UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C.
20549


_______________





Form 10-K





ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934





For
the fiscal year ended December 31, 2008


Commission
file number 000-26887





______________





Silicon
Image, Inc.


(Exact
name of registrant as specified in its charter)





Delaware
            77-0396307(State
      of incorporation)
            (IRS
      employer identification number)





1060
East Arques Avenue


Sunnyvale,
CA 94085


(Address
of principal executive offices and zip code)


Registrant’s
telephone number, including area code


(408) 616-4000





Securities
registered pursuant to section 12(b) of the Act:


Common
Stock, $0.001 par value per share





Securities
registered pursuant to section 12(g) of the Act:


None


_______________





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes oNo þ





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.  Yes oNo þ





Indicate
by check mark whether the registrant: (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to
such filing requirements for the past 90 days.  Yes þNo o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K o





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





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





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





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant was approximately $532,335,455 as of the last
business day of the registrant’s most recently completed second fiscal quarter,
based upon the closing sale price on the Nasdaq National Market reported for
such date. Shares of common stock held by each officer and director and by each
person who owned 5% or more of the outstanding Common Stock have been excluded
in that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.





The
number of shares of the Registrant’s common stock outstanding as of
January 31, 2009 was 74,070,293.





Portions
of the Definitive Proxy Statement for the 2009 Annual Meeting of Stockholders to
be filed with the Securities and Exchange Commission no later than 120 days
after the end of the fiscal year covered by this report, are incorporated by
reference in Part III of this Form 10-K.





TABLE OF CONTENTS





PagePART IItem
      1
            Business
            3Item
      1A
            Risk
      Factors
            13Item
      1B
            Unresolved Staff
      Comments
            30Item
      2
            Properties
            30Item
      3
            Legal
      Proceedings
            30Item
      4
            Submission of Matters to a Vote of Securities
      Holders
            30PART IIItem
      5
            Market for Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      Securities
            31Item
      6
            Selected Financial
      Data
            32Item
      7
            Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
            33Item
      7A
            Quantitative and Qualitative Disclosures About Market
      Risk
            46Item
      8
            Financial Statements and Supplementary
      Data
            47Item
      9
            Changes in and Disagreements with Accountants on
      Accounting and Financial Disclosure
            47Item
      9A
            Controls and
      Procedures
            47Item
      9B
            Other
      Information
            50PART IIIItem
      10
            Directors, Executive Officers and Corporate
      Governance
            50Item
      11
            Executive
      Compensation
            50Item
      12
            Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
            50Item
      13
            Certain Relationships and Related Transactions and
      Director
      Independence
            50Item
      14
            Principal Accountant Fees and
      Services
            50PART IVItem
      15
            Exhibits and Financial Statement
      Schedules
            51Signatures
            80Index to Exhibits Filed Together with this Annual
      Report
            82


EXHIBIT 10.45


EXHIBIT 10.46


EXHIBIT 10.48


EXHIBIT 21.01EXHIBIT 23.01


EXHIBIT 31.01


EXHIBIT 31.02


EXHIBIT 32.01


EXHIBIT 32.02


2
 Table of Contents


This Annual Report on
Form 10-K contains forward-looking statements within the meaning of Section 21E of
the Securities 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 Annual Report on
Form 10-K 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 Annual Report
on Form 10-K 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-K with
the Securities and Exchange Commission (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 us
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.







PART I





Item 1.Business





General





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





We
provide discrete and various levels of integrated semiconductor products as well
as IP solutions to consumer electronics, computing, display, storage, mobile and
networking equipment manufacturers. Our product and IP portfolio includes
solutions for high-definition televisions (HDTVs), high-definition set-top boxes
(STBs), high-definition digital video disc (DVD) players, digital and personal
video recorders (DVRs and PVRs), mobile devices (cellular phones, camcorders
& still cameras), high-definition game systems, consumer and enterprise
storage products and PC display products.





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





Our customers are equipment manufacturers in each of our target markets —
consumer electronics (including mobile), personal computer, and storage. As a
result of leveraging our technologies across different markets, certain of our
products may be incorporated into equipment used in multiple markets. We sell
our products to original equipment manufacturers (OEMs) throughout the world
using a direct sales force and through a network of distributors and
manufacturer’s representatives. Our net revenue is generated principally by
sales of our semiconductor products, with other revenues derived from IP core
licensing and licensing and royalty fees from our standards activities. We
maintain relationships with the ecosystem of companies that provide the products
that drive digital content creation and consumption, including the major
Hollywood studios, consumer electronics companies, retailers and service
providers. Through these and other relationships, we have formed an
understanding of the requirements for storing, distributing and viewing high
quality digital video and audio in the home and mobile environments, especially
in the area of high definition (HD) content. We have also developed an IP base
for building the standards and products necessary to promote opportunities for
our products.





Historically,
we have grown our business by introducing and promoting the adoption of new
standards and entering new markets. We collaborated with several companies and
jointly developed the DVI and HDMI standards. Our first products addressed the
PC market. Subsequently, we introduced products for a variety of CE market
segments, including DVD, STB, game console and digital television (DTV). More
recently, we have expanded our research and development activities and are
developing products based on our innovative high speed serial digital
interconnect core technology for the mobile device market, including digital
still cameras, HD camcorders, portable media players and smart phones, as well
as the dynamic random access memory (DRAM) and home networking
markets.





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


3
 Table of Contents


Strategy
and Core Technologies





Our goal
is to enable the access and presentation of high-definition digital content
anytime, anywhere, on any device. Our business strategy is to grow the available
market for our products and IP solutions through the development, introduction
and promotion of industry standards such as HDMI, DVI and Serial Advanced
Technology Attachment (SATA) in our core technology areas, which are as
follows:





Transition
Minimized Differential Signaling (TMDS)





TMDS is a
technology for transmitting high-speed serial data. It is used by the DVI and
HDMI video interfaces, as well as other digital communication
interfaces. TMDS devices are based on a transmitter/receiver pair. 
The transmitter incorporates an advanced coding algorithm which has reduced
electromagnetic interference over copper cables and enables robust clock
recovery at the receiver to achieve high skew tolerance for driving longer cable
lengths as well as shorter low cost/quality cables.





Internal
TMDS (iTMDS)





iTMDS
defines a video-only link, using a protocol that is a superset of DVI, for
connecting video paths within a DTV.  This protocol handles not only
standard 8-bit DVI, but also 10-, 12-, and 16-bit color depths.  The
protocol embeds an indicator of the current color depth within the TMDS stream
allowing the iTMDS receiver to automatically switch to the correct format
without any support microcontroller or software.





Serial
Advanced Technology Attachment (SATA)





SATA is a
computer bus primarily designed for transfer of data between a computer and mass
storage devices such as hard disk drives and optical drives. The main
advantages over the older parallel ATA interface are faster data transfer,
ability to remove or add devices while operating (hot swapping), thinner cables
that let air cooling work more efficiently, and more reliable operation with
tighter data integrity checks.





SATA was designed as a successor to the Advanced Technology Attachment standard
(ATA), and has largely replaced the older technology (retroactively renamed
Parallel ATA or PATA). Serial ATA adapters and devices communicate over a
high-speed serial cable. The current SATA specification supports data
transfer rates as high as 3.0 gigabits per second (Gbps) per device, with 6.0
Gbps on the horizon. SATA’s advantages include the fact that it uses only 4
signal lines, cables are more compact and cheaper than PATA, and it supports
hot-swapping, native command queuing (NCQ) and out of order data retrieval.
There is a special connector (eSATA) specified for external devices, and an
optionally implemented provision for clips to hold internal connectors firmly in
place.





The
preferred interface for SATA host controllers is the advanced host controller
interface (AHCI), which allows advanced features of SATA such as hot plug and
native command queuing. If AHCI is not enabled by the motherboard and chipset,
SATA controllers typically operate in  “IDE emulation” mode. 
Windows device drivers that are labeled as SATA are usually running in IDE
emulation mode unless they explicitly state that they are AHCI. While the
drivers included with Windows XP do not support AHCI, we have implemented
proprietary AHCI drivers to support the features of our advanced host
controllers.  Windows Vista and the current versions of Mac OS X and Linux
have native support for AHCI.




LiquidHDTM





LiquidHDTM(LiquidHD)
is a set of protocols designed to network consumer electronic equipment. 
Protocols are a set of rules governing how data flows through the network. The
protocol suite is comprised of resource discovery, control messaging, streaming
media, security and remote user interface components.  The protocols are
designed to be incorporated in a discrete or an integrated semiconductor chip
without the need for general purpose microprocessors thus allowing extremely
cost effective and interoperable integrated circuit (IC) implementations. 
LiquidHD protocols incorporate a content protection scheme suitable for
distribution of entertainment content and provide auto federation and
interoperability for networked CE devices.





LiquidHD
protocols are designed to operate over IP networks, therefore, they are suitable
for any physical layer with sufficient speed and latency characteristics
including MoCA, Ethernet, WiFi and power line. Using these protocols it is
possible to stream media and data without the need for complex software (XML,
HTML, Web Browsers, Java, etc.) in the receiver device. Physical layer is
layer 1 as defined  by Open Systems Interconnect
Model.


4
 Table of Contents





Consumer
Electronics Control (CEC)





CEC
defines a complete messaging protocol for controlling consumer electronic
devices over the HDMI interface.  The CEC bus wiring is mandatory within
the HDMI specification, although implementation of the CEC protocol and
messaging in a product is optional. The CEC bus uses an industry standard
messaging protocol for remote control functions over the HDMI interface and is
implemented as a one-wire bidirectional serial bus.  CEC is used to allow a
single or multiple devices’ remote controls to command and control multiple
CEC-enabled devices, and individual CEC-enabled devices to command and control
each other without user intervention.





An
example of the latter is to allow the DVD player, when the drawer closes with a
disk, to command the TV and the intervening A/V receiver (all with CEC) to
power-up, select the appropriate HDMI ports, and auto-negotiate the proper video
mode and audio mode. Similarly, the equipment can be commanded by the DVD player
to return to sleep mode when the movie ends.





Mobile
High Definition Link (MHL) Technology





Our MHL
technology is a low pin count HD audio and video serial link specifically
defined for connecting mobile devices to high definition TVs. MHL is based on
the same technology used in DVI and HDMI but only requires a single TMDS data
pair to transmit video to MHL enabled TVs at resolutions up to 1080p. MHL uses 5
signal pins that can be used with a small low pin count microUSB connector or a
proprietary connector in mobile devices. Reduced pin count connectors are
critical in small mobile devices because the available connector space is
greatly limited compared to standard consumer electronic devices such as Blu-Ray
players and set top boxes.  The MHL specification also includes a provision
to provide power to the mobile device when connected thus preserving battery
life.





Serial Port
Memory Technology (SPMT)





SPMT
is a new memory interface architecture that Silicon Image and other leading
semiconductor companies are currently developing. SPMT is initially targeted for
DRAM chips that employ a serial interface architecture rather than a parallel
interface architecture as commonly found in current memory offerings. This new
architecture will enable greater bandwidth and flexibility, significantly
reduced pin count, lower power demand resulting in savings on overall system
cost. As consumers demand more rich features, mobile device manufacturers are
faced with the challenge and expense of adding more processors to deliver this
functionality and that requires faster and denser memory. By shifting from
parallel to serial interface technology, manufacturers can:





·
            Reduce
      pin count by a minimum of 40 percent·
            Provide
      a bandwidth range from 3.2-6.4Gbps and higher·
            Reduce
      input/output power by 50 percent or more over other currently available
      DRAM offerings·
            Provide
      the ability to use either a single port or multiple ports into a single
      SPMT-enabled memory chip


All of the above directly translate into lowering overall system
cost.





Standards
Activity





We are
directly involved in the following standards efforts:





High-Definition
Multimedia Interface (HDMI)





In 2002,
we entered into a Founder’s Agreement with Sony, Matsushita Electric Industrial
Co. (Panasonic), Philips, Thomson, Hitachi and Toshiba, under which we formed a
working group to develop the HDMI specification, a next-generation digital
interface for consumer electronics. The HDMI specification is based on our
market-proven TMDS technology, the same technology underlying the HDMI
specification’s predecessor specification, DVI, which we also developed. As an
HDMI founder, we have actively participated in the evolution of the HDMI
specification and we anticipate that our involvement in this and in other
digital interface connectivity standards will continue.





Our
leadership in the market for HDMI-enabled products has been based on our ability
to introduce first-to-market semiconductor and IP solutions to manufacturers and
to continue the cycle of innovation within the standard. We introduced the
industry’s first products for each new version of the HDMI standard, providing a
time-to-market advantage to our customers.


5
 Table of Contents




Our
products also include cutting edge features like InstaportTM that reduces HDMI
port switch time from 5-7 seconds to under 1 second.  These
innovations are not yet available in other HDMI implementations. For consumers,
HDMI has provided a simpler way to connect and use devices and enjoy the
higher-quality entertainment experience available with digital content. More
than 800 manufacturers around the world have become HDMI adopters. For CE
manufacturers, HDMI is a low-cost, standardized means of interconnecting CE
devices, which enables these manufacturers to build feature-rich products that
deliver a true home theater entertainment experience. For PC and monitor
manufacturers, HDMI enables a PC connection to digital TVs and monitors at HD
quality levels. The market acceptance and adoption of HDMI enabled products have
been significant factors in our growth over the last several years, driving both
our product and licensing revenues. The market research firm In-Stat estimates
that approximately 300 million HDMI-enabled products shipped worldwide in
2008.





High-bandwidth
Digital Content Protection (HDCP)





In 2000,
the HDCP specification HDCP 1.0 was published by Intel, with contributions from
Silicon Image acknowledged in the specification. The specification was developed
to add content protection to DVI in order to prevent unauthorized copying of
content when transmitted between source and display over a DVI link. In 2003,
the HDCP specification was updated to revision level 1.1 and made available
for use with HDMI. This technology has been widely adopted in consumer
electronics products, initially in combination with DVI and more recently and
more prevalently in combination with HDMI. In 2007, the HDCP specification was
again revised in VI.3.b.1. The HDCP Compliance Test Specification VI.1 was
released in 2006.





Digital
Visual Interface (DVI)





In 1998,
together with Intel, Compaq, IBM, Hewlett-Packard, NEC and Fujitsu, we announced
the formation of the Digital Display Working Group (DDWG) and in 1999, published
the DVI 1.0 specification. The DVI 1.0 standard defines a high-speed serial data
communication link between computers and digital displays. According to In-Stat,
over 118 million DVI-enabled products were expected to ship in 2008. Today,
in many applications, DVI is being replaced by the more feature-rich HDMI. Our
HDMI products may also face competition from DisplayPort, which is a relatively
new digital display interface standard being put forth by the Video Electronics
Standards Association (VESA) that defines a digital audio/video interconnect
intended to be used primarily between a computer and its display monitor, or a
computer and a home-theater system. Several other companies have introduced
products based on the DisplayPort standard including Apple, Dell, AMD, ST Micro
and nVidia.





Serial
Advanced Technology Attachment (SATA)





We have
been a contributor to the SATA standard and a leading supplier of discrete SATA
solutions including controllers, storage processors, port multipliers and
bridges. Based on serial signaling technology, the SATA standard specifies a
computer bus technology for connecting hard disk drives and other devices and
was formed by Intel, Dell, Maxtor, Seagate and Vitesse in 1999. We sell SATA
semiconductors primarily to merchant motherboard suppliers, computer OEMs and
external drive manufacturers.





Products
and Services





We sell
products and services primarily into three markets: consumer electronics,
personal computers and storage. Our product and IP revenues from the CE, PC and
storage markets were as follows:





Year Ended
December 31,2008
            
            
            2007
            
            
            2006Consumer
      electronics
            
            $
            167,599
            
            
            $
            212,910
            
            
            $
            173,884Personal
      computers
            
            
            40,141
            
            
            
            34,283
            
            
            
            45,320Storage
            
            
            25,461
            
            
            
            25,181
            
            
            
            33,098Licensing
            
            
            41,214
            
            
            
            48,129
            
            
            
            42,656$
            274,415
            
            
            $
            320,503
            
            
            $
            294,958





CE
(DTV & Mobile)





In 2008,
we focused our activities on a new port processor architecture for DTV that, we
believe, provides OEMs with best-in-class performance relating to DTV inputs and
allows these manufacturers to bring their products to market more quickly. 
In 2008, we launched the SiI928x family of port processors, that include support
for MHL, InstaportTM, and HDMI 1.3 with Deep Color and x.v.Color
extended color gamut. Our SiI928x family of port processors expands the number
of HDMI ports available to consumers and augments the HDMI functionality with
quick, high-definition port switching and MHL support.


6
 Table of Contents





Building
on our advanced port processor and HDMI receiver technology, during 2008 we also
introduced our third generation input processor, the SiI9251.  We believe
the SiI9251 delivers outstanding HDMI audio/video quality coupled with superb HD
analog video quality for component and PC video formats.   Our SiI9251
also delivers the contemporary feature set of our port processor solutions
including support for both InstaPortTM and MHLTM technology.  We also
introduced the SiI9261 which delivers the expanded lossless HD audio features of
HDMI 1.3 and support for repeater configurations demanded by Audio Video
Receivers (AVRs) and certain wireless extenders.





Additionally,
in 2008 we released several new integrated receivers that deliver advanced HDMI
1.3 HDTV features including 1080p Deep Color and x.v.Color expanded color gamut.
Our four-port receiver (SiI9223), designed for use in HDTVs, is an advanced
four-input receiver that fits directly into the HDTV unit, offering
manufacturers a low cost, easily implemented upgrade to add HDMI 1.3
capabilities to their full range of HDTVs. We also offer a new four-port
receiver (SiI9233), designed for use in audio/video receivers supports advanced
HD features in a repeater configuration and includes support for lossless audio
formats such as Dolby® TrueHD and DTS-HD Master AudioTM.





We
believe that collectively our many new HDTV HDMI 1.3 solutions allow consumers
to enjoy the highest quality video and audio content currently available on
their HDTVs.  All of our solutions are complemented by the advanced
interoperability testing performed by Simplay Labs, and these new products offer
rapid time-to-market solutions and allow OEMs to significantly reduce
cross-platform compatibility issues.HDMI 1.3
products represented 49.3% of CE product sales.





In 2007
we introduced the next generation of HDMI transmitters for mobile devices
(SiI9022 and SiI9024) that reduce power consumption and improved reliability and
battery life in mobile devices. Our new MHL technology is a low-pin-count link
for low-power mobile devices that operates with any standard mobile connector
such as the micro USB or proprietary connector common in today’s mobile
phones, digital cameras, camcorders, and media players.  MHL allows
consumers to watch and listen to content from these devices on their HDTVs with
pristine digital quality. In 2008, we introduced the industry’s first three
products that enable MHL: two transmitters (SiI9220 and SiI9222) which are the
first MHL transmitters for mobile devices and the first MHL-to-HDMI bridge chip
(SiI9290) for the docking station.





Our HDMI
products have been selected by many of the world’s CE companies.





Transmitters.  Our
HDMI transmitter products reside in CE and PC products, such as DVD players, DVD
recorders, game consoles, STBs, digital camcorders, A/V receivers and digital
video recorders (DVRs). HDMI transmitters convert digital video and audio into a
multi-gigabit per second encrypted serialized stream and transmit the secure
content to an HDMI receiver that is built into televisions and A/V
receivers.





HDMI
Receivers.  Our HDMI receiver products reside in display
systems, such as HDTVs, plasma TVs, LCD TVs, rear-projection TVs, front
projectors, PC monitors as well as A/V receivers. HDMI receivers convert an
incoming encrypted serialized stream to digital video and audio, which is then
processed by a television or PC monitor for display.





We offer
a broad line of products targeting the CE market, including:





Type
            Target ApplicationsHDMI
      Port Processor
            LCD
      TVs, plasma TVs, projection TVs, A/V ReceiversHDMI
      Receiver
            LCD
      TVs, plasma TVs, projection TVs, A/V ReceiversInput
      Processor
            LCD
      TVs, plasma TVs, projection TVs, A/V ReceiversHDMI
      Transmitter
            Blu-ray/DVD
      players/recorders, STBsSATA
      Controller
            Consumer
      PC, DVRSATA
      Bridges
            Consumer
      PC





PC





While the
PC market has become an increasingly smaller portion of our business over time,
a trend that we anticipate will continue, the growth of digital TVs with HDMI
inputs provides a source of demand for our PC products as consumers increasingly
seek to connect their PCs to their DTVs to play games, watch high-definition
DVDs and view photos.


7
 Table of Contents


Because
HDMI is backward compatible with the DVI standard, HDMI-enabled PCs can also
connect directly to the enormous installed base of PC monitors with DVI
inputs.





Market
researcher In-Stat estimated that 15 million DVI-enabled PC devices were
shipped by industry participants in 2008. Although DVI is being replaced by the
more feature-rich HDMI in many applications, In-Stat estimated that
approximately 118 million DVI-enabled devices were expected to ship in
2008. Our HDMI products may also face competition from DisplayPort, which is a
relatively new digital display interface standard being put forth by the Video
Electronics Standards Association (VESA) that defines a digital audio/video
interconnect intended to be used primarily between a computer and its display
monitor, or a computer and a home-theater system. Several other companies have
introduced products based on the DisplayPort standard including Apple, Dell,
AMD, ST Micro and nVidia.





Silicon
Image offers a line of receivers and transmitters for the PC marketplace,
including:




Product
            Type
            Target
      Applications
            Other
      FeaturesSiI164
            DVI
              Transmitter
            Desktop
      PCs (motherboards, add-in
              boards)
      Notebook PCs
            ·I(2)C
      interface
              ·3.3V or
      1.0-1.8V interface
              ·De-skewing
      optionSiI1161
            DVI
      Receiver
            LCD
      Monitors, Plasma TVs/
              Displays,
      Projectors
            ·3.3V
      interface
              ·PC
      Interface
              ·Programmable
      equalization for long cable supportSil1364A
            DVI
      Transmitter
            Intel
      SDVO ADD2 cards
            ·HDMI
      Output
              ·PC
      interface
              ·Supports Intel
      SDVO technology
              ·Cable distance
      support greater than 10 metersSiI1362A
            DVI
      Transmitter
            PC
      motherboards, notebook PCs
            ·I2C
      interface
              ·Supports Intel
      SDVO technology
              ·Cable distance
      support greater than 10 metersSiI1392
            DVI
              Transmitter
            Notebook
      and Desktop PCs
              (motherboards,
      add-in boards)
            ·SDVO
      interface
              ·HDMI 1.2
      output
              ·HDCP


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Storage





We
continue our leadership role in SATA, a standard that has replaced PATA in
desktop storage. Through several SATA generations, we have introduced higher
levels of SATA integration, driving higher SATA performance and functionality
and delivering a family of SATA system-on-a-chip (SoC) solutions for the
consumer electronics environment. SATA may also serve as an external interface
(eSATA)  providing advanced storage features and ultra high speed for
external drives.  The latest generation of digital video recorders
(DVRs) from Scientific Atlanta, Motorola and TiVo, as well as PCs &
motherboards from HP, Dell, ASUS, MSI, ECS, Foxconn, ASRock and iWill are
equipped with eSATA ports.





SteelVine Storage
Controllers — We provide a full line of SATA controllers used in PC,
DVR and network attached storage (NAS) applications. The current generation of
SteelVine controllers provides the latest SATA Gen II features including
eSATA signal levels, 3.0 Gbps, native command queuing (NCQ), hot-plug and port
multiplier support.





SteelVine Bridges — Our
bridge products such as the SiI3811 provide PC OEMs with a solution that
connects legacy PATA optical drives to the current generation of motherboard
chip sets and are used primarily in desktop and laptop PC
applications.





