, as a result of the
resignation of most of our independent outside directors. In April 2005, four of our 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. Currently, our Board
consists of one independent outside director, David Hodges (who is the only member of our Audit,
Compensation and Governance and Nominating Committees), and three employee directors. As a
result of these resignations, we are no longer in compliance with the marketplace rules of the
Nasdaq Stock Market requiring that a majority of our Board consist of independent outside
directors and that our Audit Committee consist of three independent outside directors, one of
whom has requisite financial sophistication. In addition, we are no longer in compliance with
rules of the SEC requiring that our Audit Committee consist of three independent directors, one
of whom is a financial expert. We have notified the Nasdaq Stock
Market of these non-compliance matters. In response, the Nasdaq Stock market has notified us that the
Nasdaq staff believes that we are not in compliance with the
aforementioned marketplace rules. In addition, Nasdaq has raised
concerns regarding the circumstances of the resignations of our
independent directors, our history of independent director
resignations, and our recent executive management turnover, and
regarding our succession planning and our board of directorss
ability to act independently of management. In
April 2005, we filed a Form 10-K/A for the fiscal year ended December
31, 2004 to include corrected certifications of our principal
executive officer and principal financial officer under Section 302
of the Sarbanes-Oxley Act of 2002. The certifications included with
the original Form 10-K filing inadvertently omitted language required
for fiscal 2004 certifications. The Form 10-K/A did not include the
entire body of the original Form 10-K. The Nasdaq Stock Market has
notified us that the Nasdaq staff believes that we are not in
compliance with another marketplace rule due to the failure to
include the body of the original Form 10-K in the Form 10-K/A. As a
result, our trading symbol has been changed by the Nasdaq Stock
Market from SIMG to SIMGE. We have expanded and intensified our ongoing search for additional independent outside
directors in order to fill the vacancies on the Board and Board committees created by the
resignations and remedy our non-compliance with the Nasdaq Stock Market marketplace rules as
soon as reasonably practicable. However, we cannot predict when and if we will able to identify
and appoint additional independent outside directors with the requisite qualifications. We will
incur additional monetary costs associated with this search and this search may also divert the
Board and managements attention and resources from our ongoing business operations.
In addition, we cannot predict what actions the Nasdaq Stock Market
will take as a result of our non-compliance, which could include a
delisting of our common stock from the Nasdaq National Market,
suspension of trading in our common stock on the Nasdaq National
Market and/or investigations or hearings involving the Nasdaq staff
regarding any of the foregoing. Finally, the resignations from our Board of Directors has adversely affected our internal
controls over financial reporting. See Item 4, Controls and Procedures for further discussion of
the effect of the resignations on our internal controls. 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; 46




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
    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. 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, and the operations of CMD, which we acquired, are based in the Los Angeles
area, which is also susceptible to earthquakes. TSMC and UMC, the outside foundries that
produce the majority of our semiconductor products, are located in Taiwan. Advanced
Semiconductor Engineering, or ASE, one of the subcontractors that assembles and tests our
semiconductor products, is also located in Taiwan. For the three months ended March 31,
2005, and the years ended December 31, 2004 and 2003, customers and distributors located in
Taiwan generated 26%, 25%, and 34% of our revenue, respectively, and customers and
distributors located in Japan generated 17%, 20%, and 15% 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. Changes in environmental rules and regulations could increase our costs and reduce our revenue. Several jurisdictions are considering whether to implement rules that would require that
certain products, including semiconductors, be made lead-free. We anticipate that some
jurisdictions may finalize and enact such requirements. Some jurisdictions are also considering
whether to require abatement or disposal obligations for products made prior to the enactment of
any such rules. Although several of our products are available to customers in a lead-free
condition, most of our products are not lead-free. Any requirement that would prevent or burden the
development, manufacture or sales of lead-containing semiconductors would likely reduce our revenue
for such products and would require us to incur costs to develop substitute lead-free replacement
products, which may take time and may not always be economically or technically feasible, and 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. Provisions of our charter documents and Delaware law could prevent or delay a change in control,
and may reduce the market price of our common stock. 47




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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. Continued terrorist attacks or war could lead to further 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 has
engaged in war with Iraq and currently has an occupation force there 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 48