SteelVine Storage
Processors — We introduced our SteelVine storage processor
architecture in 2004. SteelVine integrates the capabilities of a complex
redundant array of independent disks (RAID) controller into a single-chip
architecture. Our SteelVine storage processor represent a completely new product
category that enables a new class of storage solutions for the PC, CE and
external storage markets. SteelVine storage processors deliver enterprise-class
features such as virtualization, RAID, hot-plug and hot spare, in a single very
low cost SoC. These unique SoCs allow system builders to produce appliance-like
solutions that are simple, reliable, affordable and scalable without the need
for host software. Storage processors are currently shipping in PC motherboards
as well as external storage solutions.





Our
storage products include the following:





Product
            Categories
            Key Features
            Target ApplicationsSiI5723,
              Sil4726
              Sil5744
              Sil3726
            Storage
              Processors
      & Port Multiplexers
            2
      & 5-drive SteelVine IC with 3Gbps Serial ATA and USB 2.0 host link and
      support. Also supports drive cascading, RAID 0, 1, 10 and drive
      spanning
            Consumer
      storage applications for PC and CE markets.SiI3124A
            SATA
      Controllers
            Single
      chip, quad-channel, PCI/PCI-X-to-3Gbps SATA- Gen II host controller,
      SATARAID(tm) software, 1st Party DMA, hot plug, ATAPI support, port
      multiplier support with FIS-based switching, variable output strengths for
      backplane support, Supports up to 3Gbps per channel
            Server
      motherboards, server add-in-cards, host bus adapters, RAID subsystems,
      embedded applicationsSiI3512,
      3114
            SATA
      Controllers
            Single-chip,
      PCI-to-1.5Gbps SATA-Gen I host controller, SATARAID(tm) software,
      hot  subsy RAID plug, ATAPI support, variable output strengths
      for backplane support
            PC
      motherboards, PC add-in-cards, server motherboards, host bus adapters,
      subsystems, embedded applicationsSiI3132,
      3531
            SATA
      Controllers
            Single-chip,
      PCI Express-to-3.0Gbps SATA Gen-II host controller, SATARAID(tm) software,
      hot  subsy plug, ATAPI support, port multiplier with FIS based
      switching, variable output strengths for backplane support
            PC
      motherboards, PC add-in-cards, server motherboards, host bus adapters,
      RAID subsystems, embedded applicationsSiI3811
            SATA
      Device Bridge
            1.5Gbps
      SATA-to-PATA device bridge, ATAPI support
            Notebook
      and PC motherboards, ATAPI devicesSiI0680
            PATA
      Controller
            Ultra
      ATA/133 PCI-to-ATA host Controller
            PC
      Motherboards, PC add-in-cards, server motherboards, host bus adapters,
      embedded applications





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Simplay
Labs, LLC





We
believe Simplay Labs LLC, our wholly owned subsidiary, has further enhanced our
reputation for quality, reliable products and leadership in the HDMI market. The
Simplay HD Testing Program offers one of the most robust and comprehensive
testing platforms in the consumer electronics industry as device
interoperability is of significant concern to retailers and consumers in the HD
market. Devices that pass the Simplay HD testing program are certified to meet
the HDMI and HDCP specifications and have demonstrated interoperability through
empirical testing against over 80 “peer” devices maintained by Simplay Labs. We
have service centers operating in the US and China, providing global
compatibility and performance testing centers. By December 31, 2008, more
than 370 products have been Simplay HD-verified and 95 manufacturers, installers
and retailers have participated in the Simplay HD Testing Program, enabling a
higher level of consumer trust that their products are fully interoperable with
other HDMI products.





In
December of 2008, Simplay introduced the Simplay Explorer HDMI-CEC R&D
development tool, designed to identify CEC interoperability, usability and
performance issues early in the development stage. The first HDMI-CEC R&D
tool of its kind for CE manufacturers, the Simplay CEC Explorer sets a higher
standard for development of HDMI CEC features and enables manufacturers to bring
products to market faster. We also launched a new Simplay CEC software
technology platform to reduce the time and cost of implementing CEC in HD
devices, such as HDTVs.  As of December 31, 2008, both Simplay CEC
products are in customer evaluation trials.





HDMI
Licensing, LLC





HDMI
Licensing, LLC, a wholly owned subsidiary of Silicon Image, is the agent
responsible for licensing the HDMI specification, promoting the HDMI standard
and providing education on the benefits of HDMI to retailers and consumers. The
HDMI specification continues to experience rapid growth in the consumer
electronics and PC markets, as manufacturers meet consumer demand for multimedia
convergence and continue to drive higher performance in their product offerings.
In 2008 there was an increase in adopters as well as an increase in HDMI-enabled
products as the HDMI specification continues to make its way into more
products.





As of
December 31, 2008, more than 800 manufacturing companies had licensed HDMI
from HDMI Licensing, LLC.  The adoption of HDMI specifications by
additional manufacturers during 2008 further strengthens the specification’s
position as the worldwide standard for high-definition digital connectivity.
According to market researcher In-Stat, the HDMI specification has become widely
adopted and has moved from an emerging standard to a prevalent connectivity
standard used in many consumer applications. In-Stat reports that approximately
300 million HDMI enabled devices incorporating HDMI were expected to be
shipped in 2008, with over 394 million devices expected to ship in 2009 and
an installed base of nearly 1.5 billion HDMI-enabled devices projected by
2010.





Markets
and Customers





We focus
our sales and marketing efforts on achieving design wins with OEMs of CE, PC and
storage products. Historically, a relatively small number of customers and
distributors have generated a significant portion of our revenue. Our top five
customers, including distributors, generated 55.1%, 57.7% and 57.3%, of our
revenue in 2008, 2007 and 2006, respectively. For the year ended
December 31, 2008, shipments to World Peace Industrial, generated 14.6% of
our revenue, shipments to Microtek Corporation, generated 11.8% of our revenue,
shipments to Weikeng Industrial generated 11.5% of our revenue and shipments to
Innotech Corporation, generated 10.5% of our revenue. The percentage of revenue
generated through distributors tends to be significant, since many OEMs rely
upon third-party manufacturers or distributors to provide purchasing and
inventory management functions. Our revenue generated through distributors was
52.1%, 49.5% and 50.2% of our total revenue in 2008, 2007 and 2006,
respectively.





A
substantial portion of our business is conducted outside the United States;
therefore, we are subject to foreign business, political and economic risks.
Nearly all of our products are manufactured offshore, primarily in Asia and for
the years ended December 31, 2008, 2007 and 2006, approximately 83.4%,
79.8% and 78.6%, of our total revenue respectively, was generated from customers
and distributors located outside of North America, primarily in Asia. Please
refer to the section of this report titled “Risk Factors” for a discussion of
risks associated with the sell-through arrangement with our
distributors.





Research
and Development





Our
research and development efforts continue to focus on innovative technologies
and standards, higher-bandwidth, lower-power links, efficient algorithms,
architectures and feature-rich implementations for higher-level SoCs, for
CE (including DTV), PC, mobile


10
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and
storage applications. By utilizing our patented technologies and optimized
architectures, we believe our products can scale with advances in semiconductor
manufacturing process technology, simplify system design and provide innovative
solutions for our customers. As of December 31, 2008, we had been issued
more than 120 United States patents and had in excess of 85 United States patent
applications pending. Our U.S. issued patents expire in 2015 or later,
subject to our payment of periodic maintenance fees. A discussion of risks
related to our intellectual property is set forth in the section of this report
titled “Risk Factors”.


We have
assembled a team of engineers and technologists with extensive experience in the
areas of high-speed interconnect architecture, circuit design, digital
audio-visual (A/V) processor architecture, storage architecture, logic
design/verification, firmware/software, flat panel displays, digital audio/video
systems and storage systems. We have invested and expect that we will continue
to invest, significant funds for research and development activities. Our
research and development expenses were approximately $84.8 million,
$78.0 million and $63.6 million, in 2008, 2007 and 2006, respectively,
including stock-based compensation expense of $7.1 million,
$8.4 million and 11.1 million for 2008, 2007 and 2006,
respectively.





Sales
and Marketing





We sell
our products using a direct sales force with field offices located in North
America, Europe, Taiwan, China, Japan and Korea and through a network of
distributors located throughout North America, Asia and Europe. Our sales
strategy for all products is to achieve design wins with key industry companies
in order to grow the markets in which we participate and to promote and
accelerate the adoption of industry standards that we support or are
developing.





Manufacturing





Wafer
Fabrication





Our
semiconductor products are designed using standard, complementary metal oxide
semiconductor (CMOS) processes, which permit us to use independent wafer
foundries to fabricate them. By outsourcing the manufacture of our semiconductor
products, we are able to avoid the high cost of owning and operating a
semiconductor wafer fabrication facility and to take advantage of our contract
manufacturers’ high-volume economies of scale. Outsourcing our manufacturing
also gives us direct and timely access to various process technologies. This
allows us to focus our resources on the innovation, design and quality of our
products.





Our
semiconductor products are currently fabricated using 0.35, 0.25, 0.18 and 0.13
micron processes. We continuously evaluate the benefits, primarily the improved
performance, costs and feasibility, of migrating our products to smaller
geometry process technologies. We have conducted certain development projects
for some of our customers, involving smaller geometries, namely 90 nm and
65 nm designs. We rely almost entirely on Taiwan Semiconductor
Manufacturing Company (TSMC) to produce all of our semiconductor products.
Because of the cyclical nature of the semiconductor industry, capacity
availability can change quickly and significantly. We attempt to optimize wafer
availability by continuing to use less advanced wafer geometries, such as 0.35,
0.25, 0.18 and 0.13 micron, for which foundries generally have more available
capacity.





Assembly
and Test





Our
semiconductor products are designed to use low-cost standard packages and to be
tested with widely available semiconductor test equipment. We outsource all of
our packaging and the majority of our test requirements. This enables us to take
advantage of high-volume economies of scale and supply flexibility and gives us
direct and timely access to advanced packaging and test technologies. We test a
small portion of our products in-house. Since the fabrication yields of our
products have historically been high and the costs of our packaging have
historically been low, we test our products after they are assembled. This
testing method has not caused us to experience unacceptable failures or yields.
Our operations personnel closely review the process and control and monitor
information provided to us by our foundries. To ensure quality, we have
established firm guidelines for rejecting wafers that we consider unacceptable.
However, lack of testing prior to assembly could have adverse effects if there
are significant problems with wafer processing. Additionally, for newer products
and products for which yield rates have not stabilized, we may conduct bench
testing using our personnel and equipment, which is more expensive than fully
automated testing.





Quality
Assurance





We focus
on product quality through all stages of the design and manufacturing process.
Our designs are subjected to in depth circuit simulation at temperature, voltage
and processing extremes before being fabricated. We pre-qualify each of our
subcontractors through an audit and analysis of the subcontractor’s quality
system and manufacturing capability. We also participate in quality
and


11
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reliability
monitoring through each stage of the production cycle by reviewing data from our
wafer foundries and assembly subcontractors. We closely monitor wafer foundry
production to ensure consistent overall quality, reliability and yields. Our
independent foundries and our assembly and test subcontractors have achieved
International Standards Organization (ISO) 9001 certification.




Competition





The
markets in which we participate are intensely competitive and are characterized
by rapid technological change, evolving standards, short product life cycles and
decreasing prices. We believe that some of the key factors affecting competition
in our markets are levels of product integration, compliance with industry
standards, time-to-market, cost, product capabilities, system design costs,
intellectual property, customer support, quality and reputation.





CE





In the
consumer electronics market, our digital interface products are used to connect
a variety of devices to DTVs including cable set-top boxes, satellite set-top
boxes, A/V receivers, game consoles, digital/personal video recorders (DVR/PVR),
DVD players and a growing number of mobile devices such as smart phones,
camcorders and cameras. These products incorporate HDMI technology with HDCP or
DVI and HDCP support. Companies competing for sales of HDMI and DVI solutions
include among others, Analog Devices, Analogix, Broadcom, Conexant, ST Micro,
Mstar, NXP, Texas Instruments and Thine. We also compete in some instances
against in-house processing solutions designed by large consumer electronics
OEMs.





PC





In the PC
market, our products face competition from a number of sources. We offer a
number of HDMI and DVI solutions to the PC market and we compete against several
companies such as AMD, Analog Devices, Broadcom, Chrontel, Conexant, ST Micro,
MRT, National Semiconductor, nVidia, Pixelworks, SIS, Smart ASIC, ST
Microelectronics, Texas Instruments and Thine. In addition, Intel and other
competitors have announced plans to integrate HDMI into their PC chips sets. Our
HDMI products may also face competition from DisplayPort, which is a new digital
display interface standard being put forth by the Video Electronics Standards
Association (VESA) that defines a digital audio/video interconnect intended to
be used primarily between a computer and its display monitor, or a computer and
a home-theater system. Several other companies have introduced products based on
the DisplayPort including Apple, Dell, AMD, ST Micro and
nVidia.  DisplayPort is increasingly challenging DVI as the default
standard for digital video interconnect technology.





Storage





Our SATA
products compete with similar products from Atmel, J-Micron, Marvell Technology,
Promise Technology, Silicon Integrated Systems and VIA Technologies. In
addition, other companies, such as APT, Intel and LSI Logic, have developed, or
announced intentions to develop, SATA products. We also compete against AMD,
Intel, nVidia, Silicon Integrated Systems, VIA Technologies and other
motherboard chip-set makers, which have integrated SATA functionality into their
chipsets.





Many of
our competitors have longer operating histories and greater presence in key
markets, greater name recognition, access to larger customer bases and
significantly greater financial, sales and marketing, manufacturing,
distribution, technical and other resources than we do. In particular,
well-established semiconductor companies such as Analog Devices, Intel, National
Semiconductor and Texas Instruments and consumer electronics manufacturers, such
as Hitachi, Matsushita, Sony, Thomson and Toshiba, may compete against us in the
future. We cannot assure that we can compete successfully against current or
potential competitors, or that competition will not seriously harm our
business.





Employees





As of
December 31, 2008, we had a total of 610 employees, including 259
located outside of the United States. None of our employees are represented by a
collective bargaining agreement, except, as is customary, our employees in
Germany are represented by a work council. We have never experienced any work
stoppages. We consider our relations with our employees to be good. We depend on
the continued service of our key technical, sales and senior management
personnel and our ability to attract and retain additional qualified
personnel.


12
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Item 1A.Risk
Factors





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





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





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





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





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





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





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





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





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





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





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





Because
we have little or no control over these factors and/or their magnitude, our
operating results are difficult to predict. Any substantial adverse change in
any of these factors could negatively affect our business and results of
operations.





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





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





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


13
 Table of Contents


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





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





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





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





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





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





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





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





•
            our
      ability to manage expenses and inventory
  levels; and





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





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





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





Global
credit and financial markets have been experiencing extreme disruptions in
recent months, including severely diminished liquidity and credit availability,
declines in consumer confidence, declines in economic growth, increases in
unemployment rates, and uncertainty about economic stability. There can be no
assurance that there will not be further deterioration in credit and financial
markets and confidence in economic conditions.  These economic
uncertainties affect businesses such as ours in a number of ways, making it
difficult to accurately forecast and plan our future business activities. The
current tightening of credit in financial markets may lead consumers and
businesses to postpone spending, which may cause our customers to cancel,
decrease or delay their existing and future orders with us. In addition,
financial difficulties experienced by our suppliers or distributors could result
in product delays, increased accounts receivable defaults and inventory
challenges. The volatility in the credit markets has severely diminished
liquidity and capital availability.  Our CE product revenue, which
comprised approximately 61.1%, 66.4% and 59.0% of total revenue in 2008, 2007
and 2006 respectively, is dependent on continued demand for consumer
electronics, including but not limited to, DTVs, STBs, DVDs and game consoles.
Demand for consumer electronics business is a function of the health of the
economies in the United States and around the world. Since the US economy and
other economies around the world have moved into a recession, the demand for
overall consumer electronics have been and may continue to be adversely affected
and therefore, demand for our CE, PC and storage products and our operating
results have been and may continue to be adversely affected as well. We cannot
predict the timing, strength or duration of any economic disruption or
subsequent economic recovery, worldwide, in the United States, in our industry,
or in the consumer electronics market. These and other economic factors have had
and may continue to have a material adverse effect on demand for our CE, PC and
storage products and on our financial condition and operating
results.





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


14
 Table of Contents





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





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





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





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





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





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





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


15
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results
of operations could be negatively affected.


Our
success depends on demand for our new products.





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





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





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





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





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





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





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


16
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The HDMI
founders decided to reduce the annual license fee payable by HDMI adopters from
$15,000 to $10,000 per year effective on November 1, 2006 for all adopters
after that date in order to encourage more widespread adoption of HDMI. The
annual fees collected by our subsidiary HDMI Licensing, LLC are recognized as
revenues by us. Accordingly, if there are not sufficient new adopters of HDMI to
offset the reduction in the annual license fee payable per adopter, our revenues
will be negatively impacted. In addition, during 2007, at a founders meeting,
the founders decided to share the HDMI adopter’s royalty revenues among the
various founders. Our subsidiary no longer recognizes 100% of the HDMI adopter
royalty revenues.





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





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





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





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





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





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





After we
have developed and delivered a product to a customer, the customer will usually
test and evaluate our product prior to designing its own equipment to
incorporate our product. Our customers generally need three months to over six
months to test, evaluate and adopt our product and an additional three months to
over nine months to begin volume production of equipment that incorporates our
product. Due to this lengthy sales cycle, we may experience significant delays
from the time we incur operating expenses and make investments in inventory
until the time that we generate revenue from these products. It is possible that
we may never generate any revenue from these products after incurring such
expenditures. Even if a customer selects our product to


17
 Table of Contents


incorporate
into its equipment, we have no assurances that the customer will ultimately
market and sell its equipment or that such efforts by our customer will be
successful. The delays inherent in our lengthy sales cycle increase the risk
that a customer will decide to cancel or change its product plans. Such a
cancellation or change in plans by a customer could cause us to lose sales that
we had anticipated. In addition, anticipated sales could be materially and
adversely affected if a significant customer curtails, reduces or delays orders
during our sales cycle or chooses not to release equipment that contains our
products. Further, the combination of our lengthy sales cycles coupled with
worldwide economic conditions could have a compounding negative impact on the
results of our operations.


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





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





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





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





Historically,
a relatively small number of customers and distributors have generated a
significant portion of our revenue. For the year ended December 31, 2008,
shipments to World Peace Industrial, generated 14.6% of our revenue, shipments
to Microtek Corporation, generated 11.8% of our revenue, shipments to Weikeng
Industrial generated 11.5% of our revenue and shipments to Innotech Corporation,
generated 10.5% of our revenue. For the year ended December 31, 2007,
shipments to Innotech Corporation generated 15.6% of our revenue, shipments to
Microtek Corporation generated 14.2% of our revenue, shipments to World Peace
Industrial generated 13.6% of our revenue, and shipments to Weikeng Industrial
generated less than 10% of our revenue.  In addition, an end-customer
may buy our products through multiple distributors, contract manufacturers and
/or directly, which could create an even greater concentration. We cannot be
certain that customers and key distributors that have accounted for significant
revenue in past periods, individually or as a group, will continue to sell our
products and generate revenue. As a result of this concentration of our
customers, our results of operations could be negatively affected if any of the
following occurs:





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





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





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





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





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





Many
original equipment manufacturers (“OEMs”) rely on third-party manufacturers or
distributors to provide inventory management and purchasing functions.
Distributors generated 52.1% of our revenue for the year ended December 31,
2008, 49.5% of our revenue for the year ended December 31, 2007 and 50.2%
of our revenue for the year ended December 31, 2006. 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;


18
 Table of Contents





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





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





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





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





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





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





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





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





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





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





•
            timely
      completion and introduction of new product
  designs;





•
            management
      of product life cycles;





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





•
            market
      acceptance of new
products; and





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





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


19
 Table of Contents


products.
There can be no assurance that we will be able to achieve design wins for our
planned new products, that we will be able to complete development of these
products when anticipated, or that these products can be manufactured in
commercial volumes at acceptable yields, or that any design wins will produce
any revenue. Failure to develop and introduce new products, successfully and in
a timely manner, may adversely affect our results of operations.


There
are risks to our global strategy.





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





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





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





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





•
            disruption
      of our ongoing business;





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





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





•
            inability
      to commercialize acquired
technology; and





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





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





Industry
cycles may strain our management and resources.





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





•
            improve
      operational and financial systems;





•
            train
      and manage our employee base;





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





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





•
            adjust
      spending levels according to prevailing market
  conditions.


20
 Table of Contents


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





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





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





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





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





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





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





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





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





The complex
nature of our production process, which can reduce yields and 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.


21
 Table of Contents


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





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





We face foreign
business, political and economic risks because a majority of our products and our
customers’ products are manufactured and sold outside of 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. For
the years ended December 31, 2008, 2007 and 2006, approximately 83.4%,
79.8% and 78.6% of our revenue, respectively, was generated from customers and
distributors located outside of the United States, primarily in Asia. We
anticipate that sales outside of the United States will continue to account for
a substantial portion of our revenue in future periods. In addition, we
undertake various sales and marketing activities through regional offices in
several other countries and we have significantly expanded our research and
development operations outside of the United States. We intend to continue to
expand our international business activities. Accordingly, we are subject to
international risks, including, but not limited to:





•
            political,
      social and economic instability;





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





•
            natural
      disasters and public health
emergencies;





•
            nationalization
      of business and blocking of cash
flows;





•
            trade
      and travel restrictions





•
            the
      imposition of governmental controls and
  restrictions;





•
            burdens
      of complying with a variety of foreign
laws;





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





•
            unexpected
      changes in regulatory requirements;





•
            foreign
      technical standards;





•
            changes
      in taxation and tariffs;





•
            difficulties
      in staffing and managing international
  operations;





•
            fluctuations
      in currency exchange rates;





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





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


22
 Table of Contents


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





•
            potentially
      adverse tax consequences.





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





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





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





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





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





Our participation
in working groups for the development and promotion of industry standards in our
target markets, including the Digital Visual Interface and HDMI specifications,
requires us to license some of our intellectual property for free or
under
specified terms and conditions, which may make it easier for others to
compete with us in such
markets.


23
 Table of Contents


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





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


and





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





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





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





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





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





Our
success depends on managing our relationship with Intel.





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





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





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





•
            Intel
      and Silicon Image worked together to develop
  HDCP;


24
 Table of Contents





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





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





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





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





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





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





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





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





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





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





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





We have granted
Intel rights with respect to our intellectual property, which could allow Intel to
develop products that compete with ours or otherwise reduce the value
of our
intellectual property.





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





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





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


25
 Table of Contents


damages
or royalties to a third-party and we fail to develop or license a substitute
technology, our business, results of operations or financial condition could be
materially adversely affected.





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





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





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





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





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





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





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





We
indemnify certain of our licensing customers against infringement.





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





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





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





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


26
 Table of Contents


we may
incur increased cash compensation costs or find it difficult to attract, retain
and motivate employees, either of which could harm our business.


If our
internal control over
financial reporting or disclosure controls and procedures are not effective, there
may be errors in our financial statements that could require a restatement or
our filings may not be timely and investors may lose confidence in our
reported financial information, which could lead to a decline in our
stock price.  While we have not had any material weaknesses in the
past three years, we cannot assure you that a material weakness
will not be identified in the future.