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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. We have recently established offices in Japan, Republic of Korea (South Korea), Taiwan and the
United Kingdom We have recently established offices in Japan, South Korea, Taiwan and the United Kingdom.
Accordingly, we are subject to risks, including, but not limited to:  
    being subject to Japanese, South Korean, Taiwanese and United Kingdom tax laws and
potentially liable for paying taxes in Japan, South Korea, Taiwan and the United Kingdom;
    profits, if any, earned in Japan, South Korea, Taiwan and the United Kingdom will be
subject to local tax laws and may not be repatriable to the United States;
    we have and will enter into employment agreements in connection with hiring personnel
for the Japanese and South Korean offices and are governed by the provisions of the
Japanese, South Korean, Taiwanese and United Kingdom labor laws; and
    the operations of the local office are and will be subject to the provisions of other
local laws and regulations. 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. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk Interest Rate Risk Our cash equivalents and short-term investments consist primarily of fixed-income securities
that are subject to interest rate risk and will decline in value if interest rates increase. Due to
the short duration of our cash equivalents and short-term investments, an immediate 10% change in
interest rates would not be expected to have a material effect on our near-term results of
operations or financial condition. Our long-term capital lease obligations bear interest at fixed
rates; therefore, our results of operations would not be affected by immediate changes in interest
rates. Also, components of our stock compensation expense are tied to our stock price. Changes in
our stock price can have a significant affect on the amount recorded as stock compensation expense. Foreign Currency Exchange Risk All of our sales are denominated in U.S. dollars, and substantially all of our expenses are
incurred in U.S. dollars, thus limiting our exposure to foreign currency exchange risk. We
currently do not enter into forward exchange contracts to hedge exposures denominated in foreign
currencies and do not use derivative financial instruments for trading or speculative purposes. The
effect of an immediate 10% change in foreign currency 49




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exchange rates should not have a material effect on our future operating results or cash
flows; however, a long term change in foreign currency rates would likely result in increased
wafer, packaging, assembly or testing costs. 
 Item 4. Controls and Procedures (a) Evaluation of
Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that the
information required to be disclosed in the reports we file or submit under the Securities Exchange
Act of 1934 (the Exchange Act) is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief Financial Officer
to allow timely decisions regarding required financial disclosures. As of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief Executive Officer,
Chief Financial Officer, and Chief Accounting Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Exchange Act Rule13a-15(e). Based
upon, and as of the date of this evaluation, our Chief Executive Officer, Chief Financial
Officer, and Chief Accounting Officer concluded that our disclosure controls and procedures were
ineffective because of the material weakness in our internal control over financial reporting
described below. In light of the material weakness described below, we performed additional
analysis and other post-closing procedures to ensure our consolidated financial statements were
prepared in accordance with generally accepted accounting principles. Accordingly, management
believes that the consolidated financial statements included in this report fairly present in all material
respects our financial condition, results of operations and cash flows for the periods presented. (b) Changes in Internal Control over Financial Reporting The Companys management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-5(f) under the Exchange Act. Our internal
control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Because of its inherent
limitations, internal control over financial reporting may not
prevent or detect material misstatements.
Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance
with policies and procedures may deteriorate. A material weakness is a control deficiency, or combination of control deficiencies, that
results in more than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. We identified the following material
weakness in our internal control over financial reporting as of
March 31, 2005:   Additionally, this control deficiency could result in a material misstatement to annual or
interim financial statements that would not be prevented or detected. Accordingly, management has
determined that this control deficiency constitutes a material weakness. Because of this material
weakness, we have concluded that the Company did not maintain effective internal control over
financial reporting as of March 31, 2005, based on the criteria
in the Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. 50