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





Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our internal control over financial reporting will prevent
all error and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
system’s objectives will be met. Further, the design of a control system must
reflect the fact that there are resource constraints and the benefits of
controls must be considered relative to their costs. Controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the controls. Over time, controls may
become inadequate because changes in conditions or deterioration in the degree
of compliance with policies or procedures may occur. In addition, we may
reassess the implementation or testing of certain of our current controls as a
result of the 2007 release of Public Company Accounting Oversight Board Auditing
Standard No. 5, which may lead to modifications in such controls. These
modifications could affect the overall effectiveness or evaluation of the
control system in the future by us or our independent registered public
accounting firm. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be
detected.





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





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





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





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





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





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





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





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





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





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


27
 Table of Contents





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





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





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





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





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





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





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





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





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





Our operations
and the operations of our significant customers, third-party wafer foundries and
third-party assembly and test subcontractors are located in areas susceptible to
natural disasters.





Our
operations are headquartered in the San Francisco Bay Area, which is
susceptible to earthquakes. TSMC, the outside foundry that produces the majority
of our semiconductor products, is located in Taiwan.  Siliconware
Precision Industries Co. Ltd., or SPIL, Advanced Semiconductor Engineering, or
ASE, and Amkor Taiwan are subcontractors located in Taiwan that assemble and
test our semiconductor products. For the years ended December 31, 2008,
2007 and 2006 customers and distributors located in Japan generated 24.0%, 35.3%
and 35.0%,of our revenue, respectively, and customers and distributors located
in Taiwan generated 19.8%, 16.7% and 20.3% 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.


28
 Table of Contents




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





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





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





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





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.





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;


29
 Table of Contents





•
            changes
      in expectations of our future financial
  performance;





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





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





•
            changes
      in our key executives and technical
  personnel; and





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





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





Item 1B.Unresolved Staff
Comments





Not
applicable.





Item 2.Properties





Our
principal operating facility, consisting of approximately 126,686 square
feet of space in Sunnyvale, California, is leased through July 31, 2011. We
have approximately 25,981 square feet of space in Irvine, California, which
is leased through November 30, 2012 and 29,404 square feet of space in two
locations in Shanghai, China, which are leased through April 30, 2010 and June
30, 2010. We also have approximately 5,603 square feet of space in Germany
which is leased through December 31, 2009. These facilities house our corporate
offices, the majority of our engineering team, as well as a portion of our
sales, marketing, operations and corporate services organizations.





We also
lease facilities in China, Japan, Korea, Taiwan and the Netherlands. We believe
that our existing properties are in good condition and suitable for the conduct
of our business.





Item 3.Legal
Proceedings





Information
with respect to this item may be found in Note 7 to the Consolidated
Financial Statements in Item 8, which is incorporated herein by
reference.





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





Not
applicable.


30
 Table of Contents


PART II





Item 5.Market
for Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities





Our
common shares have been traded on the NASDAQ Stock Market since our initial
public offering on October 6, 1999. Our common shares trade under the
symbol “SIMG”. Our shares are not listed on any other markets or exchanges. The
following table shows the high and low closing prices for our common shares as
reported by the NASDAQ Stock Market:





High
            
            
            Low2008Fourth
      Quarter
            
            $
            5.11
            
            
            $
            3.08Third
      Quarter
            
            
            7.40
            
            
            
            4.95Second
      Quarter
            
            
            7.66
            
            
            
            5.00First
      Quarter
            
            
            5.08
            
            
            
            3.872007Fourth
      Quarter
            
            $
            6.72
            
            
            $
            4.29Third
      Quarter
            
            
            8.70
            
            
            
            4.86Second
      Quarter
            
            
            9.31
            
            
            
            7.86First
      Quarter
            
            
            13.55
            
            
            
            8.13





As
January 30, 2009, we had approximately 95 holders of record of our common
stock and the closing price of our common stock was $3.67. Because many of such
shares are held by brokers and other institutions on behalf of stockholders, we
are unable to estimate the total number of stockholders represented by these
record holders.





We have
never declared or paid cash dividends on shares of our capital stock. We intend
to retain any future earnings to finance growth and do not anticipate paying
cash dividends.





In
February 2007, our Board of Directors authorized a stock repurchase program
under which we were authorized to purchase up to $100.0 million of common stock,
on the open market, or in negotiated or block transactions, over a 36 month
period. As of December 31, 2007, we had repurchased a total of 5.0 million
shares at a total cost of $38.1 million. In February 2008, our Board of
Directors authorized an additional $100.0 million stock repurchase program,
under which shares may be repurchased over a period of three years, to commence
following completion of our accelerated stock repurchase plan (“ASR”) (see
below). Purchases under this program may be increased, decreased or discontinued
at any time without prior notice.





In
February 2008, we entered into an ASR with Credit Suisse International (Credit
Suisse), to purchase shares of common stock for an aggregate purchase price of
approximately $62.0 million paid in February 2008.  We received
11.5 million shares under the agreement, based on a predetermined price, which
was subject to an adjustment based on the volume weighted average price during
the term of the ASR. In accordance with the ASR agreement, on June 25, 2008, we
chose to settle the arrangement in cash (rather than shares) and made a final
payment of approximately $6.2 million for the purchase of shares.  The
ASR terminated on June 30, 2008 with final settlement taking place in July 2008
(“settlement date”). On the settlement date, Credit Suisse returned
approximately $1.0 million based on the volume weighted average share price
during the period. In accordance with the relevant accounting guidance, we
reflected the 11.5 million shares repurchased and the $68.2 million paid to
Credit Suisse as treasury stock and recorded the $1.0 million received as part
of other income in the consolidated statement of income in the second and third
quarters of 2008.





With the
repurchase, we completed our original stock repurchase program announced on
February 2007 and repurchased approximately $5.0 million of our stock under the
new $100.0 million stock repurchase program approved by the Board of Directors
in February 2008.





For
Securities authorized for issuance under equity compensation plans please See
Note 5 of  our Notes to Consolidated Financial Statements
included in Item 15(a) of this report.





31
 Table of Contents


Item 6.Selected Financial
Data





The
following selected financial data should be read in connection with our
consolidated financial statements and notes thereto and “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” included
elsewhere in this Annual Report on Form 10-K. Historical results of
operations are not necessarily indicative of future results.





Year Ended
December 31,2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004(In
      thousands, except employees and per share data)Statements
      of Operations Data:Revenue
            
            $
            274,415
            
            
            $
            320,503
            
            
            $
            294,958
            
            
            $
            212,399
            
            
            $
            173,159Cost
      of revenue(1)
            
            
            113,726
            
            
            
            140,443
            
            
            
            121,247
            
            
            
            83,105
            
            
            
            68,614Gross
      margin
            
            
            160,689
            
            
            
            180,060
            
            
            
            173,711
            
            
            
            129,294
            
            
            
            104,545%
      of revenue
            
            
            58.6
            %
            
            
            56.2
            %
            
            
            58.9
            %
            
            
            60.9
            %
            
            
            60.4
            %Research
      and development(2)
            
            $
            84,819
            
            
            $
            77,994
            
            
            $
            63,598
            
            
            $
            44,860
            
            
            $
            61,459%
      of revenue
            
            
            30.9
            %
            
            
            24.3
            %
            
            
            21.6
            %
            
            
            21.1
            %
            
            
            35.5
            %Selling,
      general and administrative(3)
            
            $
            71,719
            
            
            $
            70,340
            
            
            $
            67,597
            
            
            $
            31,438
            
            
            $
            42,183%
      of revenue
            
            
            26.1
            %
            
            
            21.9
            %
            
            
            22.9
            %
            
            
            14.8
            %
            
            
            24.4
            %Restructuring
      expense(4)
            
            $
            5,858
            
            
            $
            —
            
            
            $
            —
            
            
            $
            (220
            )
            
            $
            —%
      of revenue
            
            
            2.1
            %
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %Income
      (loss) from operations
            
            $
            (8,055
            )
            
            $
            28,155
            
            
            $
            47,252
            
            
            $
            51,572
            
            
            $
            (961
            )Net
      income (loss)
            
            $
            10,063
            
            
            $
            19,001
            
            
            $
            42,465
            
            
            $
            49,549
            
            
            $
            (324
            )Net
      income per share:Basic
            
            $
            0.13
            
            
            $
            0.22
            
            
            $
            0.51
            
            
            $
            0.63
            
            
            $
            0.00Diluted
            
            $
            0.13
            
            
            $
            0.22
            
            
            $
            0.49
            
            
            $
            0.59
            
            
            $
            0.00Weighted
      average shares — basic
            
            
            75,570
            
            
            
            85,557
            
            
            
            82,787
            
            
            
            79,254
            
            
            
            75,081Weighted
      average shares — diluted
            
            
            76,626
            
            
            
            87,388
            
            
            
            86,791
            
            
            
            83,957
            
            
            
            75,081Consolidated
      Balance Sheet andOther
      Data as of Year End:Cash
      and cash equivalents
            
            $
            95,414
            
            
            $
            137,822
            
            
            $
            81,921
            
            
            $
            77,877
            
            
            $
            23,280Short-term
      investments
            
            
            89,591
            
            
            
            111,889
            
            
            
            168,724
            
            
            
            73,685
            
            
            
            70,240Working
      capital
            
            
            186,112
            
            
            
            223,688
            
            
            
            262,080
            
            
            
            152,204
            
            
            
            97,107Total
      assets
            
            
            326,541
            
            
            
            412,948
            
            
            
            380,231
            
            
            
            233,021
            
            
            
            154,908Other
      long-term liabilities
            
            
            8,064
            
            
            
            13,910
            
            
            
            538
            
            
            
            6,867
            
            
            
            —Total
      stockholders’ equity
            
            
            278,947
            
            
            
            313,847
            
            
            
            305,222
            
            
            
            176,546
            
            
            
            122,079Regular
      full-time employees
            
            
            610
            
            
            
            635
            
            
            
            442
            
            
            
            384
            
            
            
            337____________(1)
      Includes stock-based compensation expense (benefit)
            
            $
            1,445
            
            
            $
            1,597
            
            
            $
            2,427
            
            
            $
            (1,383
            )
            
            $
            2,777(2)
      Includes stock-based compensation expense (benefit)
            
            
            7,134
            
            
            
            8,411
            
            
            
            11,108
            
            
            
            (3,851
            )
            
            
            16,647(3)
      Includes stock-based compensation expense (benefit)
            
            
            10,893
            
            
            
            9,442
            
            
            
            13,696
            
            
            
            (3,297
            )
            
            
            13,359(4)
      Includes stock-based compensation expense
            
            
            14
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —





Effective
January 1, 2006, we adopted SFAS 123R “Share-Based Payment”.
Stock-based compensation expense (benefit) for years prior to 2006 was
calculated based on provisions of APB 25 “Accounting for Stock Issued to
Employees”.





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Item 7.Management’s
Discussion and Analysis of Financial Condition and Results of
Operations





Overview





Silicon
Image, Inc. is a leading provider of semiconductor and intellectual property
products for the secure distribution, presentation and storage of
high-definition content.  With a rich history of technology innovation
that includes creating industry standards such as DVI and HDMI,
our  solutions facilitate the use of digital content amongst consumer
electronics, personal computer (PC) and storage devices, with the goal to
securely deliver digital content anytime, anywhere and on any
device.  Founded in 1995, we are headquartered in Sunnyvale,
California, with regional engineering and sales offices in China, Germany,
Japan, Korea, and Taiwan.





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





Critical
Accounting Policies





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





Revenue
recognition





The
Company’s revenue recognition policy complies with Staff Accounting Bulletin
(SAB) No. 104, Revenue
Recognition(SAB No. 104). We recognize revenue when persuasive
evidence of an arrangement exists, delivery or performance has occurred, the
sales price is fixed or determinable and collectability is reasonably
assured.





Revenue
from products sold directly to end-users, or to distributors that do not receive
price concessions and rights of return, is generally recognized when title and
risk of loss has passed to the buyer which typically occurs upon shipment.
Reserves for sales returns are estimated based primarily on historical
experience and are provided at the time of shipment. All shipping costs are
charged to cost of product revenue.





For
products sold to distributors with agreements allowing for price concessions and
product returns, we recognize revenue based on our best estimate of when the
distributor sold the product to its end customer. Our estimate of such
distributor sell-through is based on point of sales reports received from our
distributors. Revenue is not recognized upon shipment since, due to various
forms of price concessions, the sales price is not substantially fixed or
determinable at that time. Price concessions are recorded when incurred, which
is generally at the time the distributor sells the product to an end-user.
Additionally, these distributors have contractual rights to return products, up
to a specified amount for a given period of time. Revenue is earned when the
distributor sells the product to an end-user, at which time our sales price to
the distributor becomes fixed. Pursuant to our distributor agreements, older or
end-of-life products are sold with no right of return and are not eligible for
price concessions. For these products, revenue is recognized upon shipment and
title transfer assuming all other revenue recognition criteria are
met.





Revenue
for 2007 includes approximately $6.7 million of product revenue and cost of
revenue includes approximately $2.6 million related to distributor sales
for the month of December 2007. Historically, the Company had deferred the
recognition of sell-through revenue from distributor sales for the third month
of a quarter until the following quarter due to the unavailability of reliable
sell-through information in a timely manner. As a result of improved business
processes, the Company was able to eliminate this delay beginning with the
fourth quarter of 2007, resulting in fiscal year 2007 revenue including an
additional month of product revenue from distributor sales in December 2007.
This one-time effect of the inclusion of an additional month of revenue for
fiscal year 2007 is an increase to net income by approximately $2.6 million
and an increase to net income per share, basic and diluted, by
approximately $0.03.


33
 Table of Contents




At the
time of shipment to distributors, we record a trade receivable for the selling
price since there is a legally enforceable right to payment, relieve inventory
for the carrying value of goods shipped since legal title has passed to the
distributor and record the gross margin in “deferred margin on sale to
distributors”, a component of current liabilities in our consolidated balance
sheet. Deferred margin on the sale to distributor effectively represents the
gross margin on the sale to the distributor. However, the amount of gross margin
we recognize in future periods will be less than the originally recorded
deferred margin on sale to distributor as a result of negotiated price
concessions. We sell each item in our product price book to all of our
distributors worldwide at a relatively uniform list price. However, distributors
resell our products to end customers at a very broad range of individually
negotiated price points based on customer, product, quantity, geography,
competitive pricing and other factors. The majority of our distributors’ resale
are priced at a discount from list price. Often, under these circumstances, we
remit back to the distributor a portion of their original purchase price after
the resale transaction is completed. Thus, a portion of the “deferred margin on
the sale to distributor” balance represents a portion of distributors’ original
purchase price that will be remitted back to the distributor in the future. The
wide range and variability of negotiated price concessions granted to
distributors does not allow us to accurately estimate the portion of the balance
in the deferred margin on the sale to distributors line item that will be
remitted back to the distributors. We reduce deferred margin by anticipated or
determinable future price concessions.





We derive
revenue from license of our internally developed intellectual property (IP). We
enter into IP licensing agreements that generally provide licensees the right to
incorporate our IP components in their products with terms and conditions that
vary by licensee. Revenue earned under contracts with our licensees is
classified as licensing revenue. Our license fee arrangements generally include
multiple deliverables and for multiple deliverable arrangements we follow the
guidance in EITF 00-21, Revenue Arrangements with Multiple
Deliverables, to determine whether there is more than one unit of
accounting. To the extent that the deliverables are separable into multiple
units of accounting, we allocate the total fee on such arrangements to the
individual units of accounting using the residual method, if objective and
reliable evidence of fair value does not exist for delivered elements. We then
recognize revenue for each unit of accounting depending on the nature of the
deliverable(s) comprising the unit of accounting in accordance with the
provisions of SAB No. 104.





The IP
licensing agreements generally include a nonexclusive license for the underlying
IP. Fees under these agreements generally include (a) license fees relating
to our IP, (b) support, typically for one year; and (c) royalties
payable following the sale by our licensees of products incorporating the
licensed technology. The license for our IP has standalone value and can be used
by the licensee without support. Further, objective and reliable evidence of
fair value exists for support. Accordingly, license and support fees are each
treated as separate units of accounting.





Certain
licensing agreements provide for royalty payments based on agreed upon royalty
rates. Such rates can be fixed or variable depending on the terms of the
agreement. The amount of revenue we recognize is determined based on a time
period or on the agreed-upon royalty rate, extended by the number of units
shipped by the customer. To determine the number of units shipped, 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 of receiving
royalties from a specific customer for us to make an estimate based on available
information from the licensee such as quantities held, manufactured and other
information. These estimates for royalties necessarily involve the application
of management judgment. As a result of our use of estimates, period-to-period
numbers are “trued-up” in the following period to reflect actual units shipped.
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 reports are
received.





For
contracts related to licenses of our technology that involve significant
modification, customization or engineering services, we recognize revenue in
accordance the provisions of SOP 81-1 “Accounting for Performance
of Construction-Type
and Certain Production-Type Contracts”. Revenues derived from such
license contracts are accounted for using the percentage-of-completion method.
We determine progress to completion based on input measures using labor-hours
incurred by our engineers. The amount of revenue recognized is based on the
total contract fees and the percentage of completion achieved. Estimates of
total project requirements are based on prior experience of customization,
delivery and acceptance of the same or similar technology and are reviewed and
updated regularly by management. If there is significant uncertainty about
customer acceptance, or the time to complete the development or the deliverables
by either party, we consider applying the completed contract method. If
application of the percentage-of-completion method results in recognizable
revenue prior to an invoicing event under a customer contract, we recognize the
revenue and record an unbilled receivable assuming collectability is reasonably
assured. Amounts invoiced to our customers in excess of recognizable revenues
are recorded as deferred revenues.








34
 Table of Contents





Stock-based
compensation





Effective
January 1, 2006, we adopted the fair value recognition provisions of
Statement of Financial Accounting Standards, or SFAS No. 123R, Share-Based Payment,
(SFAS No. 123R), requiring us to recognize expense related to the fair
value of our stock-based compensation awards. We elected to use the modified
prospective transition method as permitted by SFAS No. 123R and
therefore have not restated our financial results for prior periods. Under this
transition method, stock-based compensation expense for the year ended
December 31, 2006 includes compensation expense for all stock-based
compensation awards granted prior to, but not yet vested as of December 31,
2005, based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123, as adjusted for estimated
forfeitures. Stock- based compensation expense for all stock-based compensation
awards granted subsequent to December 31, 2005 was based on the grant-date
fair value estimated in accordance with the provisions of
SFAS No. 123R. Under SFAS No. 123R, our ESPP is considered a
compensatory plan and we are required to recognize compensation cost for grants
made under the ESPP. We recognize stock-based compensation expense on a
straight-line basis for all share-based payment awards, consisting primarily of
employee stock options, our employee stock purchase plan and employee restricted
stock units (RSUs), over the respective requisite service period of the awards.
For purposes of calculating the pool of excess tax benefits available to absorb
tax deficiencies recognized subsequent to the adoption of
SFAS No. 123(R), we followed the alternative transition method
discussed in FASB Staff Position No. 123(R)-3 “Transition Election to Accounting for the Tax
Effects of Share-Based Payment Awards.”





Cash
Equivalents and Short-Term Investments





We
account for our investments in debt and equity securities under, SFAS
No. 115, Accounting for
Certain Investments in
Debt and Equity Securitiesand FASB Staff Position, or FSP,
SFAS No. 115-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.Management determines the appropriate classification of such securities
at the time of purchase and reevaluates such classification as of each balance
sheet date. The investments are adjusted for amortization of premiums and
discounts to maturity and such amortization is included in interest income. We
follow the guidance provided by EITF No. 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments, to assess
whether our investments with unrealized loss positions are other than
temporarily impaired. Realized gains and losses and declines in value judged to
be other than temporary are determined based on the specific identification
method and are reported in the statements of income. Factors considered in
determining whether a loss is temporary include the length of time and extent to
which fair value has been less than the cost basis, the financial condition and
near-term prospects of the investee, and our intent and ability to hold the
investment for a period of time sufficient to allow for any anticipated recovery
in market value. We place our investments in instruments that meet high credit
quality standards, as specified in our investment policy guidelines. These
guidelines also limit the amount of credit exposure to any one issue, issuer or
type of instrument.





The
longer the duration of our investment securities, the more susceptible they are
to changes in market interest rates and bond yields. As yields increase, those
securities purchased with a lower yield-at-cost show a mark-to-market unrealized
loss. All unrealized losses are due to changes in interest rates and bond
yields. We expect to realize the full value of all these investments upon
maturity or sale.





The
classification of our investments into cash equivalents and short term
investments is in accordance with Statement of Financial Accounting Standard
No. 95 (SFAS No. 95) Statement of Cash Flows.Cash
equivalents consist of short-term, highly liquid financial instruments with
insignificant interest rate risk that are readily convertible to cash and have
maturities of three months or less from the date of purchase. Short-term
investments consist of taxable commercial paper, United States government agency
obligations, corporate/municipal notes and bonds with high-credit quality and
money market preferred stock. These securities have maturities greater than
three months from the date of purchase.





We believe all of the financial instruments’ recorded values approximate current
fair values because of their nature and respective durations. The fair value of
marketable securities is determined using quoted market prices for those
securities or similar financial instruments.





Allowance
for Doubtful Accounts





We review
collectability of accounts receivable on an on-going basis and provide an
allowance for amounts we estimate will not be collectible. During our review, we
consider our historical experience, the age of the receivable balance, the
credit-worthiness of the customer and the reason for the delinquency. Delinquent
account balances are written-off after management has determined that the likelihood
of collection is remote. Write-offs to date have not been material. While we
endeavor to accurately estimate the allowance, we may record unanticipated
write-offs in the future.


35
 Table of Contents





Inventories





We record
inventories at the lower of actual cost, determined on a first-in first-out
(FIFO) basis, or market. Actual cost approximates standard cost, adjusted for
variances between standard and actual. Standard costs are determined based on
our estimate of material costs, manufacturing yields, costs to assemble, test
and package our products and allocable indirect costs. We record differences
between standard costs and actual costs as variances. These variances are
analyzed and are either included on the consolidated balance sheet or the
consolidated statement of income in order to state the inventories at actual
costs on a FIFO basis. Standard costs are evaluated at least
annually.





Provisions
are recorded for excess and obsolete inventory and are estimated based on a
comparison of the quantity and cost of inventory on hand to management’s
forecast of customer demand. Customer demand is dependent on many factors and
requires us to use significant judgment in our forecasting process. We must also
make assumptions regarding the rate at which new products will be accepted in
the marketplace and at which customers will transition from older products to
newer products. Generally, inventories in excess of six months demand are
written down to zero and the related provision is recorded as a cost of revenue.
Once a provision is established, it is maintained until the product to which it
relates is sold or otherwise disposed of, even if in subsequent periods we
forecast demand for the product.





Goodwill,
intangible and long-lived assets





Consideration
paid in connection with acquisitions is required to be allocated to the assets,
including identifiable intangible assets and liabilities acquired. Acquired
assets and liabilities are recorded based on our estimate of fair value, which
requires significant judgment with respect to future cash flows and discount
rates.





For
certain long-lived assets, primarily fixed assets and identifiable intangible
assets, for example, our IP acquired from Sunplus (refer to Note 12 in our notes
to consolidated financial statements), we are required to estimate the useful
life of the asset and recognize its cost as an expense over the useful life. We
use the straight-line method to depreciate long-lived assets. We evaluate the
recoverability of our long-lived assets in accordance with
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived
Assets.Whenever events or circumstances indicate that the carrying
amount of long-lived assets may not be recoverable, we compare the carrying
amount of long-lived assets to our projection of future undiscounted cash flows,
attributable to such assets. In the event that the carrying amount exceeds the
future undiscounted cash flows, we record an impairment charge against income
equal to the excess of the carrying amount over the asset’s fair value.
Predicting future cash flows attributable to a particular asset is difficult and
requires the use of significant judgment.





We assign
the following useful lives to our fixed assets — three years for computers
and software, one to five years for equipment and five to seven years for
furniture and fixtures. Leasehold improvements and assets held under capital
leases are amortized on a straight-line basis over the shorter of the lease term
or the estimated useful life, which ranges from two to five years. Depreciation
expense was $10.3 million, $9.5 million and $7.1 million, for the
years ended December 31, 2008, 2007 and 2006, respectively.





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


36
 Table of Contents


Significant
assumptions are inherent and highly subjective in this process. However, there
can be no assurance that we will not incur impairment losses for goodwill and
other intangible assets in the future, which could adversely affect our
earnings.




Subsequent
to the year-end, the Company’s quoted market price of equity securities, and
thus, its market capitalization declined. A sustained decline in the Company’s
market capitalization may represent an event or circumstance that could
necessitate a goodwill impairment test between annual tests.





Income
Taxes





We must
make certain estimates and judgments in determining income tax expense for
financial statement purposes. These estimates and judgments occur in the
calculation of tax credits, tax benefits and deductions and in the calculation
of certain tax assets and liabilities, which arise from differences in the
timing of recognition of revenue and expense for tax and financial statement
purposes. Significant changes to these estimates may result in an increase or
decrease to our tax provision in the subsequent period when such a change in
estimate occurs.





Deferred
tax assets





We
account for deferred tax assets in accordance with the Statement of Financial
Accounting Standard No. 109 (SFAS No. 109), Accounting for Income Taxes.
In the first quarter of 2007, we adopted the Financial Accounting Standards
Board (FASB) FIN No. 48, Accounting for Uncertainty in Income
Taxes — an Interpretation of FASB Statement
No. 109. FIN No. 48 requires that management determine
whether a tax position is more likely than not to be sustained upon examination,
including resolution of any related appeals or litigation processes, based on
the technical merits of the position. For income taxes we use an asset and
liability approach, which requires recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in our financial statements, but have not been reflected in our
taxable income. In general, a valuation allowance is established to reduce
deferred tax assets to their estimated realizable value, if based on the weight
of available evidence, it is more likely than not that some portion, or all, of
the deferred tax asset will not be realized. We evaluate the realizability of
the deferred tax assets quarterly and will continue to assess the need for
valuation allowances.





At
December 31, 2008, we had gross deferred tax assets, related primarily to
stock-based compensation, accruals and reserves that are not currently
deductible, depreciable and amortizable items, and tax credit carry forwards of
$34.9 million. At December 31, 2007 our gross deferred tax assets of $24.0
million consisted primarily of tax credit carry forwards and stock-based
compensation not currently deductable for tax purposes.





Guarantees,
Indemnifications and Warranty Liabilities





Certain
of our licensing agreements indemnify our customers for expenses or liabilities
resulting from claimed infringements of patent, trademark or copyright by third
parties related to the intellectual property content of our products. Certain of
these indemnification provisions are perpetual from execution of the agreement
and, in some instances; the maximum amount of potential


future
indemnification is not limited. To date, we have not paid any such claims or
been required to defend any lawsuits with respect to a claim.





At the
time of revenue recognition, we provide an accrual for estimated costs (included
in accrued liabilities in the accompanying consolidated balance sheets) to be
incurred pursuant to our warranty obligation. Our estimate is based primarily on
historical experience.





Restructuring Expenses





We record
provisions for workforce reduction costs and exit costs when they are probable
and estimable. Severance paid under
ongoing benefit arrangements is recorded in accordance with SFAS No. 112, Employers’ Accounting for Postemployment Benefits. One-time termination benefits and
contract settlement and lease costs are recorded in accordance with SFAS No.
146, Accounting for Costs Associated with Exit
or Disposal Activities. At each reporting date, we evaluate our accruals
related to workforce reduction charges, contract settlement and lease costs and
plant and equipment write downs to ensure that these accruals are still
appropriate. As of December 31, 2008, we had $3.3 million in accruals related to
workforce reduction charges and $0.2 million in accruals related to lease costs,
which included estimates, primarily related to sublease income over the lease
terms and other costs for vacated properties. Adjustments to workforce reduction
accruals may be required when employees previously identified for separation do
not receive severance payments because they are no longer employed by us or were
redeployed due to circumstances not foreseen when the original plan was
initiated. In these cases, we reverse any related accrual to earnings when it is
determined it is no longer


37
 Table of Contents


required.
Alternatively, in certain circumstances, we may determine that certain accruals
are insufficient as new events occur or as additional information is obtained.
In these cases, we would increase the applicable existing accrual with the
offset recorded against earnings. Increases or decreases to the accruals for
changes in estimates are classified as restructuring expenses in the
consolidated  statement of income.





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 55.1%, 57.7% and 57.3% of our revenue in 2008,
2007 and 2006, respectively. The percentage of revenue generated through
distributors tends to be significant, since many OEMs rely upon third-party
manufacturers or distributors to provide purchasing and inventory management
functions. In 2008, 52.1% of our revenue was generated through distributors,
compared to 49.5% in 2007 and 50.2% in 2006. World Peace Inc., comprised 14.6%,
13.6% and 11.6% of our revenue in 2008, 2007 and 2006, respectively. Microtek
comprised 11.8%, 14.2% and 16.3% of our revenue in 2008, 2007 and 2006,
respectively. Weikeng Industrial generated 11.5% of our revenue in 2008, in 2007
and 2006 revenue from Weikeng made up less than 10% of our revenue, and Innotech
Corporation, comprised 10.5%, 15.6% and 15.7% of our revenue in 2008, 2007 and
2006, respectively. Our licensing revenue is not generated through distributors
and to the extent licensing revenue increases, we would expect a decrease in the
percentage of our revenue generated through distributors. In addition, we
have been named as defendants in a number of judicial and administrative
proceedings incidental to its business and may be named again from time to time,
and although adverse decisions or settlements may occur in one or more of such
cases, the final resolution of these matters, individually or in the aggregate,
is not expected to have a material adverse effect on our results of operations,
financial position or cash flows.





A
significant portion of our revenue is generated from products sold overseas.
Sales (including licensing) to customers in Asia, including distributors,
generated 71.2%, 71.7% and 72.2% of our revenue in 2008, 2007 and 2006,
respectively. The reason for our geographical concentration in Asia is that most
of our products are incorporated into 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. Primarily all revenue to date has been denominated in
U.S. dollars.





Legal
Matters




We are
subject to various legal proceedings and claims, either asserted or unasserted.
We evaluate, among other factors, the degree of probability of an unfavorable
outcome and reasonably estimate the amount of the loss. Significant judgment is
required in both the determination of the probability and as to whether an
exposure can be reasonably estimated. When we determine that it is probable that
a loss has been incurred, the effect is recorded promptly in the consolidated
financial statements. Although the outcome of these claims cannot be predicted
with certainty, we do not believe that any of the existing legal matters will
have a material adverse effect on our financial condition and results of
operations. However, significant changes in legal proceedings and claims or the
factors considered in the evaluation of those matters could have a material
adverse effect on our business, financial condition and results of
operations.


Recent
Accounting Pronouncements





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





In April
2008, the FASB issued Staff Position No. FAS 142-3, Determination of the Useful Life of Intangible Assets(“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under SFAS No. 142, Goodwill
and Other Intangible Assets (“SFAS 142”). The intent of FSP FAS 142-3 is to
improve the consistency between the useful life of a recognized intangible asset
under SFAS 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS 141(R) and other applicable
accounting


38
 Table of Contents


literature.
FSP FAS 142-3 is effective for fiscal years beginning after December 15,
2008. We do not believe that the implementation of this standard will have a
material impact on our consolidated financial statements.


In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations(“SFAS 141(R)”) and SFAS
No. 160, Noncontrolling Interests in
Consolidated Financial Statements — an amendment of ARB No. 51(“SFAS
160”). SFAS 141(R)  significantly changes current practices regarding
business combinations. Among the more significant changes, SFAS 141(R) expands
the definition of a business and a business combination; requires the acquirer
to recognize the assets acquired, liabilities assumed and noncontrolling
interests (including goodwill), measured at fair value at the acquisition date;
requires acquisition-related expenses and restructuring costs to be recognized
separately from the business combination; requires assets acquired and
liabilities assumed from contractual and non-contractual contingencies to be
recognized at their acquisition-date fair values with subsequent changes
recognized in earnings; and requires in-process research and development to be
capitalized at fair value as an indefinite-lived intangible asset. SFAS 160 will
change the accounting and reporting for minority interests, reporting them as
equity separate from the parent entity’s equity, as well as requiring expanded
disclosures. SFAS 141(R) and SFAS 160 are effective for financial statements
issued for fiscal years beginning after December 15, 2008. We do not believe
that the implementation of these standards will have a material impact on our
consolidated financial statements.





Annual
Results of Operations





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


2008
            
            
            Change
            
            
            2007
            
            
            Change
            
            
            2006(Dollars
      in thousands)Consumer
      electronics
            
            $
            167,599
            
            
            
            (21.3
            )%
            
            $
            212,910
            
            
            
            22.4
            %
            
            $
            173,884Personal
      computer
            
            
            40,141
            
            
            
            17.1
            %
            
            
            34,283
            
            
            
            (24.4
            )%
            
            
            45,320Storage
            
            
            25,461
            
            
            
            1.1
            %
            
            
            25,181
            
            
            
            (23.9
            )%
            
            
            33,098Total
      product
      revenue
            
            $
            233,201
            
            
            
            (14.4
            )%
            
            $
            272,374
            
            
            
            8.0
            %
            
            $
            252,302Percentage
      of total
      revenue
            
            
            85.0
            %
            
            
            
            
            
            
            85.0
            %
            
            
            
            
            
            
            85.5
            %Licensing
      revenue
            
            $
            41,214
            
            
            
            (14.4
            )%
            
            $
            48,129
            
            
            
            12.8
            %
            
            $
            42,656Percentage
      of total
      revenue
            
            
            15.0
            %
            
            
            
            
            
            
            15.0
            %
            
            
            
            
            
            
            14.5
            %Total
      revenue
            
            $
            274,415
            
            
            
            (14.4
            )%
            
            $
            320,503
            
            
            
            8.7
            %
            
            $
            294,958





Revenue
(including development, licensing and royalty revenues (collectively, “licensing
revenue”), by product line):


2008
              
              
              Change
              
              
              2007
              
              
              Change
              
              
              2006(Dollars
      in thousands)Consumer
      electronics
              
              $
              199,591
              
              
              
              (19.3
              )%
              
              $
              247,205
              
              
              
              24.3
              %
              
              $
              198,803Personal
      computer
              
              
              44,311
              
              
              
              8.7
              %
              
              
              40,767
              
              
              
              (25.4
              )%
              
              
              54,680Storage
      products
              
              
              30,513
              
              
              
              (6.2
              )%
              
              
              32,531
              
              
              
              (21.6
              )%
              
              
              41,475Total
      revenue
              
              $
              274,415
              
              
              
              (14.4
              )%
              
              $
              320,503
              
              
              
              8.7
              %
              
              $
              294,958




Total
revenue for 2008 was $274.4 million and represented a decline of 14.4% from
2007 levels. The decrease in product revenue in 2008 of 14.4% as compared to
2007 was primarily driven by declines in sales of our Consumer Electronics
(“CE”) products and our licensing revenues, offset partially by an increase in
revenues from our Personal Computers (“PC”) products.  In 2008 our
customers were transitioning to our newer products, this transition period
resulted in lower 2008 revenue compared to 2007. In addition to our product
transition, the unfavorable global economic environment impacted product revenue
primarily in the fourth quarter of 2008. Revenue for 2007 includes approximately
$6.7 million of product revenue and cost of revenue includes approximately
$2.6 million related to distributor sales for the month of December 2007.
Historically, the Company had deferred the recognition of sell-through revenue
from distributor sales for the third month of a quarter until the following
quarter due to the unavailability of reliable sell-through information in a
timely manner. As a result of improved business processes, the Company was able
to eliminate this delay beginning with the fourth quarter of 2007, resulting in
fiscal year 2007 revenue including an additional month of product revenue from
distributor sales in December 2007. We expect our business to follow normal
seasonal patterns declining in the first quarter of 2009 as compared
to the fourth quarter of 2008.





Total
revenue in 2007 was $320.5 million, which represented an 8.7% increase
year-over-year compared to 2006. This increase was due primarily to increased
unit shipments and the above-mentioned recognition of an extra month of
distributor revenue, partially offset by declines in average selling prices
(ASP) across all product categories. We currently expect revenue to decline in
the first quarter of 2009 due to the unfavorable global economic climate,
however we expect revenue to begin to recover in the second half of 2009 due to
the roll-out of our new products, and the expected improvement in our customer’s
business.


39
 Table of Contents





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 the intellectual property we license
includes a field of use restriction that prevents the licensee from building
products that directly compete with ours in those market segments we have chosen
to pursue. Revenue from licensing accounted for 15.0%, 15.0% and 14.5% of our
revenues for the years ended December 31, 2008, 2007 and 2006,
respectively. The decrease in licensing revenues (in absolute dollars) in 2008
as compared to 2007 was due primarily to the overall softening of demand for
consumer products as a result of the deterioration of the global economic
climate.





The
increase in licensing revenues in 2007 as compared to 2006 was primarily due to
the recognition of $4.9 million of revenue for the delivery of IP
technology sold, which represented the $5.0 million license amount less
$0.1 million for the fair value of support and maintenance which we are
required to provide to Sunplus for one year. We completed the delivery of IP
technology sold to Sunplus under the license agreement and received final
acceptance. Licensing contracts are complex and the recognition of related
revenue depends upon many factors that require significant judgments including
completion of milestones, allocation of values to delivered items and customer
acceptances.





From time
to time we enter into “direct agreements” for certain of our parts for certain
identified end customers with our distributors who previously had the rights for
price concessions and product returns. The “direct agreement” converts the
previously existing distributor relationship for these parts and identified
customers into a direct customer whereby the distributor does not have price
protection or return rights. Revenue for such sales are recorded at the time of
shipment.  For the year ended December 31, 2008 we recorded $2.7
million in revenue under such arrangements.





Revenues
from products sold into the CE market have decreased year-over-year as a
percentage of our total revenues and generated 61.1%, 66.4% and 59.0% of our
total revenues for the years ended December 31, 2008, 2007 and 2006,
respectively. If we include licensing revenues, these percentages would be
72.7%, 77.1% and 67.4% for the years ended December 31, 2008, 2007 and
2006, respectively. The decrease in CE product revenues in 2008 compared to 2007
was primarily due to lower revenues as a result of our previously announced
product transition, lower revenues from our discrete receiver chips and input
processors from DTVs in our CE business, increased competition for
discrete and integrated solutions from other companies and decline in average
selling prices (ASPs) over the same period. The weakening
consumer demand due to concerns about the economy also had a negative impact on
our revenue. In addition, the decrease in overall CE revenues reflects a product
transition wherein sales of our HDMI 1.1 and 1.2 products are decreasing,
partially offset by increased sales of HDMI 1.3 products. The increase
in the CE product revenue in 2007 compared to 2006 was due primarily to strong
sales volumes of HDMI 1.3 receivers and transmitters partially offset by
decrease in ASPs. Our HDMI 1.3 chips are targeted towards the DTV, AV receiver,
Blu Ray recorders, HD DVD, DVD, game console and mobile markets.





Product
revenues from the PC market have increased in 2008 as compared to 2007 and
generated 14.6% of our revenue in 2008, 10.7% of our revenue in 2007 and 15.4%
of our revenues in 2006. If we include licensing revenues, these percentages
would be 16.1%, 12.7% and 18.5% for the years ended December 31, 2008, 2007
and 2006, respectively. The increase in PC revenues in 2008 compared to 2007 was
due primarily to the transition from the DVI to HDMI standard in PC’s, (our HDMI
products carry higher prices than our DVI products), partially offset by a
decline in ASPs in the PC business. The decrease in PC revenues in 2007 as
compared to 2006  was due primarily to lower shipments coupled with
declines in ASPs of our HDMI and DVI products. The decrease in ASPs in the PC
business was due to the competitive nature of the PC business.





Products
sold into the storage market, as a percentage of our total revenues, generated
9.3%, 7.9% and 11.2% of our revenue for the years ended December 31, 2008,
2007 and 2006, respectively. If we include storage related licensing revenues,
these percentages were 11.1%, 10.1% and 14.1%, for the years ended
December 31, 2008, 2007 and 2006, respectively. The increase in storage
revenue in 2008 compared to 2007 was primarily due to growth in sales of
our Steelvine processor chips and a slight increase in the ASP’s for our storage
market products We have seen a significant increase in Steelvine processor
adoption on high end and midrange PC motherboards. The decline in storage
revenue in 2007 as compared to 2006 was primarily due to declining sales in SATA
controllers partially offset by an increase in sale of storage processor
products.







40
 Table of Contents


COST
OF REVENUE AND GROSS MARGIN


2008
              
              
              Change
              
              
              2007
              
              
              Change
              
              
              2006(Dollars
      in thousands)Cost
      of product revenue (1)
              
              $
              112,539
              
              
              
              (16.7
              )%
              
              $
              135,168
              
              
              
              12.5
              %
              
              $
              120,173Cost
      of licensing revenue
              
              
              1,187
              
              
              
              (77.5
              )%
              
              
              5,275
              
              
              
              391.2
              %
              
              
              1,074Total
      cost of revenue
              
              $
              113,726
              
              
              
              (19.0
              )%
              
              $
              140,443
              
              
              
              15.8
              %
              
              $
              121,247Total
      gross margin
              
              $
              160,689
              
              
              
              (10.8
              )%
              
              $
              180,060
              
              
              
              3.7
              %
              
              $
              173,711Gross
      margin as a percentage of total revenue
              
              
              58.6
              %
              
              
              
              
              
              
              56.2
              %
              
              
              
              
              
              
              58.9
              %(1)
      Includes stock-based compensation expense
              
              $
              1,445
              
              
              
              
              
              
              $
              1,597
              
              
              
              
              
              
              $
              2,427




Cost of
revenue consists primarily of costs incurred to manufacture, assemble and test
our products, and costs to license our technology which involves modification,
customization or engineering services, as well as other related overhead costs
relating to the aforementioned costs including stock-based compensation expense.
Gross margin, as a percentage of revenue was 58.6%, 56.2% and 58.9% for 2008,
2007 and 2006, respectively. The 19.0% decrease in cost of revenue in 2008 as
compared with 2007 was primarily due to a decrease in revenue, lower
manufacturing and outside processing costs through negotiation, increased use of
our testing equipment, improved supply chain efficiencies and better inventory
control offset by higher shipping and warehousing fees as a result of an
increase in fuel prices.





The
increase in cost of revenue in 2007 as compared to 2006 was primarily due to
increased unit volume associated with increased sales partially offset by
manufacturing cost reductions and cost of sales associated with licensing
revenue that has not increased proportionately to licensing sales.





Cost of
revenue for 2007 includes approximately $2.6 million related to
$6.7 million of product revenue recognized from distributor sales for the
month of December. Historically, we have deferred the recognition of
sell-through revenue and the related costs from distributor sales for the third
month of a quarter until the following quarter due to the unavailability of
reliable sell-through information in a timely manner. As a result of improved
business processes, we have been able to eliminate this delay beginning with the
fourth quarter of 2007, resulting in an increase to the fourth quarter and the
fiscal year 2007 cost of revenues.





Total
gross margin decreased by $19.4 million in the twelve months ended December 31,
2008 compared to 2007. Our gross margin of 58.6% for the twelve months ended
December 31, 2008 increased from 56.2% in 2007, primarily due to product design
cost reduction activities, lower wafer pricing and operational efficiencies as
described above. The decrease in gross margins in 2007 as compared to 2006 was
primarily due to increased competition in all business lines reflected in
decline in ASPs partially offset by increase in units sold.   We
expect our gross margin to decline slightly in the first quarter of 2009 due
lower expected revenue as a result of the unfavorable global economic
climate.





OPERATING
EXPENSES





Research and Development
            
            2008
            
            
            Change
            
            
            2007
            
            
            Change
            
            
            2006(Dollars
      in thousands)Research
      and development(1)
            
            $
            84,819
            
            
            
            8.8
            %
            
            $
            77,994
            
            
            
            22.6
            %
            
            $
            63,598Percentage
      of total revenue
            
            
            30.9
            %
            
            
            
            
            
            
            24.3
            %
            
            
            
            
            
            
            21.6
            %(1)
      Includes stock-based compensation expense
            
            
            7,134
            
            
            
            
            
            
            
            8,411
            
            
            
            
            
            
            
            11,108





Research and development
(R&D).  R&D expense consists primarily of employee
compensation and benefits, fees for independent contractors, the cost of
software tools used for designing and testing our products and costs associated
with prototype materials. R&D expense, including stock-based compensation
expense, was $84.8 million, or 30.9% of revenue for 2008 compared to
$78.0 million, or 24.3% of revenue for 2007 and $63.6 million, or
21.6% of revenue for 2006. R&D expenses increased $6.8 million in the twelve
months ended December 31, 2008 as compared to the comparable period in 2007, due
to higher compensation and related expenses and an overall increase in other
R&D activities during the year, which resulted in higher tape-out expenses,
higher depreciation expenses, which were offset partially by a decline in
stock-based compensation expense.





The
increase in R&D expenses in 2007 compared to 2006 was primarily due to the
expansion of our R&D operations through the sci-worx acquisition and the
establishment of a new China R&D facility in the third quarter of 2006. This
expansion resulted in an increase in salaries, software and equipment and tape
out costs. The increase in R&D costs was partially offset by decrease in
stock-based compensation expense from 2006.


41
 Table of Contents





Selling, General and
      Administrative
            
            2008
            
            
            Change
            
            
            2007
            
            
            Change
            
            
            2006(Dollars
      in thousands)Selling,
      general and administrative(1)
            
            $
            71,719
            
            
            
            2.0
            %
            
            $
            70,340
            
            
            
            4.1
            %
            
            $
            67,597Percentage
      of total revenue
            
            
            26.1
            %
            
            
            
            
            
            
            21.9
            %
            
            
            
            
            
            
            22.9
            %(1)
      Includes stock-based compensation expense
            
            
            10,893
            
            
            
            
            
            
            
            9,442
            
            
            
            
            
            
            
            13,696





Selling, general and administrative
(SG&A).  SG&A expense consists primarily of employee
compensation, including stock-based compensation expense, sales commissions,
professional fees, marketing and promotional expenses. The increase in SG&A
expenses of $1.4 million in 2008 as compared to 2007 was primarily due to
increased compensation expenses as a result of higher headcount,  an
increase in stock-based compensation expense as a result of the granting of
restricted stock units to employees and executives, higher bad debt expenses
partially offset by lower expenses incurred on use of consultants.





SG&A
expense was $70.3 million or 21.9% of revenue in 2007 as compared to
$67.6 million, or 22.9% of revenue for 2006 The increase was primarily due
to higher compensation expense, lower allocation of general and administrative
costs to other functional lines, increase in consulting fees as a result of our
global strategy, increase in litigation and patent related expenses and increase
in facilities related expenses. These increases were partially offset by a
decrease in the stock-based compensation expense in 2007.