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Except as noted above, there have not been any changes in our internal control over financial
reporting that occurred during our most recently completed fiscal quarter that have materially
affected, or are reasonably likely to materially affect, our internal control over financial
reporting. (c) Remediation of Material Weakness The
Company is actively seeking additional qualified Board of Directors and Audit Committee members who
will provide effective oversight of the Companys external financial reporting and internal control
over financial reporting. and who will satisfy the independence and financial experience
requirements of NASDAQ and the SEC. The Companys remaining outside director, Mr. David Hodges,
has taken responsibility on behalf of the Company to lead its efforts in identifying qualified
Board members to serve on the Companys Audit Committee and to fulfill the Companys corporate
governance requirements. To date, a number of potential candidates have been identified and under Mr. Hodges
leadership, interviews, background checks, and other actions are in process. While the Company is
actively seeking new Board and Audit Committee members, there can be no assurance, when or if, the
Companys efforts will be successful. 
 Part II. Other Information 
 Item 1. Legal Proceedings On April 24, 2001, we filed suit in the U.S. District Court for the Eastern District of
Virginia against Genesis Microchip Corp. and Genesis Microchip, Inc. (collectively, Genesis) for
infringement of our U.S. patent number 5,905,769 (USDC E.D. Virginia Civil Action No.: CA-01-266-R)
(the Federal Suit). On April 24, 2001, we also filed a complaint against Genesis with the
International Trade Commission of the United States government (ITC) for unlawful trade practices
related to the importation of articles infringing our patent (the ITC investigation). The actions
sought injunctions to halt the importation, sale, manufacture and use of Genesis DVI receiver chips
that infringe our patent, and monetary damages. We voluntarily moved to dismiss the ITC
investigation, with notice that we would proceed directly in the Federal Suit. Our motion to
dismiss was granted on February 7, 2002. We filed an amended complaint in the Federal Suit as of
February 28, 2002, adding a claim for infringement of our U.S. patent number 5,974,464. In April
2002, Genesis answered and made counterclaims against us for non-infringement, license, patent
invalidity, fraud, antitrust, unfair competition and patent misuse. Also in April 2002, we filed a
motion to dismiss certain of Genesiss counterclaims. In addition, we filed a motion to bifurcate
trial of the counterclaims to the extent the court does not dismiss them. In May 2002, the Court
granted our motion to dismiss certain of the counterclaims, with leave to amend. Genesis re-filed
counterclaims against us for fraud and patent misuse. We filed another motion to dismiss these
counterclaims, which the Court granted with prejudice on August 6, 2002. In December 2002, the
parties entered into a memorandum of understanding (MOU) to settle the case. When the parties
failed to reach agreement on a final, definitive agreement as required by the MOU, in January 2003,
the parties filed motions with the Court to enforce their respective interpretations of the MOU. On
July 15, 2003, the Court granted our motion to interpret the MOU in the manner we requested, and
ruled that Genesis had engaged in efforts to avoid its obligations under the MOU. On August 6,
2003, the Court entered a final judgment based on its July 15, 2003 ruling. Under the final
judgment order, Genesis was ordered to make a substantial cash payment, and to make royalty
payments; although Genesis has made a cash payment to the Court, it has not made all the payments
that are required under the final judgment order. We filed motions for reimbursement of some of our
expenses, including some of our legal fees, and for modification and/or clarification of certain
items of the judgment, and to hold Genesis in contempt of Court for breaching the protective order
in the case by disclosing secret information to at least one of our competitors. On December 19,
2003, the Court granted our motions in part and denied them in part: the court issued an amended
judgment, and held Genesis in contempt of Court for breaching the protective order. Under the
amended judgment, Genesis was ordered to make a substantial cash payment, royalty payments, and
interest; although Genesis has made cash payments to the Court, it may not have made all the
payments that are required under the amended judgment. On January 16, 2004, Genesis filed a notice
of appeal to the U.S. Court of Appeals for the Federal Circuit. On August 26, 2004, the parties
completed the filing of their respective appeal briefs. On October 26, 2004, the Court of Appeals
for the Federal Circuit issued an order 51