Amortization of Intangible
      Assets
            
            2008
            
            
            Change
            
            
            2007
            
            
            Change
            
            
            2006(Dollars
      in thousands)Amortization
      of intangible assets
            
            $
            6,348
            
            
            
            78.9
            %
            
            $
            3,549
            
            
            
            598.6
            %
            
            $
            508Percentage
      of total revenue
            
            
            2.3
            %
            
            
            
            
            
            
            1.1
            %
            
            
            
            
            
            
            0.2
            %





Amortization of intangible
assets.  Amortization of intangible assets was $6.3 million in
the twelve months ended December 31, 2008, as compared to $3.5 million for the
same period in 2007. The increase in the amortization of intangible assets was
primarily caused by the commencement of amortization of the acquired Sunplus
technology in the fourth quarter of 2007.  See further discussion in
Note 12 of our Notes to Consolidated Financial Statements. Increase in
amortization of intangible assets for 2007 as compared to 2006 was primarily due
to the increase in amortization as a result of capitalization of intangibles
acquired from Sunplus and intangibles from our sci-worx acquisition during 2007.
See Note 1 of our Notes to Consolidated Financial Statements for the
future amortization schedule for the above referenced intangibles.





Restructuring
            
            2008Restructuring
      expense(1)
            
            $
            5,858Percentage
      of total revenue
            
            
            2.1
            %(1)
      Includes stock-based compensation expense
            
            
            14





In
July 2008 and December 2008, we announced restructuring plans to improve
the effectiveness and efficiency of our operating model as part of our program
to pursue continuous improvement. The restructuring expense for the twelve
months ended December 31, 2008, consists primarily of $4.6 million related to
employee severance and benefit arrangements due to the termination of 57
employees, a charge of $1.1 million relating to retirement of certain assets and
a charge of $0.2 million relating to operating lease termination costs. We did
not have any restructuring charges in the prior fiscal years.  Refer
to Note 11 of our Notes to Consolidated Financial Statements for more
information on our restructuring plans.





Patent Assertion Costs (Reimbursement),
      Net
            
            2008
            
            
            Change
            
            
            2007
            
            
            Change
            
            
            2006(Dollars
      in thousands)Patent
      assertion costs (reimbursement), net
            
            
            —
            
            
            
            —
            
            
            $
            22
            
            
            
            (100.4
            )%
            
            $
            (5,244
            )Percentage
      of total revenue
            
            
            0
            %
            
            
            —
            
            
            
            0.0
            %
            
            
            
            
            
            
            (1.8
            )%





Patent assertion costs
(reimbursement), net.  The reimbursement of patent assertion
costs in the amount of $5.4 million recorded in 2006, relates to the
reimbursement of litigation expenses incurred in connection with the ST
Micro  (previously “Genesis”) litigation. The reimbursement of
$5.4 million had been offset by $143,000 in patent assertion costs incurred
in 2006.


Interest Income and Other,
    Net
              
              2008
              
              
              Change
              
              
              2007
              
              
              Change
              
              
              2006(Dollars
      in thousands)Interest
      income and other, net
              
              $
              6,245
              
              
              
              (45.2
              )%
              
              $
              11,397
              
              
              
              23.8
              %
              
              $
              9,205Percentage
      of total revenue
              
              
              2.3
              %
              
              
              
              
              
              
              3.6
              %
              
              
              
              
              
              
              3.1
              %




Interest income and other,
net.Interest income and other, net, which principally
includes interest income, decreased 45.2% in the


42
 Table of Contents


twelve
months ended December 31, 2008 when compared to the same period in 2007. The
decrease was primarily due to a lower average total cash balances as a result of
the stock repurchase payments made during the first nine months
of  2008, payments made to Sunplus for IP accrued in 2007, a lower
interest rate environment, and a switch to investments in tax exempt securities
in 2008, which generally carry lower interest rates than similar taxable
securities.  The increase in interest income in the twelve months
ended December 31, 2007 when compared to the same period in 2006 was
attributable primarily to the increased cash, cash equivalents and short-term
investments   Provision (benefit) for Income
      Taxes
                
                2008
                
                
                Change
                
                
                2007
                
                
                Change
                
                
                2006(Dollars
      in thousands)Provision
      (benefit) for income taxes
                
                $
                (11,873
                )
                
                
                (157.8
                )%
                
                $
                20,551
                
                
                
                46.9
                %
                
                $
                13,992Percentage
      of total revenue
                
                
                (4.3
                )%
                
                
                
                
                
                
                6.4
                %
                
                
                
                
                
                
                4.7
                %




Provision (benefit) for Income
Taxes.  For the year ended December 31, 2008, we recorded
an income tax benefit of $11.9 million, compared to income tax expense of
$20.6 million in 2007 and $14.0 million in 2006. Our effective income
tax rate was 656% in 2008. In 2008, the difference between the benefit for
income taxes and the income tax determined by applying the statutory federal
income tax rate of 35% was due primarily to the following items: (1) $5.0
million of tax benefits related to the geographic and tax jurisdictional mix of
earnings within the Company’s global business structure, (2) $4.2 million of tax
benefits associated with research and development tax credits and related FIN 48
reserves re-evaluated by the Company during the fourth quarter of 2008 upon
completion of a study of credits claimed through 2007, (3) $1.6 million of tax
benefits related to federal and state research and development tax credits
generated during 2008, and (4) $0.9 million of tax benefits associated with tax
exempt interest income.





For the
year ended December 31, 2007, we recorded income tax expense of $20.6 million.
Our effective income tax rate was 52% in 2007. The difference between the
provision for income taxes and the income tax determined by applying the
statutory federal income tax rate of 35% was due primarily to the following
items: (1) $3.1 million of tax benefits related to tax credits
generated during 2007, (2) $2.8 million of additional tax charges
associated with the certain foreign income and withholding taxes and
(3) $5.1 million of additional tax charges related to foreign
unbenefited losses associated with the implementation of our global business
structure. The tax charges related to unbenefited foreign losses represent
expenses for sharing in the costs of our ongoing research and development
efforts as well as licensing commercial rights to exploit pre-existing
intangibles to better align with customers outside the Americas. The new global
strategy is designed to better align asset ownership and business functions with
our expectations related to the sources, timing and amounts of future revenues
and profits.





For the
year ended December 31, 2006, we recorded income tax expense of
$14.0 million. Our effective income tax rate was 25% in 2006. In 2006, the
difference between the provision for income taxes and the income tax determined
by applying the statutory federal income tax rate of 35% was due primarily to
the following three items: (1) $18.5 million of federal loss
carryforwards utilized, inclusive of $14.3 million related to excess stock
option tax benefits for which the reduction of the related valuation allowance
was recorded to additional paid-in capital, (2) $24.8 million
associated with the impact of the release of our remaining valuation allowance
inclusive of certain current year changes in the deferred tax asset to which the
valuation allowance relates and (3) $22.8 million of tax charges
related to unbenefited foreign losses in connection with the ongoing
implementation of a new global strategy. The tax charges related to unbenefited
foreign losses represent expenses for sharing in the costs of our ongoing
research and development efforts as well as licensing commercial rights to
exploit pre-existing intangibles to better align with customers outside the
Americas.





Liquidity
and Capital Resources





2008
            
            
            Change
            
            
            2007
            
            
            Change
            
            
            2006(Dollars
      in thousands)Cash
      and cash equivalents
            
            $
            95,414
            
            
            $
            (42,408
            )
            
            $
            137,822
            
            
            $
            55,901
            
            
            $
            81,921Short-term
      investments
            
            
            89,591
            
            
            
            (22,298
            )
            
            
            111,889
            
            
            
            (56,835
            )
            
            
            168,724Total
      cash, cash equivalents and short-term investment
            
            $
            185,005
            
            
            $
            (64,706
            )
            
            $
            249,711
            
            
            $
            (934
            )
            
            $
            250,645Percentage
      of total assets
            
            
            56.6
            %
            
            
            
            
            
            
            60.5
            %
            
            
            
            
            
            
            65.9
            %Total
      current assets
            
            $
            225,642
            
            
            $
            (83,237
            )
            
            $
            308,879
            
            
            $
            (27,672
            )
            
            $
            336,551Total
      current liabilities
            
            
            (39,530
            )
            
            
            45,661
            
            
            
            (85,191
            )
            
            
            (10,720
            )
            
            
            (74,471
            )Working
      capital
            
            $
            186,112
            
            
            $
            (37,576
            )
            
            $
            223,688
            
            
            $
            (38,392
            )
            
            $
            262,080Cash
      provided by operating activities
            
            $
            25,641
            
            
            $
            (41,502
            )
            
            $
            67,143
            
            
            $
            21,140
            
            
            $
            46,003Cash
      provided by (used in) investing activities
            
            
            14,825
            
            
            
            3,009
            
            
            
            11,816
            
            
            
            112,463
            
            
            
            (100,647
            )Cash
      (used in) provided by financing activities
            
            
            (82,152
            )
            
            
            (58,980
            )
            
            
            (23,172
            )
            
            
            (81,841
            )
            
            
            58,669Effect
      of exchange rate changes on cash & cash
    equivalents
            
            
            (722
            )
            
            
            (836
            )
            
            
            114
            
            
            
            95
            
            
            
            19Net
      (decrease) increase in cash and cash equivalents
            
            $
            (42,408
            )
            
            $
            (98,309
            )
            
            $
            55,901
            
            
            $
            51,857
            
            
            $
            4,044





43
 Table of Contents


Our principal source of liquidity is cash provided by operations and exercise of
stock options. At December 31, 2008, we had $186.1 million of working
capital and $185.0 million of cash, cash equivalents and short-term
investments.





In
February 2007, our Board of Directors authorized a stock repurchase program
under which we were authorized to purchase up to $100.0 million of common stock,
on the open market, or in negotiated or block transactions, over a 36 month
period. As of December 31, 2007, we had repurchased a total of 5.0 million
shares at a total cost of $38.1 million. In February 2008, the Company’s Board
of Directors authorized an additional $100 million stock repurchase program,
under which shares may be repurchased over a period of three years, to commence
following completion of the Company’s accelerated stock repurchase plan (“ASR”)
(see below). Purchases under this program may be increased, decreased or
discontinued at any time without prior notice.





In
February 2008, we entered into an accelerated stock repurchase agreement (ASR)
with Credit Suisse International (Credit Suisse), to purchase shares of common
stock for an aggregate purchase price of approximately $62 million paid in
February 2008.  We received 11.5 million shares under the agreement,
based on a predetermined price, which was subject to an adjustment based on the
volume weighted average price during the term of the ASR. In accordance with the
ASR agreement, on June 25, 2008, we chose to settle the arrangement in cash
(rather than shares) and made a final payment of approximately $6.2 million for
the purchase of shares.  The ASR terminated on June 30, 2008
(‘termination date’) with final settlement taking place in July 2008
(“settlement date”). On the settlement date, Credit Suisse returned
approximately $1 million based on the volume weighted average share price during
the period. In accordance with the relevant accounting guidance, we reflected
the 11.5 million shares repurchased and the $68.2 million paid to Credit Suisse
as treasury stock and recorded the $1 million received as part of other income
in the consolidated statement of income in the second and third quarters of
2008.





We
believe that our current cash, cash equivalents and short-term investment
balances together with income derived from sales of our products and licensing
will be sufficient to meet our liquidity requirements in the foreseeable
future.





Operating
Activities





In the
year ended December 31, 2008, our operating activities provided
$25.6 million of cash. The cash generated from working capital consisted
primarily of the strong cash collection on our accounts receivable, efficient
management of inventory offset by cash used in prepaid expenses and other
assets, accounts payables, accrued liabilities, deferred revenue and deferred
margin on sale to distributors.





Net
accounts receivable decreased to $6.0 million at December 31, 2008 as compared
to $21.3 million at 2007 due to increased collection and lower invoicing
activity, due to deterioration in the global economic environment, in the month
of December 2008. Inventories decreased to $12.8 million as of December 31, 2008
from $20.2 million as of December 31, 2007 primarily due to efficient inventory
management practices, and a reduced inventory build plan compared to the same
period a year ago in response to the deterioration in the economic climate. Our
inventory turns decreased to 6.8 at December 31, 2008 as compared to 7.1 at
December 31, 2007. Inventory turns are computed on an annualized basis, using
the most recent quarter results and are a measure of the number of times
inventory is replenished during the year. Accounts payable decreased to $7.2
million at December 31, 2008 as compared to $17.9 million at December 31, 2007
due to the timing of vendor payments and decrease in the inventory balance at
December 31, 2008. Deferred margin on sales to distributors decreased by $19.6
million in 2008 as compared to 2007, as a result of reduced inventory at
distributors due to the deterioration in the economic environment in December
2008 .





Operating
activities provided $67.1 million of cash during 2007 primarily due to cash
generated by operations. The cash generated from working capital consisted
primarily of strong cash collections on our accounts receivables, cash generated
by inventory management and accounts payable partially offset by cash used in
prepaid accounts, accrued expenses and deferred revenue.





Net
accounts receivable decreased to $21.3 million in 2007 from
$40.0 million in 2006 reflecting the timing of invoicing and strong cash
collections during the fourth quarter of 2007. Inventories decreased to
$20.2 million at December 31, 2007 from $28.3 million at
December 31, 2006. This decrease was attributable primarily to increased
sales and better inventory management including allowing our distributors to use
up the existing inventory that was built up in 2006. Our inventory turns
increased to 7.1 at December 31, 2007 from 4.7 at December 31, 2006.
Inventory turns are computed on an annualized basis, using the most recent
quarter results and are a measure of the number of times inventory is
replenished during the year. Deferred revenue, which includes deferred
intellectual property license revenue that is being recognized on a percentage
of completion basis, decreased $1.4 million in 2007 as compared to 2006.
This decrease was primarily related to the invoicing under the terms of the
agreement and the recognition of revenue for which contracts exist. Deferred
margin on sales to distributors increased $8.7 million in 2007 as compared
to 2006, primarily due to the improved business processes which resulted in the
company being able to eliminate the previously existing delay in recognition
of


44
 Table of Contents


sell-through
revenue from distributor sales for the third month of a quarter until the
following quarter. Other current liabilities including accounts payable and
accrued liabilities, increased to $54.9 million from $52.0 million
attributable primarily with the volume of our business, the timing of vendor
payments, the payments on accruals for inventory related items and miscellaneous
other items.





Investing
Activities





In 2008,
net cash provided by investing activities was $14.8 million, consisting
primarily of proceeds from the sale of short-term investments (net of purchases)
of $21.9 million, partially offset by purchases of property and equipment
of $7.0 million. Net cash provided by investing activities during 2007
consisted primarily of sale of investments of $137.1 million which was used
to fund the purchase of sci-worx for $13.8 million, net of cash acquired,
the acquisition of Sunplus IP for $40.0 million, of which
$18.8 million was paid in 2007 and purchases of property, plant and
equipment of $13.4 million. Cash used in investing activities in 2006
consisted primarily of purchases of short-term investments (net of proceeds from
sales and maturities of investments) of $94.0 million and purchases of
property and equipment of $13.5 million.





We held
no direct investments in auction rate securities, collateralized debt
obligations, structured investment vehicles or mortgage-backed securities. We
are not a capital-intensive business. Our purchases of property and equipment in
2008, 2007 and 2006 related mainly to testing equipment, leasehold improvements
and information technology infrastructure.





Financing
Activities





In 2008,
net cash used in financing activities was $82.2 million, consisting primarily of
repurchases of common stock of $68.2 million, payment of $19.3
million to Sunplus and Oracle in connection with the financing of
intangibles and software purchased, partially offset by proceeds from stock
options exercises and purchases under our employee stock purchase program (ESPP)
of $4.8 million. Net cash used in financing activities in 2007 consisted
primarily of repurchases of common stock of $38.1 million, partially offset
by proceeds from stock option exercises and purchases under our employee stock
purchase program (ESPP) of $12.9 million. Net cash flows provided by
financing activities in 2006 consisted primarily of proceeds from stock options
exercises and ESPP purchases of $35.1 million.





Cash
Requirements and Commitments





In
addition to our normal operating cash requirements, our principal future cash
requirements will be to fund capital expenditures, share repurchases and any
strategic acquisitions, in addition we have approximately $8.2 million in
commitments for fiscal years including and beyond 2009 as disclosed in the
operating lease commitments table below.





Lease
Obligations





In
December 2002, we entered into a non-cancelable operating lease renewal for our
principal operating facility. In June 2004 and May 2006, we entered into
amendments to the operating lease agreements. The amendments expanded the leased
premises. The lease was amended in May 2006 to extend the lease expiration date
to July 2011, and to set the monthly rental payments at $146,237, with annual
increases of 3% thereafter.  We also lease an operating facility in
Irvine, California, pursuant to a non-cancelable operating lease agreement with
a term that extends through November 2012 and provides for base monthly rental
payments of approximately $14,800 is required.





We also
lease office space in China, Germany, Japan, Korea, Taiwan and the
Netherlands.





Rent
expense totaled $5.1 million, $3.8 million and $2.6 million in
2008, 2007 and 2006, respectively. Future minimum lease payments under operating
leases have not been reduced by expected sub lease rental income or by the
amount of our restructuring accrual that relates to the leased
facilities.











45
 Table of Contents





Our
future operating lease and software purchase commitments at December 31,
2008 are as follows (in thousands):





Payments Due InTotal
            
            
            Less
      than
              1 Year
            
            
            1-3 Years
            
            
            3-5 Years
            
            
            More
      than
              5 YearsContractual
      Obligations:Operating
      lease obligations
            
            $
            7,876
            
            
            $
            3,863
            
            
            $
            3,833
            
            
            $
            180
            
            
            $
            —Software
      purchase commitment
            
            
            315
            
            
            
            105
            
            
            
            210
            
            
            
            —
            
            
            
            —Total
            
            $
            8,191
            
            
            $
            3,968
            
            
            $
            4,043
            
            
            $
            180
            
            
            $
            —





The
amounts above exclude liabilities under FASB Interpretation No. 48 “Accounting for Uncertainty in
Income Taxes”, as we are unable to reasonably estimate the timing of
settlement. See Note 3, “Income Taxes,” in the Notes to Consolidated
Financial


Statements
for further discussion.





Long-Term
Liquidity





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 twelve months. We expect to continue to invest in property and
equipment in the ordinary course of business. Our future operating and capital
requirements depend on many factors, including the levels at which we generate
product revenue and related margins, the extent to which we generate cash
through stock option exercises and proceeds from sales of shares under our
employee stock purchase plan, the timing and extent of licensing revenue,
investments in inventory, property, plant and equipment 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. While, we believe that our current cash, cash equivalents
and short-term investment balances together with income derived from sales of
our products and licensing will be sufficient to meet our liquidity requirements
in the foreseeable future, 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 when we need them, or if available, we may not be able to
obtain them on terms favorable to us.





Global
credit and financial markets have been experiencing extreme disruptions in
recent months, including severely diminished liquidity and credit availability,
declines in consumer confidence, declines in economic growth, increases in
unemployment rates, and uncertainty about economic stability. There can be no
assurance that there will not be further deterioration in credit and financial
markets and confidence in economic conditions.  These economic
uncertainties affect businesses such as ours in a number of ways, making it
difficult to accurately forecast and plan our future business activities. The
current tightening of credit in financial markets may lead consumers and
businesses to postpone spending, which may cause our customers to cancel,
decrease or delay their existing and future orders with us. In addition,
financial difficulties experienced by our suppliers or distributors could result
in product delays, increased accounts receivable defaults and inventory
challenges.





Item 7A.Quantitative and
Qualitative Disclosures About Market Risk





Interest
Rate Risk





The
primary objective of our investment activities is to preserve principal while at
the same time maximizing the income we receive from our investments without
significantly increasing risk. To achieve this objective, we maintain our
portfolio of cash equivalents and short-term investments in a variety of
securities, including government and corporate securities and money market
funds. These securities are classified as available for sale and consequently
are recorded on the balance sheet at fair value with unrealized gains or losses
reported as a separate component of accumulated other comprehensive income
(loss). We also limit our exposure to interest rate and credit risk by
establishing and monitoring clear policies and guidelines of our fixed income
portfolios. The guidelines also establish credit quality standards, limits on
exposure to any one issuer and limits on exposure to the type of instrument. Due
to the limited duration and credit risk criteria established in our guidelines
we do not expect the exposure to interest rate risk and credit risk to be
material. If interest rates rise, the market value of our investments may
decline, which could result in a realized loss if we are forced to sell an
investment before its scheduled maturity. As of December 31, 2008, we had
an investment portfolio of securities as reported in short-term investments,
including those classified as cash equivalents of approximately
$185.0 million. A sensitivity analysis was performed on our investment
portfolio as of December 31, 2008. This sensitivity analysis was based on a
modeling technique that measures the hypothetical market value changes that
would result from a parallel shift in the yield curve of plus 50, 100, or
150 basis points over a twelve-month time horizon.


46
 Table of Contents


the value
of our investments given a shift in the yield curve used in our sensitivity
analysis.




0.5%
            1.0%
            1.5%$250,000
            $500,000
            $751,000





As of
December 31, 2007, we had an investment portfolio of securities as reported
in short-term investments, including those classified as cash equivalents of
approximately $249.7 million. These securities are subject to interest rate
fluctuations. The following represents the potential change to the value of
our fixed income securities given a shift in the yield curve used in our
sensitivity analysis.





0.5%
            1.0%
            1.5%$171,000
            $343,000
            $515,000





Financial
instruments that potentially subject us to significant concentrations of credit
risk consist primarily of cash equivalents and short-term investments and
accounts receivable. A majority of our cash and investments are maintained with
two major financial institutions headquartered in the United States. As part of
our cash and investment management processes, we perform periodic evaluations of
the credit standing of the financial institutions and we have not sustained any
credit losses from investments held at these financial institutions. The
counterparties to the agreements relating to our investment securities consist
of various major corporations and financial institutions of high credit
standing.





We
perform on-going credit evaluations of our customers’ financial condition and
may require collateral, such as letters of credit, to secure accounts receivable
if deemed necessary. We maintain an allowance for potentially uncollectible
accounts receivable based on our assessment of collectability.





Foreign
Currency Exchange Risk





A
majority of our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars. However, certain operating expenditures and
capital purchases are incurred in or exposed to other currencies, primarily the
Euro, British Pound, the South Korean Won, Taiwan Dollar and the Chinese Yuan.
The effect of an immediate 10% change in foreign currency exchange rates may
impact our future operating results or cash flows as any such increases in our
currency exchange rate may result in increased wafer, packaging, assembly or
testing costs as well as ongoing operating activities in our foreign operations.
Additionally, many of our foreign distributors price our products in the local
currency of the countries in which they sell. Therefore, significant
strengthening or weakening of the U.S. dollar relative to those foreign
currencies could result in reduced demand or lower U.S. dollar prices or
vice versa, for our products, which would negatively affect our operating
results. Cash balances held in foreign countries are subject to local banking
laws and may bear higher or lower risk than cash deposited in the United States.
As of December 31, 2008, cash held in foreign countries was approximately
$1.2 million. The following represents the potential impact of
a change in the value of the U.S. dollar compared to the Euro, British
Pound and Japanese Yen.  This sensitivity analysis aggregates our
annual activity in these three currencies, translated to U.S. dollars, and
applies a change in the U.S. dollar value of 5%, 7.5% and 10%.





5%
            7.5%
            10%$1.3
      million
            $2.0
      million
            $2.7
      million





Item 8.Financial Statements and
Supplementary Data





The
Financial Statements and Supplemental Data required by this item are set forth
at the pages indicated at Item 15(a).





Item 9.Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure





Not
applicable.





Item 9A.Controls and
Procedures





Evaluation
of Disclosure Controls and Procedures





Management
is required to evaluate our disclosure controls and procedures, as defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the
“Exchange Act”). Disclosure controls and procedures are controls and other
procedures


47
 Table of Contents


designed
to ensure that information required to be disclosed in our reports filed under
the Exchange Act, such as this Annual Report on Form 10-K, is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission’s
rules and forms. Disclosure controls and procedures include controls and
procedures designed to ensure that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer as appropriate to allow timely decisions regarding required
disclosure. Our disclosure controls and procedures include components of our
internal control over financial reporting, which consists of control processes
designed to provide reasonable assurance regarding the reliability of our
financial reporting and the preparation of financial statements in accordance
with generally accepted accounting principles in the U.S. To the extent
that components of our internal control over financial reporting are included
within our disclosure controls and procedures, they are included in the scope of
our periodic controls evaluation.  Based on our management’s
evaluation (with the participation of our principal executive officer and
principal financial officer), as of the end of the period covered by this
report, our principal executive officer and principal financial officer have
concluded that our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended,
(the “Exchange Act”) are effective to ensure that information required to be
disclosed by us in the reports filed and submitted under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in Securities and Exchange Commission rules and forms and
is accumulated and communicated to our management, including our Principal
Executive Officer and Principal Financial Officer, as appropriate to allow
timely decisions regarding required disclosure.




Management’s
Report on Internal Control over Financial Reporting





Management
is responsible for establishing and maintaining adequate internal control over
financial reporting, as defined in Rule 13a-15(f) under the Exchange Act.
Internal control over financial reporting is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external reporting purposes in accordance with
generally accepted accounting principles. Internal control over financial
reporting includes those policies and procedures that:





•
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;





•
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles and that receipts and expenditures are being made
      only in accordance with authorizations of our management and
      directors; and





•
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
statements.





Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal
control over financial reporting is a process that involves human diligence and
compliance and is subject to lapses in judgment and breakdowns resulting from
human failures. Because of such limitations, there is a risk that material
misstatements may not be prevented or detected on a timely basis by internal
control over financial reporting.





Management
conducted an assessment of the Company’s internal control over financial
reporting as of December 31, 2008 based on the framework established by the
Committee of Sponsoring Organization (COSO) of the Treadway Commission in
Internal Control — Integrated Framework. Based on this assessment,
management concluded that, as of December 31, 2008, our internal control
over financial reporting was effective.





The
effectiveness of the Company’s internal control over financial reporting as of
December 31, 2008 has been audited by Deloitte & Touche LLP, an
independent registered public accounting firm, as stated in their report which
appears herein.





Changes
in Internal Control Over Financial Reporting





There
were no changes in our internal controls over financial reporting during the
fourth quarter of our 2008 fiscal year that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.


48
 Table of Contents


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Stockholders of Silicon Image, Inc.


Sunnyvale,
California




We have
audited the internal control over financial reporting of Silicon Image, Inc. and
subsidiaries (the “Company”) as of December 31, 2008, based on criteria
established in Internal
Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. The Company’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying Management’s Report on Internal Control
over Financial Reporting. Our responsibility is to express an opinion on the
Company’s internal control over financial reporting based on our
audit.




We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.




A
company’s internal control over financial reporting is a process designed by, or
under the supervision of, the company’s principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company’s board of directors, management, and other personnel 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. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.




Because
of the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.




In our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2008, based on the
criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission.




We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements as of and
for the year ended December 31, 2008 of the Company and our report dated
February 13, 2009, expressed an unqualified opinion on those financial
statements and included an explanatory paragraph related to the adoption of
Statement of Financial Accounting Standards No. 157, Fair Value Measurements,
effective January 1, 2008.




/s/  DELOITTE &
TOUCHE LLP





San Jose,
California


February 13,
2009




49
 Table of Contents


Item 9B.  Other Information







Not
applicable.





PART III





Item 10.Directors, Executive
Officers and Corporate Governance





The
information required by this Item is herein incorporated by reference from
Silicon Image’s Proxy Statement for its 2009 Annual Meeting of
Stockholders.





Item 11.Executive
Compensation





The
information required by this Item is herein incorporated by reference from
Silicon Image’s Proxy Statement for its 2009 Annual Meeting of
Stockholders.





Item 12.Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters





The
information required by this Item is herein incorporated by reference from
Silicon Image’s Proxy Statement for its 2009 Annual Meeting of
Stockholders.





Item 13.Certain
Relationships and Related Transactions and Director Independence





The
information required by this Item is herein incorporated by reference from
Silicon Image’s Proxy Statement for its 2009 Annual Meeting of
Stockholders.





Item 14.Principal Accountant
Fees and Services





The
information required by this Item is herein incorporated by reference from
Silicon Image’s Proxy Statement for its 2009 Annual Meeting of
Stockholders.


50
 Table of Contents


PART IV





Item 15.Exhibits and Financial
Statement Schedules





(a) The
following documents are filed as a part of this Form:





1. Financial
Statements:





PageConsolidated Balance Sheets at December 31, 2008
      and December 31, 2007
            52Consolidated Statements of Income for each of the
      three years ended December 31, 2008
            53Consolidated Statements of
      Stockholders’ Equity for each of the three years ended December 31,
      2008
            54Consolidated Statements of Cash Flows for each
      of the three years ended December 31, 2008
            55Notes to the Consolidated Financial
      Statements
            56Unaudited Selected Quarterly Financial Data for the
      two years ended December 31, 2008
            78Report of Deloitte & Touche LLP,
      Independent Registered Public Accounting Firm
            79





2. Financial Statement
Schedules





Financial
Statement Schedules have been omitted because they are not applicable or
required, or the information required to be set forth therein is included in the
Consolidated Financial Statements or Notes thereto.





3. Exhibits.





The
exhibits listed in the Index to Exhibits are incorporated herein by reference as
the list of exhibits required as part of this Annual Report on
Form 10-K.


51
 Table of Contents


SILICON
IMAGE, INC.





CONSOLIDATED BALANCE SHEETS





December 31,2008
            
            
            2007(In
      thousands, except share and per share amounts)ASSETSCurrent
      Assets:Cash
      and cash equivalents
            
            $
            95,414
            
            
            $
            137,822Short-term
      investments
            
            
            89,591
            
            
            
            111,889Accounts
      receivable, net of allowances for doubtful accounts of $1,778 on
      December 31, 2008 and $1,565 on December 31,
2007
            
            
            5,922
            
            
            
            21,254Inventories
            
            
            12,775
            
            
            
            20,198Prepaid
      expenses and other current assets
            
            
            15,275
            
            
            
            13,732Deferred
      income taxes
            
            
            6,665
            
            
            
            3,984Total
      current
      assets
            
            
            225,642
            
            
            
            308,879Property
      and equipment, net
            
            
            19,394
            
            
            
            24,191Goodwill
            
            
            19,210
            
            
            
            19,210Intangible
      assets, net
            
            
            32,921
            
            
            
            39,269Deferred
      income taxes, non-current
            
            
            28,193
            
            
            
            19,978Other
      assets
            
            
            1,181
            
            
            
            1,421Total
      assets
            
            $
            326,541
            
            
            $
            412,948LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      Liabilities:Accounts
      payable
            
            $
            7,278
            
            
            $
            17,892Accrued
      and other liabilities
            
            
            23,023
            
            
            
            36,996Deferred
      revenue
            
            
            2,348
            
            
            
            3,860Deferred
      margin on sales to distributors
            
            
            6,881
            
            
            
            26,443Total
      current
      liabilities
            
            
            39,530
            
            
            
            85,191Other
      long-term liabilities
            
            
            8,064
            
            
            
            13,910Total
      liabilities
            
            
            47,594
            
            
            
            99,101Commitments
      and contingencies (Notes 4 and 7)Stockholders’
      equity:Convertible
      preferred stock, par value $0.001; 5,000,000 shares authorized; no
      shares issued or outstanding
            
            
            —
            
            
            
            —Common
      stock, par value $0.001; 150,000,000 shares authorized;
      shares  issued and outstanding: 74,070,293 — 2008 and
      84,313,316 — 2007
            
            
            92
            
            
            
            90Additional
      paid-in capital
            
            
            442,228
            
            
            
            418,796Treasury
      stock
            
            
            (106,276
            )
            
            
            (38,096
            )Accumulated
      deficit
            
            
            (57,030
            )
            
            
            (67,093
            )Accumulated
      other comprehensive income (loss)
            
            
            (67
            )
            
            
            150Total
      stockholders’
      equity
            
            
            278,947
            
            
            
            313,847Total
      liabilities and stockholders’
      equity
            
            $
            326,541
            
            
            $
            412,948





See
accompanying Notes to Consolidated Financial Statements.


52
 Table of Contents


SILICON
IMAGE, INC.





CONSOLIDATED STATEMENTS OF INCOME





Year Ended
December 31,2008
            
            
            2007
            
            
            2006(In
      thousands, except per share amounts)Revenue:Product
            
            $
            233,201
            
            
            $
            272,374
            
            
            $
            252,302Licensing
            
            
            41,214
            
            
            
            48,129
            
            
            
            42,656Total
      revenue
            
            
            274,415
            
            
            
            320,503
            
            
            
            294,958Cost
      of revenue and operating expenses:Cost
      of product revenue(1)
            
            
            112,539
            
            
            
            135,168
            
            
            
            120,173Cost
      of licensing revenue
            
            
            1,187
            
            
            
            5,275
            
            
            
            1,074Research
      and development(2)
            
            
            84,819
            
            
            
            77,994
            
            
            
            63,598Selling,
      general and administrative(3)
            
            
            71,719
            
            
            
            70,340
            
            
            
            67,597Amortization
      of intangible assets
            
            
            6,348
            
            
            
            3,549
            
            
            
            508Patent
      assertion costs (reimbursement), net
            
            
            —
            
            
            
            22
            
            
            
            (5,244
            )Restructuring
      Expense(4)(Note
      11)
            
            
            5,858
            
            
            
            —
            
            
            
            —Total
      cost of revenue and operating
      expenses
            
            
            282,470
            
            
            
            292,348
            
            
            
            247,706Income
      (loss) from
      operations
            
            
            (8,055
            )
            
            
            28,155
            
            
            
            47,252Interest
      income
            
            
            4,660
            
            
            
            11,346
            
            
            
            9,438Other
      income (expenses), net
            
            
            1,585
            
            
            
            51
            
            
            
            (233
            )Income
      (loss) before provision for income
      taxes
            
            
            (1,810
            )
            
            
            39,552
            
            
            
            56,457Provision
      (benefit) for income taxes
            
            
            (11,873
            )
            
            
            20,551
            
            
            
            13,992Net
      income
            
            $
            10,063
            
            
            $
            19,001
            
            
            $
            42,465Net
      income per shareBasic
            
            $
            0.13
            
            
            $
            0.22
            
            
            $
            0.51Diluted
            
            $
            0.13
            
            
            $
            0.22
            
            
            $
            0.49Weighted
      average sharesBasic
            
            
            75,570
            
            
            
            85,557
            
            
            
            82,787Diluted
            
            
            76,626
            
            
            
            87,388
            
            
            
            86,791


__________





(1)
      Includes stock-based compensation expense
            
            $
            1,445
            
            
            
            1,597
            
            
            
            2,427(2)
      Includes stock-based compensation expense
            
            
            7,134
            
            
            
            8,411
            
            
            
            11,108(3)
      Includes stock-based compensation expense
            
            
            10,893
            
            
            
            9,442
            
            
            
            13,696(4)
      Includes stock-based compensation expense
            
            
            14
            
            
            
            —
            
            
            
            —








See
accompanying Notes to Consolidated Financial Statements.


53
 Table of Contents


SILICON
IMAGE, INC.





CONSOLIDATED STATEMENTS OF STOCKHOLDERS’
EQUITY





AccumulatedAdditional
            
            
            
            
            
            
            
            
            
            
            
            OtherCommon Stock
            
            
            Paid-in
            
            
            Treasury
            
            
            Unearned
            
            
            Accumulated
            
            
            Comprehensive(in thousands)
            
            Shares
            
            
            Amount
            
            
            Capital
            
            
            Stock
            
            
            Compensation
            
            
            Deficit
            
            
            Income (Loss)
            
            
            TotalBalance
      at December 31, 2005
            
            
            80,492
            
            
            $
            80
            
            
            $
            307,149
            
            
            
            
            
            $
            (6,742
            )
            
            $
            (123,429
            )
            
            $
            (512
            )
            
            $
            176,546Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            —
            
            
            
            —
            
            
            
            42,465
            
            
            
            —
            
            
            
            42,465Unrealized
      net gain on available-for-sale investments, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            334
            
            
            
            334Foreign
      currency translation adjustments
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            19
            
            
            
            19Total
      comprehensive income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            42,818Net
      issuances of common stock
            
            
            5,571
            
            
            
            6
            
            
            
            31,120
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            31,126Common
      stock issued for ESPP
            
            
            421
            
            
            
            1
            
            
            
            3,916
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,917Elimination
      of unearned compensation in connection with FAS 123(R)
      adoption
            
            
            —
            
            
            
            —
            
            
            
            (6,742
            )
            
            
            —
            
            
            
            6,742
            
            
            
            —
            
            
            
            —
            
            
            
            —Tax
      benefit from equity based compensation
              plans
            
            
            —
            
            
            
            —
            
            
            
            23,584
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            23,584Stock-based
      compensation expense
            
            
            —
            
            
            
            —
            
            
            
            27,231
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            27,231Balance
      at December 31, 2006
            
            
            86,484
            
            
            
            87
            
            
            
            386,258
            
            
            
            —
            
            
            
            —
            
            
            
            (80,964
            )
            
            
            (159
            )
            
            
            305,222Net
      income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            19,001
            
            
            
            —
            
            
            
            19,001Unrealized
      net gain on available-for-sale investments, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            204
            
            
            
            204Foreign
      currency translation adjustments, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            105
            
            
            
            105Total
      comprehensive income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            19,310Effect
      of FIN 48 adoption on retained earnings
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (5,130
            )
            
            
            —
            
            
            
            (5,130
            )Net
      issuances of common stock
            
            
            2,324
            
            
            
            2
            
            
            
            9,358
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            9,360Common
      stock issued for ESPP
            
            
            505
            
            
            
            1
            
            
            
            3,548
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,549Tax
      benefit from equity based compensation
              plans
            
            
            —
            
            
            
            —
            
            
            
            182
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            182Repurchase
      of common stock
            
            
            (5,000
            )
            
            
            —
            
            
            
            —
            
            
            
            (38,096
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (38,096
            )Stock-based
      compensation expense
            
            
            —
            
            
            
            —
            
            
            
            19,450
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            19,450Balance
      at December 31, 2007
            
            
            84,313
            
            
            
            90
            
            
            
            418,796
            
            
            
            (38,096
            )
            
            
            —
            
            
            
            (67,093
            )
            
            
            150
            
            
            
            313,847Net
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            10,063
            
            
            
            —
            
            
            
            10,063


Unrealized
      net gain on available-for-sale investments, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            219
            
            
            
            219Foreign
      currency translation adjustments, net of tax
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (436
            )
            
            
            (436
            )Total
      comprehensive income
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            9,846Net
      issuances of common stock
            
            
            487
            
            
            
            1
            
            
            
            1,711
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            1,712Common
      stock issued for ESPP
            
            
            808
            
            
            
            1
            
            
            
            3,045
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            3,046Tax
      loss from equity based compensation
              plans
            
            
            —
            
            
            
            —
            
            
            
            (810
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (810
            )Repurchase
      of common stock
            
            
            (11,538
            )
            
            
            —
            
            
            
            —
            
            
            
            (68,180
            )
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (68,180
            )Stock-based
      compensation expense
            
            
            —
            
            
            
            —
            
            
            
            19,486
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            19,486Balance
      at December 31, 2008
            
            
            74,070
            
            
            $
            92
            
            
            $
            442,228
            
            
            $
            (106,276
            )
            
            $
            —
            
            
            $
            (57,030
            )
            
            $
            (67
            )
            
            $
            278,947





See
accompanying Notes to Consolidated Financial Statements


54
 Table of Contents


SILICON
IMAGE, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


Year Ended
December 31,2008
            
            
            2007
            
            
            2006(In
      thousands)Cash
      flows from operating activities:Net
      income
            
            $
            10,063
            
            
            $
            19,001
            
            
            $
            42,465Adjustments
      to reconcile net income to cash provided by operating
      activities:Depreciation
            
            
            10,349
            
            
            
            9,464
            
            
            
            7,108Provision
      for doubtful accounts
            
            
            1,218
            
            
            
            334
            
            
            
            215Stock-based
      compensation expense
            
            
            19,486
            
            
            
            19,450
            
            
            
            27,231Amortization
      of intangible assets
            
            
            6,348
            
            
            
            3,549
            
            
            
            508Amortization/(Accretion)
      of investment premium/(discount)
            
            
            1,189
            
            
            
            (524
            )
            
            
            (869
            )Tax
      benefit (loss) from employee based compensation plans
            
            
            (810
            )
            
            
            182
            
            
            
            23,584Excess
      tax benefits from employee stock transactions
            
            
            (548
            )
            
            
            (2,543
            )
            
            
            (23,856
            )Realized
      (gain) / loss on sale of investments
            
            
            (301
            )
            
            
            18
            
            
            
            82Unrealized
      loss on derivative transactions
            
            
            —
            
            
            
            —
            
            
            
            41Non-cash
      restructuring expenses
            
            
            1,063
            
            
            
            —
            
            
            
            —Deferred
      income taxes
            
            
            (10,896
            )
            
            
            1,195
            
            
            
            (23,279
            )Loss
      on disposal of property and equipment
            
            
            554
            
            
            
            1,270
            
            
            
            15Changes
      in assets and liabilities, net of amounts acquired:Accounts
      receivable
            
            
            14,114
            
            
            
            21,430
            
            
            
            (10,005
            )Inventories
            
            
            7,423
            
            
            
            8,280
            
            
            
            (11,215
            )Prepaid
      expenses and other current assets
            
            
            (1,303
            )
            
            
            (7,999
            )
            
            
            (1,824
            )Accounts
      payable
            
            
            (10,684
            )
            
            
            1,857
            
            
            
            (453
            )Accrued
      and other liabilities
            
            
            (550
            )
            
            
            (14,227
            )
            
            
            22,200Deferred
      revenue
            
            
            (1,512
            )
            
            
            (2,325
            )
            
            
            (3,019
            )Deferred
      patent infringement proceeds
            
            
            —
            
            
            
            —
            
            
            
            (6,867
            )Deferred
      margin on sales to distributors
            
            
            (19,562
            )
            
            
            8,731
            
            
            
            3,941Cash
      provided by operating activities
            
            
            25,641
            
            
            
            67,143
            
            
            
            46,003Cash
      flows from investing activities:Purchases
      of short-term investments
            
            
            (224,499
            )
            
            
            (79,473
            )
            
            
            (240,308
            )Proceeds
      from sales of short-term investments
            
            
            246,370
            
            
            
            137,135
            
            
            
            146,273Purchases
      of property and equipment
            
            
            (7,046
            )
            
            
            (13,388
            )
            
            
            (13,479
            )Payments
      for intellectual property
            
            
            —
            
            
            
            (18,750
            )
            
            
            —Business
      combination, net of cash acquired
            
            
            —
            
            
            
            (13,751
            )
            
            
            —Proceeds
      from sale of property and equipment
            
            
            —
            
            
            
            43
            
            
            
            —Release
      of restriction on cash received in conjunction with resolution of
      litigation
            
            
            —
            
            
            
            —
            
            
            
            6,867Cash
      provided by (used in) investing activities
            
            
            14,825
            
            
            
            11,816
            
            
            
            (100,647
            )Cash
      flows from financing activities:Proceeds
      from issuances of common stock
            
            
            4,758
            
            
            
            12,909
            
            
            
            35,043Repayments
      of debt and capital lease obligations
            
            
            —
            
            
            
            —
            
            
            
            (230
            )Payments
      to acquire treasury stock
            
            
            (68,180
            )
            
            
            (38,096
            )
            
            
            —Payments
      for vendor financed software and intangibles purchased
            
            
            (19,278
            )
            
            
            (528
            )
            
            
            —Excess
      tax benefits from employee stock transactions
            
            
            548
            
            
            
            2,543
            
            
            
            23,856Cash
      provided by (used in) financing activities
            
            
            (82,152
            )
            
            
            (23,172
            )
            
            
            58,669Effect
      of exchange rate changes on cash and cash equivalents
            
            
            (722
            )
            
            
            114
            
            
            
            19Net
      (decrease) / increase in cash and cash equivalents
            
            
            (42,408
            )
            
            
            55,901
            
            
            
            4,044Cash
      and cash equivalents — beginning of year
            
            
            137,822
            
            
            
            81,921
            
            
            
            77,877Cash
      and cash equivalents — end of year
            
            $
            95,414
            
            
            $
            137,822
            
            
            $
            81,921Supplemental
      cash flow information:Cash
      payments for interest
            
            $
            68
            
            
            $
            35
            
            
            $
            10Cash
      payments for taxes
            
            $
            3,624
            
            
            $
            36,316
            
            
            $
            1,316Unrealized
      net gain on available-for-sale securities
            
            $
            219
            
            
            $
            204
            
            
            $
            334Property
      and equipment received and accrued
            
            $
            79
            
            
            $
            1,566
            
            
            $
            2,462Intellectual
      property received and accrued
            
            $
            —
            
            
            $
            21,250
            
            
            $
            420


See
accompanying Notes to Consolidated Financial Statements.


55
 Table of Contents





SILICON
IMAGE, INC.





NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS





NOTE 1 —
THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES





The
Company





Silicon
Image, Inc. (referred to herein as “We”, “Our”, “the Company”, or “Silicon
Image”), a Delaware corporation, was incorporated June 11, 1999. The
Company is a leader in driving the architecture and semiconductor
implementations for the secure storage, distribution and presentation of
high-definition content in the consumer electronics and personal computing
markets. Silicon Image creates and drives industry standards for digital content
delivery such as DVI, HDMItm
and Serial ATA (SATA), leveraging partnerships with global leaders in the
consumer electronics and personal computing markets to meet the growing digital
content needs of consumers worldwide.





The
Company provides discrete and various levels of integrated semiconductor
products as well as IP licensing to consumer electronics, computing, display,
storage, mobile and networking equipment manufacturers. The Company’s product
and IP portfolio includes solutions for high-definition television (HDTV),
high-definition set-top boxes (STBs), high-definition digital video disc (DVD)
players, digital and personal video recorders (DVRs and PVRs), mobile devices
(cellular phones, camcorders & still cameras), high-definition game systems,
consumer and enterprise storage products and PC display products.





Basis
of presentation





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





Certain
prior year amounts have been reclassified to conform to the current year
presentation, including the reclassification of revenue generated by the
Company’s Simplay subsidiary from the “Licensing” revenue caption to “Product”
revenue and revenue between the Company’s lines of business, in order to more
closely align its revenue presentation with its key operating metrics. The
Company has also renamed the caption “Development, licensing and royalty”
revenue as “Licensing” revenue.





Revenue
recognition





The
Company’s revenue recognition policy complies with Staff Accounting Bulletin
(SAB) No. 104, Revenue
Recognition(SAB No. 104). We recognize revenue when persuasive
evidence of an arrangement exists, delivery or performance has occurred, the
sales price is fixed or determinable and collectability is reasonably
assured.





Revenue
from products sold directly to end-users, or to distributors that do not receive
price concessions and rights of return, is generally recognized when title and
risk of loss has passed to the buyer which typically occurs upon shipment.
Reserves for sales returns are estimated based primarily on historical
experience and are provided at the time of shipment. All shipping costs are
charged to cost of product revenue.