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setting an oral argument in for the appeal on December 7, 2004. The hearing took place as
scheduled. At the end of the hearing, the panel of Federal Circuit judges hearing the case stated
that they believed that no final order had been issued by the trial court, and that therefore the
Federal Circuit did not have jurisdiction to hear the appeal. The Federal Circuit issued its
opinion on January 28, 2005 and, as expected, the Federal Circuit dismissed Genesis appeal for
lack of jurisdiction. The Federal Circuit held that the parties agreement to settle the case, as
embodied in the MOU that was found by the lower court to be valid and enforceable, requires that
Genesis pay us a portion of the settlement as a condition to dismissing the case. Because the lower
court allowed Genesis to pay the amount into escrow instead of directly to us, the Federal Circuit
held that the underlying claims asserted below remain pending, and therefore that the judgment
below was not final and was not appealable. The case was remanded by the Federal Circuit back to
the lower court. The parties have negotiated a stipulation by which the lower court can enter a
new final judgment which is likely to result in a new appeal by Genesis to the Federal Circuit by
Genesis. To date, we have not received any cash payments nor have we recognized any revenue associated
with the matter. If the MOU is upheld in its present form after all appeals have been exhausted,
Genesis will be granted a royalty-bearing license for the right to use certain non-necessary patent
claims referred to in the DVI Adopters Agreement. In addition, upon Genesiss becoming a signatory
to the HDMI Adopters Agreement, Genesis will be granted a royalty-bearing license for the right to
use these claims as part of their HDMI implementation. Genesis will also be granted a
royalty-bearing license to expand use of certain DVI- related patent claims to the consumer
electronics marketplace. We expect that an amended final, appealable order will be entered in Q2
2005. We further expect that Genesis will refile its appeal. Through March 31, 2005, we have
spent approximately $11 million on this matter and expect to continue to incur significant legal
costs until the matter is resolved. Silicon Image, certain officers and directors, and Silicon Images underwriters have been
named as defendants in a securities class action lawsuit captioned Gonzales v. Silicon Image, et
al., No. 01 CV 10903 (SDNY 2001) pending in Federal District Court for the Southern District of New
York. The lawsuit alleges that all defendants were part of a scheme to manipulate the price of
Silicon Images stock in the aftermarket following Silicon Images initial public offering in
October 1999. Response to the complaint and discovery in this action on behalf of Silicon Image and
individual defendants has been stayed by order of the court. The lawsuit is proceeding as part of a
coordinated action of over 300 such cases brought by plaintiffs in the Southern District of New
York. Pursuant to a tolling agreement, individual defendants have been dropped from the suit for
the time being. In February 2003, the Court denied motions to dismiss brought by the underwriters
and certain issuers and ordered that the case may proceed against certain issuers including against
Silicon Image. A proposed settlement has been negotiated and has received preliminary approval by
the Court. In the event that the settlement is granted final approval, we do not expect it to have
a material effect on our results of operations or financial position. In the event that the
settlement is not finally approved, we could not accurately predict the outcome the litigation, but
we intend to defend this matter vigorously. In May 2003, Silicon Image, certain officers and directors, and Silicon Images underwriters
were named as defendants in a securities class action lawsuit captioned Liu v. Credit Suisse First
Boston Corp., et al., No. 03-20459 (S.D. Fla. 2003) and filed in Federal District Court for the
Southern District of Florida. The action was filed on behalf of a putative class of shareholders
who purchased stock from some or all of approximately 50 issuers whose public offerings were
underwritten by Credit Suisse First Boston. The initial complaint alleged that Silicon Image and
certain officers were part of a scheme by Credit Suisse First Boston to artificially inflate the
price of Silicon Images stock through the dissemination of allegedly false analysts reports.
Silicon Image was never served with a copy of the complaint. In June 2003, the action was
transferred to the Federal District Court for the Southern District of New York. The plaintiff in
this matter filed an amended complaint shortly thereafter, from which Silicon Image, and the named
officers, were dropped as defendants. Plaintiffs have not amended their complaint or otherwise
indicated that they intend to name Silicon Image or its officers or directors as defendants in the
action since that time. We believe that these claims were without merit and, if revived, we would
defend this matter vigorously. Silicon Image and certain of its officers were named as defendants in a securities class
action litigation captioned Curry v. Silicon Image, Inc., Steve Tirado, and Robert Gargus, No. C05
00456 MMC, commenced on January 31, 2005 and pending in the United States District Court for the
Northern District of California. Plaintiffs filed the action on behalf of a putative class of
shareholders who purchased Silicon Image stock between October 19, 2004 and January 24, 2005. The
lawsuit alleges that the Company and certain of its officers and directors made alleged
misstatements of material facts and violated certain provisions of Sections 20(a) and 10(b) of the
Exchange Act of 52