For
products sold to distributors with agreements allowing for price concessions and
product returns, the Company recognizes revenue based on its best estimate of
when the distributor sold the product to its end customer. The Company’s
estimate of such distributor sell-through is based on point of sales reports
received from its distributors. Revenue is not recognized upon shipment since,
due to various forms of price concessions, the sales price is not substantially
fixed or determinable at that time. Price concessions are recorded when
incurred, which is generally at the time the distributor sells the product to an
end-user. Additionally, these distributors have contractual rights to return
products, up to a specified amount for a given period of time. Revenue is earned
when the distributor sells the product to an end-user, at which time our sales
price to the distributor becomes fixed. Pursuant to our distributor agreements,
older end-of-life and certain other products are sold with no right of return
and are not eligible for price concessions. For these products, revenue is
recognized upon shipment and title transfer assuming all other revenue
recognition criteria are met.


56
 Table of Contents





Revenue
for 2007 includes approximately $6.7 million of product revenue and cost of
revenue includes approximately $2.6 million related to distributor sales
for the month of December 2007. Historically, the Company had deferred the
recognition of sell-through revenue from distributor sales for the third month
of a quarter until the following quarter due to the unavailability of reliable
sell-through information in a timely manner. As a result of improved business
processes, the Company was able to eliminate this delay beginning with the
fourth quarter of 2007, resulting in fiscal year 2007 revenue including an
additional month of product revenue from distributor sales in December 2007.
This one-time effect of the inclusion of an additional month of revenue for
fiscal year 2007 is an increase to net income by approximately $2.6 million
and an increase to net income per share, basic and diluted, by approximately
$0.03.





At the
time of shipment to distributors, the Company records a trade receivable for the
selling price since there is a legally enforceable right to payment, relieves
inventory for the carrying value of goods shipped since legal title has passed
to the distributor and records the gross margin in “deferred margin on sale to
distributors”, a component of current liabilities in its consolidated balance
sheet. Deferred margin on the sale to distributor effectively represents the
gross margin on the sale to the distributor. However, the amount of gross margin
the Company recognizes in future periods will be less than the originally
recorded deferred margin on sales to distributor as a result of negotiated price
concessions. The Company sells each item in its product price book to all of its
distributors worldwide at a relatively uniform list price. However, distributors
resell our products to end customers at a very broad range of individually
negotiated price points based on customer, product, quantity, geography,
competitive pricing and other factors. The majority of The Company’s
distributors’ resale is priced at a discount from list price. Often, under these
circumstances, the Company remits back to the distributor a portion of their
original purchase price after the resale transaction is completed. Thus, a
portion of the “deferred margin on the sale to distributor” balance represents a
portion of distributors’ original purchase price that will be remitted back to
the distributor in the future. The wide range and variability of negotiated
price concessions granted to distributors does not allow the Company to
accurately estimate the portion of the balance in the deferred margin on the
sale to distributors line item that will be remitted back to the distributors.
The Company reduces deferred margin by anticipated or determinable future price
concessions.





The
Company derives revenue from license of its internally developed intellectual
property (IP). The Company enters into IP licensing agreements that generally
provide licensees the right to incorporate its IP components in their products
with terms and conditions that vary by licensee. Revenue earned under contracts
with the Company’s licensees is classified as license revenue. The Company’s
license fee arrangements generally include multiple deliverables and for
multiple deliverable arrangements it follows the guidance in EITF 00-21,
Revenue Arrangements with
Multiple Deliverables, to determine
whether there is more than one unit of accounting. To the extent that the
deliverables are separable into multiple units of accounting, the Company
allocates the total fee on such arrangements to the individual units of
accounting using the residual method, if objective and reliable evidence of fair
value does not exist for delivered elements. The Company then recognizes revenue
for each unit of accounting depending on the nature of the deliverable(s)
comprising the unit of accounting in accordance with the provisions of
SAB No. 104.





The IP
licensing agreements generally include a nonexclusive license for the underlying
IP. Fees under these agreements generally include (a) license fees relating
to our IP, (b)  support, typically for one year; and (c) royalties
payable following the sale by our licensees of products incorporating the
licensed technology. The license for the Company’s IP has standalone value and
can be used by the licensee without support. Further, objective and reliable
evidence of fair value exists for support. Accordingly, license and support fees
are each treated as separate units of accounting.





Certain
licensing agreements provide for royalty payments based on agreed upon royalty
rates. Such rates can be fixed or variable depending on the terms of the
agreement. The amount of revenue the Company recognizes is determined based on a
time period or on the agreed-upon royalty rate, extended by the number of units
shipped by the customer. To determine the number of units shipped, the Company
relies upon actual royalty reports from its customers when available and rely
upon estimates in lieu of actual royalty reports when the Company has a
sufficient history of receiving royalties from a specific customer for us to
make an estimate based on available information from the licensee such as
quantities held, manufactured and other information. These estimates for
royalties necessarily involve the application of management judgment. As a
result of the Company’s use of estimates, period-to-period numbers are
“trued-up” in the following period to reflect actual units shipped. In cases
where royalty reports and other information are not available to allow the
Company to estimate royalty revenue, it recognize revenue only when royalty
reports are received.





For
contracts related to licenses of our technology that involve significant
modification, customization or engineering services, the Company recognizes
revenue in accordance the provisions of SOP 81-1 “Accounting for Performance
of Construction-Type and
Certain Production-Type Contracts”. Revenues derived from such license contracts
are accounted for using the percentage-of-completion method.


57
 Table of Contents


The
Company determines progress to completion based on input measures using
labor-hours incurred by its engineers. The amount of revenue recognized is based
on the total contract fees and the percentage of completion achieved. Estimates
of total project requirements are based on prior experience of customization,
delivery and acceptance of the same or similar technology and are reviewed and
updated regularly by management. If there is significant uncertainty about
customer acceptance, or the time to complete the development or the deliverables
by either party, the Company applies the completed contract method. If
application of the percentage-of-completion method results in recognizable
revenue prior to an invoicing event under a customer contract, the Company
recognizes the revenue and records an unbilled receivable assuming
collectability is reasonably assured. Amounts invoiced to the Company’s
customers in excess of recognizable revenues are recorded as deferred
revenue.





Stock-based
compensation





Effective
January 1, 2006, the Company adopted the fair value recognition provisions
of Statement of Financial Accounting Standards, or SFAS, No. 123R,
Share-Based Payment,
(SFAS No. 123R), requiring it to recognize expense related to the fair
value of our stock-based compensation awards. The Company elected to use the
modified prospective transition method as permitted by SFAS No. 123R.
Under this transition method, stock-based compensation expense for the year
ended December 31, 2006 includes compensation expense for all stock-based
compensation awards granted prior to, but not yet vested as of December 31,
2005, based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123, as adjusted for estimated
forfeitures. Stock-based compensation expense for all stock-based compensation
awards granted subsequent to December 31, 2005 was based on the grant-date
fair value estimated in accordance with the provisions of
SFAS No. 123R. Under SFAS No. 123R, our ESPP is considered a
compensatory plan and we are required to recognize compensation cost for grants
made under the ESPP. The Company recognizes stock-based compensation expense on
a straight-line basis for all share-based payment awards, consisting primarily
of employee stock options, employee stock purchase plan and employee restricted
stock units (RSUs), over the respective requisite service period of the awards.
For purposes of calculating the pool of excess tax benefits available to absorb
tax deficiencies recognized subsequent to the adoption of
SFAS No. 123(R), we followed the alternative transition method
discussed in FASB Staff Position No. 123(R)-3 “Transition Election to Accounting
for the Tax Effects of Share-Based Payment Awards.”





Financial
Instruments





The
Company accounts for its investments in debt securities under SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities and FASB Staff
Position, or FSP No. 115-1/124-1, The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments. Management determines the
appropriate classification of such securities at the time of purchase and
reevaluates such classification as of each balance sheet date. The investments
are adjusted for amortization of premiums and discounts to maturity and such
amortization is included in interest income. We follow the guidance provided by
FSP 115-1/124-1 and Emerging Issues Task Force ("EITF") No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments, to
assess whether our investments with unrealized loss positions are other than
temporarily impaired. Realized gains and losses and declines in value judged to
be other than temporary are determined based on the specific identification
method and are reported in the consolidated statements of income. Factors
considered in determining whether a loss is temporary include the length of time
and extent to which fair value has been less than the cost basis, the financial
condition and near-term prospects of the investee, and our intent and ability to
hold the investment for a period of time sufficient to allow for any anticipated
recovery in market value.





The
classification of our investments into cash equivalents and short term
investments is in accordance with SFAS No. 95 ("SFAS No. 95") Statement of Cash Flows. Cash
equivalents have maturities of three months or less from the date of purchase.
Short-term investments consist of commercial paper, United States government
agency obligations, corporate/municipal notes and bonds. These securities have
maturities greater than three months from the date of purchase.





Effective
January 1, 2008, the Company adopted the provisions of SFAS No. 157 ("SFAS 157")
“Fair Value Measurements”, which defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements
required under other accounting pronouncements. SFAS 157 clarifies that fair
value is an exit price, representing the amount that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants. SFAS 157 also requires that a fair value measurement
reflect the assumptions market participants would use in pricing an asset or
liability based on the best information available. Assumptions include the risks
inherent in a particular valuation technique (such as a pricing model) and/or
the risks inherent in the inputs to the model. SFAS 157 is effective for the
current fiscal year. The adoption of SFAS 157 did not have a significant impact
on our financial statements.


58
 Table of Contents


SFAS 157
establishes a fair value hierarchy that prioritizes the inputs to valuation
techniques used to measure fair value. The hierarchy gives the highest priority
to unadjusted quoted prices in active markets for identical assets or
liabilities (level 1 measurements) and the lowest priority to unobservable
inputs (level 3 measurements). The three levels of the fair value hierarchy
under SFAS No. 157 are described below:





Level
1   Unadjusted quoted prices in active markets that are
accessible at the measurement date for identical, unrestricted assets or
liabilities;





Level
2   Quoted prices in markets that are not active or financial
instruments for which all significant inputs are observable, either directly or
indirectly;





Level
3   Prices or valuations that require inputs that are both
significant to the fair value measurement and unobservable.





A
financial instrument’s level within the fair value hierarchy is based on the
lowest level of any input that is significant to the fair value
measurement.





In
February 2008, the Financial Accounting Standards Board ("FASB") issued Staff
Position No. 157-2 ("FSP 157-2") that delays the effective date of SFAS 157 for
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). The delay is intended to allow the FASB and
constituents additional time to consider the effect of various implementation
issues that have arisen, or that may arise, from the application of SFAS
157.





Further
information about the application of SFAS 157 may be found in Note 13
below.





Derivative
Instruments





The
Company recognizes derivative instruments as either assets or liabilities and
measures those instruments at fair value. The accounting for changes in the fair
value of a derivative depends on the intended use of the derivative and the
resulting designation. The Company accounts for derivative instruments in
accordance with authoritative accounting standards, including Statement of
Financial Accounting Standards (SFAS) 133 - Accounting for Derivative Instruments and Hedging
Activitiesand SFAS 52 - Foreign
Currency Translation. For a derivative instrument designated as a cash
flow hedge, the effective portion of the derivative’s gain or loss is initially
reported as a component of accumulated other comprehensive income and
subsequently reclassified into earnings when the hedged exposure affects
earnings. The ineffective portion of the gain or loss is reported in earnings
immediately. As of December 31, 2008 the Company had no outstanding derivative
instruments.





Allowance
for Doubtful Accounts





The
Company reviews collectability of accounts receivable on an on-going basis and
provides an allowance for amounts it estimates will not be collectible. During
the Company’s review, it considers its historical experience, the age of the
receivable balance, the credit-worthiness of the customer and the reason for the
delinquency. Delinquent account balances are written-off after the Company has
determined that the likelihood of collection is remote. Write-offs to date have
not been material.





2008
            
            
            2007
            
            
            2006(In
      thousands)Balance
      at January 1,
            
            $
            1,565
            
            
            $
            235
            
            
            $
            417Provision
      for doubtful accounts
            
            
            1,218
            
            
            
            1,868
            
            
            
            215Write
      offs/recoveries
            
            
            (1,005
            )
            
            
            (538
            )
            
            
            (397
            )Balance
      at December 31,
            
            $
            1,778
            
            
            $
            1,565
            
            
            $
            235





Inventories





The
Company records inventories at the lower of actual cost, determined on a
first-in first-out (FIFO) basis, or market. Actual cost approximates standard
cost, adjusted for variances between standard and actual. Standard costs are
determined based on the Company’s estimate of material costs, manufacturing
yields, costs to assemble, test and package its products and allocable indirect
costs. The Company records differences between standard costs and actual costs
as variances. These variances are analyzed and are


59
 Table of Contents


either
included on the consolidated balance sheet or the consolidated statement of
income in order to state the inventories at actual costs on a FIFO basis.
Standard costs are evaluated at least annually.





Provisions
are recorded for excess and obsolete inventory and are estimated based on a
comparison of the quantity and cost of inventory on hand to the Company’s
forecast of customer demand. Customer demand is dependent on many factors and
requires the Company to use significant judgment in its forecasting process. The
Company must also make assumptions regarding the rate at which new products will
be accepted in the marketplace and at which customers will transition from older
products to newer products. Generally, inventories in excess of six months
forecasted demand are written down to zero and the related provision is recorded
as a cost of revenue. Once a provision is established, it is maintained until
the product to which it relates is sold or otherwise disposed of, even if in
subsequent periods we forecast demand for the product.





Goodwill,
intangible and long-lived assets





Consideration
paid in connection with acquisitions is required to be allocated to the assets,
including identifiable intangible assets and liabilities acquired. Acquired
assets and liabilities are recorded based on the Company’s estimate of fair
value, which requires significant judgment with respect to future cash flows and
discount rates.





For
certain long-lived assets, primarily fixed assets and identifiable intangible
assets, for example the Company’s IP acquired from Sunplus (refer to Note 12
below), the Company is required to estimate the useful life of its asset and
recognize the cost as an expense over the useful life. The Company uses the
straight-line method to depreciate long-lived assets. The Company evaluates the
recoverability of our long-lived assets in accordance with
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived
Assets.Whenever events or circumstances indicate that the carrying
amount of long-lived assets may not be recoverable, the Company compares the
carrying amount of long-lived assets to its projection of future undiscounted
cash flows, attributable to such assets. In the event that the carrying amount
exceeds the future undiscounted cash flows, the Company records an impairment
charge against income equal to the excess of the carrying amount over the
asset’s fair value. Predicting future cash flows attributable to a particular
asset is difficult and requires the use of significant judgment.





The
Company assigns the following useful lives to its fixed assets — three
years for computers and software, one to five years for equipment and five to
seven years for furniture and fixtures. Leasehold improvements and assets held
under capital leases are amortized on a straight-line basis over the shorter of
the lease term or the estimated useful life, which ranges from two to five
years. Depreciation expense was $10.3 million, $9.5 million and
$7.1 million, for the years ended December 31, 2008, 2007 and
2006.





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





Income
Taxes





The
Company must make certain estimates and judgments in determining income tax
expense for financial statement purposes. These estimates and judgments occur in
the calculation of tax credits, tax benefits and deductions and in the
calculation of certain tax assets and liabilities, which arise from differences
in the timing of recognition of revenue and expense for tax and financial
statement purposes. Significant changes to these estimates may result in an
increase or decrease to our tax provision in the subsequent period when such a
change in estimate occurs.


60
 Table of Contents


Deferred
tax assets





We
account for deferred tax assets in accordance with the Statement of Financial
Accounting Standard No. 109 (SFAS No. 109), Accounting for Income Taxes.
In the first quarter of 2007, we adopted the Financial Accounting Standards
Board (FASB) FIN No. 48, Accounting for Uncertainty in Income
Taxes — an Interpretation of FASB Statement
No. 109. FIN No. 48 requires that the Company determines
whether a tax position is more likely than not to be sustained upon examination,
including resolution of any related appeals or litigation processes, based on
the technical merits of the position. For income taxes the Company uses an asset
and liability approach, which requires recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in its financial statements, but have not been reflected in its
taxable income. In general, a valuation allowance is established to reduce
deferred tax assets to their estimated realizable value, if based on the weight
of available evidence, it is more likely than not that some portion, or all, of
the deferred tax asset will not be realized. The Company evaluates the
realizability of the deferred tax assets quarterly and will continue to assess
the need for valuation allowances.





At
December 31, 2008, the Company had gross deferred tax assets, related
primarily to stock-based compensation, accruals and reserves that are not
currently deductible, depreciable and amortizable items, and tax credit carry
forwards of $34.9 million. At December 31, 2007 the Company’s gross
deferred tax assets of $24.0 million consisted primarily of tax credit carry
forwards and stock-based compensation not currently deductable for tax
purposes.





Guarantees,
Indemnifications and Warranty Liabilities





Certain
of the Company’s licensing agreements indemnify its customers for expenses or
liabilities resulting from claimed infringements of patent, trademark or
copyright by third parties related to the intellectual property content of our
products. Certain of these indemnification provisions are perpetual from
execution of the agreement and, in some instances; the maximum amount of
potential future indemnification is not limited. To date, the Company has not
paid any such claims or been required to defend any lawsuits with respect to a
claim.





At the
time of revenue recognition, the Company provides an accrual for estimated costs
(included in accrued liabilities in the accompanying consolidated balance
sheets) to be incurred pursuant to its warranty obligation. The Company’s
estimate is based primarily on historical experience.





The
following table represents the Company’s warranty activity for the three years
ended December 31, 2008





2008
            
            
            2007
            
            
            2006(In
      thousands)Balance
      at January 1,
            
            $
            62
            
            
            $
            60
            
            
            $
            382Provision
      for warranties issued during the year
            
            
            1
            
            
            
            21
            
            
            
            30Reduction
      to pre-existing warranties
            
            
            —
            
            
            
            —
            
            
            
            (314
            )Cash
      and other settlements made during the year
            
            
            (25
            )
            
            
            (19
            )
            
            
            (38
            )Balance
      at December 31,
            
            $
            38
            
            
            $
            62
            
            
            $
            60





Restructuring
Expenses





The
Company records provisions for workforce reduction costs and exit costs when
they are probable and estimable. Severance paid under ongoing benefit
arrangements is recorded in accordance with SFAS No. 112, Employers’ Accounting for Postemployment Benefits. One-time termination benefits and
contract settlement and lease costs are recorded in accordance with SFAS No.
146, Accounting for Costs Associated with Exit
or Disposal Activities. At each reporting date, we evaluate our accruals
related to workforce reduction charges, contract settlement and lease costs and
plant and equipment write downs to ensure that these accruals are still
appropriate. As of December 31, 2008, we had $3.3 million in accruals related to
workforce reduction charges and $0.2 million in accruals related to lease costs,
which included estimates, primarily related to sublease income over the lease
terms and other costs for vacated properties. Increases or decreases to the
accruals for changes in estimates are classified as restructuring expenses in
the consolidated statement of income.





Foreign
Currency translation





The
Company accounts for foreign currency transactions in accordance with the
Statement of Financial Accounting Standard No. 52 (SFAS No. 52),
Foreign Currency Translation.The Company
determines the functional currency for its foreign subsidiaries by reviewing the
currencies in which their respective operating activities occur. The functional
currency for the Company’s foreign subsidiaries is the local currency.
Transaction gains and losses arising from activities in other than the
applicable functional currency


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are
calculated using average exchange rates for the applicable period and reported
in  the Company’s consolidated statement of income as a non-operating
item in each year. Monetary balance sheet items of the Company’s subsidiaries
denominated in foreign currency are translated using the exchange rate in effect
on the balance sheet date and any adjustments arising from remeasurements are
included in other comprehensive income.





Research
and Development





Research
and development costs are expensed as incurred. It is the Company’s policy to
record a reduction to research and development expense for funding received from
outside parties for research and development projects. During the years ended
December 31, 2008 and 2006, the Company recorded a reduction to research
and development expense totaling approximately $0.5 million, and
$1.0 million, respectively,  related to funding received from
outside parties for one engineering project. There was no funding received in
2007.





Net
income per share





Basic net
income per share is based on weighted average common shares outstanding,
excluding shares subject to repurchase and diluted net income per share is based
on weighted average common shares and dilutive equivalents outstanding, if any.
The following tables set forth the computation of basic and diluted net income
per share (in thousands, except per share amounts):





Year Ended
December 31,2008
            
            
            2007
            
            
            2006Numerator:Net
      income
            
            $
            10,063
            
            
            $
            19,001
            
            
            $
            42,465Denominator:Weighted
      average shares of common stock outstanding
            
            
            75,570
            
            
            
            85,557
            
            
            
            82,787Weighted
      average shares — basic
            
            
            75,570
            
            
            
            85,557
            
            
            
            82,787Weighted-average
      dilutive common stock options and restricted stock units outstanding under
      the treasury stock method
            
            
            1,056
            
            
            
            1,831
            
            
            
            4,004Weighted
      average shares — diluted
            
            
            76,626
            
            
            
            87,388
            
            
            
            86,791Net
      income per shareBasic
            
            $
            0.13
            
            
            $
            0.22
            
            
            $
            0.51Diluted
            
            $
            0.13
            
            
            $
            0.22
            
            
            $
            0.49





The
securities that were anti-dilutive and excluded from our net income per share
calculations were approximately 12.4 million, 11.3 million and 9.6 million for
the years ended December 31, 2008, 2007 and 2006 respectively.





Recent
accounting pronouncements





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





In April
2008, the FASB issued Staff Position No. FAS 142-3, Determination of the Useful
Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors
that should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). The intent of
FSP FAS 142-3 is to improve the consistency between the useful life of a
recognized intangible asset under SFAS 142 and the period of expected cash flows
used to measure the fair value of the asset under SFAS 141(R) and other
applicable accounting literature. FSP FAS 142-3 is effective for fiscal years
beginning after December 15, 2008. The Company does not believe that the
implementation of this standard will have a material impact on its consolidated
financial statements.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS 141(R)”) and SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS 160”).
SFAS 141(R)  significantly changes current practices regarding
business combinations. Among the more significant changes, SFAS 141(R) expands
the definition of a business and a business combination; requires the acquirer
to recognize the assets acquired, liabilities


62
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assumed
and noncontrolling interests (including goodwill), measured at fair value at the
acquisition date; requires acquisition-related expenses and restructuring costs
to be recognized separately from the business combination; requires assets
acquired and liabilities assumed from contractual and non-contractual
contingencies to be recognized at their acquisition-date fair values with
subsequent changes recognized in earnings; and requires in-process research and
development to be capitalized at fair value as an indefinite-lived intangible
asset. SFAS 160 will change the accounting and reporting for minority interests,
reporting them as equity separate from the parent entity’s equity, as well as
requiring expanded disclosures. SFAS 141(R) and SFAS 160 are effective for
financial statements issued for fiscal years beginning after December 15, 2008.
The Company does not believe that the implementation of these standards will
have a material impact on its consolidated financial statements.