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1934 and Rule 10b-5 promulgated thereunder. Two individuals, not including named plaintiff
Curry, have filed a motion to be designated by the court as lead plaintiffs. The Company intends to
defend itself vigorously in this matter. On
January 14, 2005, the Company received a notification that the
Securities and Exchange
Commission had commenced a formal, private investigation involving trading in the Companys
securities. The Company is fully cooperating with the investigation. 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. We intend to
defend such matters vigorously, and although adverse decisions or settlements may occur in one or
more of such cases, the final resolution of these matters, individually or in the aggregate, is not
expected to have a material adverse effect on our results of operations or financial position. The amount of legal fees we incur with respect to the litigation matters described above will
depend on the duration of our litigation matters, as well as the nature and extent of the
litigation activities. We are not able to accurately estimate the amount of legal fees we will
incur in 2005 with respect to the litigation matters described above, however, we do expect to
incur substantial amounts through fourth quarter of 2005. 
 Item 2. Unregistered
Sale 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 On April 20, 2005, Mr. Darrel Slack was appointed as the Companys chief financial officer,
succeeding Mr. Robert C. Gargus, who resigned as of the same date, as planned. On April 24, 2005, four members of the Companys board of directors resigned. As a result of
these resignations, the Company notified The NASDAQ Stock Market, Inc. (NASDAQ), that the Company
fails to comply with NASDAQ Marketplace Rules requiring that a majority of the board consist of
independent directors and requiring that the audit committee consist of three independent
directors, one of whom has requisite financial sophistication due to the vacancies on the board
and its audit committee. The Company is actively seeking directors who will satisfy the
independence and financial experience requirements of NASDAQ and the Securities and Exchange
Commission and are willing to serve with a view to remedying the noncompliance. On April 25, 2005, Mr. David Lee notified the Board that he would not stand for reelection at
the 2005 annual meeting of stockholders and would accept the position of chairman emeritus (a
non-voting position). On April 25, 2005, the Board, then consisting of Mr. Steve Tirado, Mr. Lee and Mr. David
Hodges, appointed Mr. Slack as a Class I director and Mr. Patrick Reutens, the chief legal officer
of the Company, as a Class II director to fill two of the vacancies created by the resignations
above. At that meeting, the Board reduced the number of directors from eight to four. Immediately
after the vote, Mr. Reutens resigned from the board. The 53




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remaining directors appointed Mr. Hodges, the lone remaining independent director and a member
of the governance and nominating committee, to also serve on the audit and compensation committees. On May 4, 2005, we announced that the NASDAQ Listing Qualifications Hearings Department
notified Silicon Image by letter dated May 2, 2005, that Silicon Image was not in compliance with
certain NASDAQ Marketplace Rules because its Form 10-K filed with the Securities and Exchange Commission
on March 16, 2004 for the year ended December 31, 2004 was incomplete. The Section 302
certifications of its principal executive officer and principal financial officer was the same form
as had been used for the preceding year, and inadvertently omitted additional language required for
certifications for 2004. The Company subsequently filed an amendment to the Form 10-K that
contained only a corrected certification. This amendment was deemed incomplete because it did not
include the body of the entire Form 10-K, as previously filed, with
the corrected certification. In addition, due to the resignations of
four independent directors from the Board, the Company is not in
compliance with NASDAQ Marketplace Rules requiring that a majority of the board consist of
independent directors and requiring that the audit committee consist of three independent
directors, including at least one director with requisite financial sophistication. The Hearings Department also notified the Company by letter dated May 3, 2005, that due to the
incomplete filing of its Form 10-K for the year ended December 31, 2004, described above, the
Companys trading symbol will change from SIMG to SIMGE commencing on May 5, 2005. The
Company intends to take appropriate steps to seek to bring the Company into compliance with the
NASDAQ Marketplace Rules in a timely manner. However, there can be no assurance that NASDAQ will
allow the continued listing of the Companys common stock on the NASDAQ National Market. 
 Item 6. Exhibits 10.01
    
    Compensation Plan for Directors10.02
    
    Letter Agreement with Dale Brown dated April 22, 200531.01
    
    Certification of Chief Executive
Officer under Section 302 of
the Sarbanes-Oxley Act of 200231.02
    
    Certification of Chief Financial
Officer under Section 302 of
the Sarbanes-Oxley Act of 200232.01
    
    Certification of Chief Executive
Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.02
    
    Certification of Chief Financial
Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 54




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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. Dated:
May 10, 2005
    
    Silicon Image, Inc./s/ Darrel SlackDarrel SlackChief Financial Officer(Principal Financial Officer)
 55




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EXHIBIT INDEX 10.01
    
    Compensation Plan for Directors10.02
    
    Letter Agreement with Dale Brown dated April 22, 200531.01
    
    Certification of Chief Executive
Officer under Section 302 of
the Sarbanes-Oxley Act of 200231.02
    
    Certification of Chief Financial
Officer under Section 302 of
the Sarbanes-Oxley Act of 200232.01
    
    Certification of Chief Executive
Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.02
    
    Certification of Chief Financial
Officer Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002