NOTE 2 —
CONSOLIDATED BALANCE SHEET COMPONENTS





Cash,
cash equivalents and short-term investments consisted of the following as of
December 31, 2008:


Book
                Value
              
              
              Gross
                Unrealized
                Gain
              
              
              Gross
                Unrealized
                Loss
              
              
              Market
                Value(in
      thousands)Classified
      as current assets:Cash
              
              $
              79,027
              
              
              $
              —
              
              
              $
              —
              
              
              $
              79,027Cash
      equivalents:Money
      market funds
              
              
              16,387
              
              
              
              —
              
              
              
              —
              
              
              
              16,387Total
      cash and cash equivalents
              
              
              95,414
              
              
              
              —
              
              
              
              —
              
              
              
              95,414Short-term
      investments:Municipal
      bonds
              
              
              89,168
              
              
              
              423
              
              
              
              —
              
              
              
              89,591Total
      short-term investments
              
              
              89,168
              
              
              
              423
              
              
              
              —
              
              
              
              89,591Total
      cash and cash equivalents and short-term investments
              
              $
              184,582
              
              
              $
              423
              
              
              $
              —
              
              
              $
              185,005


For
investments in securities classified as available-for-sale, market value and the
amortized cost of debt securities have been classified in accordance with the
following maturity groupings based on the contractual maturities of those
securities as of December 31, 2008.


Market value
              
              
              Amortized cost(In
      thousands)Contractual
      maturityLess
      than 1 year
              
              $
              74,453
              
              
              $
              74,1961-5 years
              
              
              15,138
              
              
              
              14,9725-10 years
              
              
              —
              
              
              
              —More
      than 10 years
              
              
              —
              
              
              
              —Total
              
              $
              89,591
              
              
              $
              89,168




Cash,
cash equivalents and short-term investments consisted of the following as of
December 31, 2007:





Book
              Value
            
            
            Gross
              Unrealized
              Gain
            
            
            Gross
              Unrealized
              Loss
            
            
            Market
              Value(in
      thousands)Classified
      as current assets:Cash
            
            $
            60,657
            
            
            $
            —
            
            
            $
            —
            
            
            $
            60,657Cash
      equivalents:Money
      market funds
            
            
            59,732
            
            
            
            —
            
            
            
            —
            
            
            
            59,732Commercial
      paper
            
            
            17,427
            
            
            
            7
            
            
            
            (1
            )
            
            
            17,433Total
      cash equivalents
            
            
            77,159
            
            
            
            7
            
            
            
            (1
            )
            
            
            77,165Total
      cash and cash equivalents
            
            
            137,816
            
            
            
            7
            
            
            
            (1
            )
            
            
            137,822Short-term
      investments:Corporate
      securities
            
            $
            73,077
            
            
            
            56
            
            
            
            (40
            )
            
            $
            73,093Asset-backed
      securities
            
            
            30,635
            
            
            
            24
            
            
            
            (70
            )
            
            
            30,589United
      States government agencies
            
            
            6,603
            
            
            
            102
            
            
            
            —
            
            
            
            6,705Certificate
      of deposit
            
            
            1,500
            
            
            
            2
            
            
            
            —
            
            
            
            1,502Total
      short-term investments
            
            
            111,815
            
            
            
            184
            
            
            
            (110
            )
            
            
            111,889Total
      cash and cash equivalents and short-term investments
            
            $
            249,631
            
            
            $
            191
            
            
            $
            (111
            )
            
            $
            249,711





63
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Components
of inventory and property and equipment consisted of the following:





December 31,2008
            
            
            2007(In
      thousands)Inventories:Raw
      materials
            
            $
            4,962
            
            
            $
            3,132Work
      in process
            
            
            545
            
            
            
            2,719Finished
      goods
            
            
            7,268
            
            
            
            14,347$
            12,775
            
            
            $
            20,198Property
      and equipment:Computers
      and software
            
            $
            24,250
            
            
            $
            29,950Equipment
            
            
            25,059
            
            
            
            28,188Furniture
      and fixtures
            
            
            2,701
            
            
            
            4,06152,010
            
            
            
            62,199Less:
      accumulated depreciation
            
            
            (32,616
            )
            
            
            (38,008
            )$
            19,394
            
            
            $
            24,191





Components
of intangible assets were as follows:





December 31, 2008
            
            
            December 31, 2007EstimatedUseful
      Lives
            
            Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization
            
            
            Gross
              Carrying
              Amount
            
            
            Accumulated
              Amortization(In thousands)Intangible
      assets subject to amortization:Acquired
      technology-Sunplus
            84 months
            
            $
            39,600
            
            
            $
            (7,065
            )
            
            $
            39,600
            
            
            $
            (1,414
            )Non-compete
      agreement
            36 months
            
            
            —
            
            
            
            —
            
            
            
            1,849
            
            
            
            (1,849
            )Acquired
      technology
            36-48 months
            
            
            —
            
            
            
            —
            
            
            
            1,780
            
            
            
            (1,780
            )Contractual
      backlog
            9-12 months
            
            
            —
            
            
            
            —
            
            
            
            1,360
            
            
            
            (1,360
            )Core/Developed
      technology
            24-48 months
            
            
            970
            
            
            
            (747
            )
            
            
            970
            
            
            
            (374
            )Customer
      relationships
            24-48 months
            
            
            810
            
            
            
            (647
            )
            
            
            810
            
            
            
            (323
            )$
            41,380
            
            
            $
            (8,459
            )
            
            $
            46,369
            
            
            $
            (7,100
            )Intangible
      assets not subject to amortization:Goodwill
            
            
            $
            19,210
            
            
            
            
            
            
            $
            19,210





Estimated
future amortization expense for the Company’s intangible assets is as follows
for the fiscal years ending December 31 (in thousands):




2009
            
            $
            5,8892010
            
            
            5,8022011
            
            
            5,6522012
            
            
            5,6522013
            
            
            5,6522014
            
            
            4,274$
            32,921





Amortization
of identifiable intangibles, totaled $6.3 million, $3.5 million and $0.5
million, for the years ended December 31, 2008, 2007 and 2006,
respectively.





Based on
the impairment test performed for 2008 and 2007 in accordance with
SFAS No. 142, there was no impairment of goodwill at December 31,
2008 and 2007. Subsequent to the year-end, the Company’s quoted market price of
equity securities, and thus, its market capitalization declined. A sustained
decline in the Company’s market capitalization may represent an event or
circumstance that could necessitate a goodwill impairment test between annual
tests.





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 Table of Contents


December 31,2008
              
              
              2007(In
      thousands)Accrued
      liabilities:Accrued
      payroll and related expenses
              
              $
              5,359
              
              
              $
              5,586Accrued
      restructuring
              
              
              3,452
              
              
              
              —Software
      and IP commitments
              
              
              2,500
              
              
              
              18,034Bonus
      accrual
              
              
              1,556
              
              
              
              176Accrued
      and other liabilities
              
              
              10,156
              
              
              
              13,200$
              23,023
              
              
              $
              36,996Other
      long-term liabilities:FIN
      48 non-current
      liability
              
              
              7,426
              
              
              
              9,507Software
      and IP
      commitments
              
              
              —
              
              
              
              3,750Other
      liabilities
              
              
              638
              
              
              
              653$
              8,064
              
              
              $
              13,910




NOTE 3 —
INCOME TAXES


Income
(loss) before taxes and the provision for income taxes consisted of the
following:
 Year Ended
December 31,2008
              
              
              2007
              
              
              2006(In
      thousands)Income
      (loss) before provision for income taxes:U.S.
              
              $
              (36,077
              )
              
              $
              54,785
              
              
              $
              121,577Non
      U.S.
              
              
              34,267
              
              
              
              (15,233
              )
              
              
              (65,120
              )Total
      income (loss) before provision for income taxes
              
              $
              (1,810
              )
              
              $
              39,552
              
              
              $
              56,457
  
 Year Ended
December 31,Provision (benefit) for
    Taxes
              
              2008
              
              
              2007
              
              
              2006(In
      thousands)Current:Federal
              
              $
              (3,470
              )
              
              $
              16,590
              
              
              $
              12,130State
              
              
              (409
              )
              
              
              733
              
              
              
              205Foreign
              
              
              3,811
              
              
              
              2,961
              
              
              
              1,352(68
              )
              
              
              20,284
              
              
              
              13,687Deferred
      (benefit):Federal
              
              
              (8,076
              )
              
              
              358
              
              
              
              (14,573
              )State
              
              
              (3,281
              )
              
              
              158
              
              
              
              (8,706
              )Foreign
              
              
              359
              
              
              
              (431
              )
              
              
              —Total
      deferred
              
              
              (10,998
              )
              
              
              85
              
              
              
              (23,279
              )Charge
      (benefit) in lieu of taxes attributable to employee stock
      plans
              
              
              (807
              )
              
              
              182
              
              
              
              23,584Total
      (benefit) provision for income taxes
              
              $
              (11,873
              )
              
              $
              20,551
              
              
              $
              13,992
 
 Our
effective tax rate differs from the federal statutory rate due to the following
(in thousands):
 Year Ended
December 31,2008
              
              
              2007
              
              
              2006Tax
      provision (benefit) at federal statutory rate
              
              $
              (633
              )
              
              $
              13,843
              
              
              $
              19,760State
      income taxes
              
              
              (3,062
              )
              
              
              786
              
              
              
              644Foreign
      income and withholding taxes
              
              
              (2,463
              )
              
              
              2,827
              
              
              
              1,361U.S.
      federal losses utilized
              
              
              —
              
              
              
              —
              
              
              
              (18,471
              )Changes
      in valuation allowance related to employee stock
    transactions
              
              
              —
              
              
              
              —
              
              
              
              14,333Foreign
      unbenefited losses
              
              
              —
              
              
              
              5,077
              
              
              
              22,811Impact
      of valuation allowance release
              
              
              —
              
              
              
              —
              
              
              
              (24,779
              )Tax
      credits
              
              
              (5,914
              )
              
              
              (3,084
              )
              
              
              (3,277
              )Stock-based
      compensation
              
              
              966
              
              
              
              954
              
              
              
              1,526Tax
      exempt income
              
              
              (865
              )
              
              
              —
              
              
              
              —Non-deductible
      expenses
              
              
              77
              
              
              
              79
              
              
              
              84Other
              
              
              21
              
              
              
              69
              
              
              
              —Tax
      provision (benefit)
              
              $
              (11,873
              )
              
              $
              20,551
              
              
              $
              13,992


65
 Table of Contents


The Company’s 2008 income tax benefit includes $5.0 million of tax benefits
related to the geographic and tax jurisdictional mix of earnings within the
Company’s global business structure.  Additionally, in the fourth
quarter of 2008, the Company completed a study of its research and development
tax credits and, as a result, recorded $4.2 million of tax benefits associated
with changes in estimates related to these credits and associated FIN 48
reserves.





Deferred
income tax assets reflect the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The components of net deferred
income tax assets were (in thousands):





December 31,2008
            
            
            2007Net
      operating loss carryforwards
            
            $
            127
            
            
            $
            670Stock-based
      compensation
            
            
            15,413
            
            
            
            11,135Accruals
      and other reserves
            
            
            3,817
            
            
            
            1,704Depreciable
      and amortizable items
            
            
            6,114
            
            
            
            3,920Tax
      credits
            
            
            7,399
            
            
            
            3,928Inventory
      valuation
            
            
            70
            
            
            
            —Capitalized
      research and development
            
            
            531
            
            
            
            792Other
      items not currently deductible
            
            
            1,387
            
            
            
            1,81334,858
            
            
            
            23,962Less:
      valuation allowance
            
            
            —
            
            
            
            —Net
      deferred tax assets
            
            $
            34,858
            
            
            $
            23,962Reported
      as:Deferred
      income taxes
            
            $
            6,665
            
            
            $
            3,984Deferred
      income taxes, non-current
            
            
            28,193
            
            
            
            19,978Net
      deferred taxes
            
            $
            34,858
            
            
            $
            23,962





In
assessing the ability to realize the Company’s deferred tax assets, it
considered whether it was more likely than not that some portion or all the
deferred tax assets will not be realized. The Company considered historical book
income, the scheduled reversal of deferred tax assets and the projected taxable
income. Based on this analysis and considering all positive and negative
evidence, the Company determined that the deferred tax assets as of
December 31, 2008 were more likely than not to be realized.





As of
December 31, 2008, the Company had research credit carryforwards for state
purposes of approximately $12.2 million that carryforward indefinitely. In
the event the Company experiences a future cumulative ownership change of
greater than 50% pursuant to Internal Revenue Code sections 382 and 383 or
similar state and foreign rules, its ability to utilize the carryforwards may be
limited.





As of
December 31, 2008, the Company had gross tax effected unrecognized tax
benefits of $18.4 million of which $5.8 million, if recognized, would
affect the effective tax rate. The Company does not believe there will be any
material changes in its unrecognized tax benefits over the next twelve
months.





A
reconciliation of the beginning and ending amount of unrecognized tax benefits
is as follows (in thousands):





2008Balance
      as of January 1,
            
            $
            20,719Tax
      positions related to the current period:Gross
      increase
            
            
            2,131Gross
      decrease
            
            
            —Tax
      positions related to prior periodsGross
      increase
            
            
            656Gross
      decrease
            
            
            (5,132
            )Settlements
            
            
            —Lapse
      of statute of limitations
            
            
            —Balance
      as of December 31,
            
            $
            18,374





The
Company’s policy is to include interest and penalties related to unrecognized
tax benefits within the provision for income taxes. As of the adoption of FIN
48, the Company had interest related to unrecognized tax benefits of
approximately $60,000. During the years ended December 31, 2008 and 2007,
the Company accrued approximately $35,000 and $275,000, respectively of
additional


66
 Table of Contents


interest
related to unrecognized tax benefits. The Company conducts business globally
and, as a result, it and its subsidiaries file income tax returns in various
jurisdictions throughout the world including with the U.S. federal and
various U.S. state jurisdictions as well as with various foreign
jurisdictions. In the normal course of business the Company is subject to
examination by taxing authorities throughout the world. The Company remains
subject to federal and state examination for all years from 1996 and forward by
virtue of the tax attributes carrying forward from those years. The Company also
remains subject to examination in most foreign jurisdictions for all years since
2002 or the year we began operations in those countries if later. The Company is
not aware of any material income tax examinations in progress at this
time.





Included
in the Company’s 2007 consolidated income tax expense of $20.6 million were tax
charges of approximately $5.1 million related to the ongoing implementation
of a new global business structure.  The tax charges related to
unbenefited foreign losses represent expenses for sharing in the costs of the
Company’s ongoing research and development efforts as well as licensing
commercial rights to utilize pre-existing intangibles to better align with
customers outside the Americas. The new structure is intended to align asset
ownership and business functions with the Company’s expectations related to the
sources, timing and amounts of future revenues and profits.





As of
December 31, 2007, the Company had net operating loss carryforwards for
foreign tax purposes of approximately $1.7 million that carryforward
indefinitely. As of December 31, 2007, the Company had research credit
carryforwards for state purposes of approximately $8.2 million that carry
forward indefinitely. In the event the Company experience a future cumulative
ownership change of greater than 50% pursuant to Internal Revenue Code
sections 382 and 383 or similar state and foreign rules, the Company’s
ability to utilize the losses and credit carryforwards may be
limited.





The
Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement No. 109, ("FIN 48") on January 1,
2007.  As a result of the adoption of FIN 48, the Company recorded a
reduction to opening retained earnings as of January 1, 2007 of approximately
$5.1 million related primarily to its measurement of certain tax credits based
on the requirements of FIN 48.  The $5.1 million reflects an increase
of $0.4 million from the amount previously disclosed in the Company’s quarterly
financial statements to correct an error in the original computation of the
cumulative effect of the adoption of FIN 48. The Company has historically
classified accruals for tax uncertainties in current taxes payable and, where
appropriate, as a reduction to deferred tax assets.  As a result of
the adoption of FIN 48, the Company reclassified $5.6 million from current taxes
payable to other long term liabilities. In addition, the Company further
increased other long term liabilities by $4.0 million, decreased current
deferred tax assets by $2.3 million and increased non-current deferred tax
assets by $1.3 million (the amount related to our non-current deferred tax
assets has been decreased by $0.4 million from the applicable amounts previously
disclosed in the Company’s 2007 quarterly financial statements for the above
mentioned correction).   As of the adoption date, the Company had
gross tax affected unrecognized tax benefits of approximately $14.4 million of
which $11.5 million, if recognized, would affect the effective tax rate. As of
December 31, 2007, we had gross tax affected unrecognized tax benefits of $20.7
million of which $8.4 million, if recognized, would affect the effective tax
rate.





During
2006, the Company released the remaining valuation allowance of approximately
$52.3 million that reduced the carrying value of its deferred tax assets as
of December 31, 2005. In assessing the ability to realize the Company’s
deferred tax assets, it considered whether it was more likely than not that some
portion or all the deferred tax assets will not be realized. The Company
considered historical book income, the scheduled reversal of deferred tax assets
and the projected taxable income. Based on this analysis and considering all
positive and negative evidence, the Company determined that the deferred tax
assets as of December 31, 2006 was more likely than not to be
realized.








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 Table of Contents


NOTE 4 —LEASE
AND OTHER OBLIGATIONS





The
Company’s future operating lease obligations and purchase commitments at
December 31, 2008 were as follows (in thousands):





Payments Due InTotal
            
            
            Less
      than
              1 Year
            
            
            1-3 Years
            
            
            3-5 Years
            
            
            More
      than
              5 YearsContractual
      Obligations:Operating
      lease obligations
            
            $
            7,876
            
            
            $
            3,863
            
            
            $
            3,833
            
            
            $
            180
            
            
            $
            —Software
      purchase commitment
            
            
            315
            
            
            
            105
            
            
            
            210
            
            
            
            —
            
            
            
            —Total
            
            $
            8,191
            
            
            $
            3,968
            
            
            $
            4,043
            
            
            $
            180
            
            
            $
            —





The
amounts above exclude liabilities under FASB Interpretation No. 48 “Accounting for Uncertainty in
Income Taxes”, as the Company is unable to reasonably estimate the timing
of settlement. See Note 3, “Income Taxes,” above for further
discussion.





NOTE 5 —
STOCKHOLDERS’ EQUITY





1995
Equity Incentive Plan (the “1995 Plan”)





In
September 1995, the Board of Directors adopted the 1995 Equity Incentive Plan
(the “1995 Plan”), which provides for the granting of incentive stock options
(ISOs) and non-qualified stock options (NSOs) to employees, directors and
consultants. In accordance with the 1995 Plan, the stated exercise price shall
not be less than 100% and 85% of the fair market value of our common stock on
the date of grant for ISOs and NSOs, respectively. In September 1998, the 1995
Plan was amended to allow ISOs to be exercised prior to vesting. We have the
right to repurchase such shares at their original purchase price if the optionee
is terminated from service prior to vesting. Such right expires as the options
vest.  This option plan was replaced by the 1999 Equity Incentive Plan
detailed below.





1999
Equity Incentive Plan (the “1999 Plan”)





In
October 1999, the 1999 Plan became the successor to the 1995 Plan and was
changed to prohibit early exercise of stock options. The number of shares
reserved for issuance under the 1999 Plan was increased automatically on January
1 of each year by an amount equal to 5% of our total outstanding common shares
as of the immediately preceding December 31.





In June
and July 2001, in connection with the CMD and SCL acquisitions, the Company
assumed all outstanding options and options available for issuance under the CMD
1999 Stock Incentive Plan and SCL 1999 Stock Option Plan. In April 2004, in
connection with the TransWarp acquisition, the Company assumed all outstanding
options and options available for issuance under the TransWarp Stock Option
Plan. The terms of these Plans are very similar to those of the 1999 Plan. The
Company’s assumption of the CMD, SCL and TransWarp Plans and the outstanding
options did not require the approval of and was not approved by, the Company’s
stockholders.







Options
granted under the above mentioned stock option plans are exercisable over
periods not to exceed ten years and vest over periods ranging from one to five
years and generally vest annually as to 25% of the shares subject to the
options, although stock option grants to members of our Board of Directors vest
monthly, over periods not to exceed four years. Some options provide for
accelerated vesting if certain identified milestones are achieved. Effective in
May 2008, the board of directors determined that no further options would be
granted under the 1999 Plan, and all outstanding options would continue to be
governed and remain outstanding in accordance with their existing
terms.





2008
Equity Incentive Plan (the “2008 Plan”)





In April
2008, the board of directors adopted the 2008 Equity Incentive Plan (the “2008 Plan”), and in May
2008, the 2008 Plan was approved by the stockholders, as a replacement for the
1999 Stock Option Plan (the “1999 Plan”).  The 2008 Plan provides for
the grant of non-qualified and incentive stock options, restricted stock awards,
stock bonus awards, stock appreciation rights, restricted stock unit awards and
performance stock awards to employees, directors and consultants, under the
direction of the compensation committee of the board of directors or those
persons to whom administration of the 2008 Plan, or part of the 2008 Plan, has
been delegated or permitted by law. The exercise price for incentive stock
options and stock appreciation rights is generally at least
100%


68
 Table of Contents


of the
fair market value of the underlying shares on the date of grant. Options
generally vest over 48 months measured from the date of grant. Options
generally expire no later than seven years after the date of grant, subject to
earlier termination upon an optionee’s cessation of employment or
service. Under this stock plan, as of the approval date, the maximum number
of shares authorized for issuance was 4.0 million.  As of
December 31, 2008 the 2008 Plan had 3.5 million shares available for
issuance.





Non-plan
options





In 2004
and 2003, our Board of Directors granted non-plan options to purchase
1.7 million and 625,000 shares, respectively, of our common stock to
three executives and an employee. There were no other non-plan option grants
made subsequently. All non-plan options were granted with exercise prices equal
to the fair market value on the date of grant and with vesting periods ranging
from four to five years and expire in ten years. Our non-plan option grants did
not require the approval of and were not approved by, our
stockholders.





Determining
Fair Value





Valuation and amortization
method — The Company estimates the fair value of stock options
granted using the Black-Scholes option valuation model and a single option award
approach. This fair value is then amortized on a straight-line basis over the
requisite service periods of the awards, which is generally the vesting
period.





Expected Term — The
expected term represents the period that the Company’s stock-based awards are
expected to be outstanding and was determined based on historical experience of
similar awards, giving consideration to the contractual terms of the stock-based
awards, vesting schedules and expectations of future employee behavior as
influenced by changes to the terms of its stock-based awards.





Expected Volatility —
The Company’s computation of expected volatility for the year ended
December 31, 2008 is based on historical volatility of the Company’s stock
price.





Risk-Free Interest
Rate — The risk-free interest rate used in the Black-Scholes option
valuation method is based on the implied yield currently available on
U.S. Treasury zero-coupon issue with a remaining term equal to the expected
term of the option.





Expected Dividend — The
dividend yield reflects that the Company has not paid any dividends and has no
intention to pay dividends in the foreseeable future.





The
Company estimates the fair value of stock options using a Black-Scholes option
valuation model, consistent with the provisions of SFAS No. 123R,
SAB 107. The Company used the following assumptions to estimate the fair
value of options granted under its stock option plans and stock purchase
plans.





Years Ended
    December 31,2008
            
            
            2007
            
            
            2006Employee
      stock option plans:Expected
      life in years
            
            
            4.8
            
            
            
            4.9
            
            
            
            5.0Expected
      volatility
            
            
            64.5
            %
            
            
            72.1
            %
            
            
            86.4
            %Risk-free
      interest rate
            
            
            2.8
            %
            
            
            4.5
            %
            
            
            4.7
            %Expected
      dividends
            
            none
            
            
            none
            
            
            noneWeighted
      average grant date fair value
            
            $
            2.81
            
            
            $
            5.36
            
            
            $
            7.47Employee
      Stock Purchase Plan:Expected
      life in years
            
            
            0.5
            
            
            
            0.5
            
            
            
            1.3Expected
      volatility
            
            
            65.8
            %
            
            
            51.2
            %
            
            
            58.0
            %Risk-free
      interest rate
            
            
            3.0
            %
            
            
            5.1
            %
            
            
            4.9
            %Expected
      dividends
            
            none
            
            
            none
            
            
            noneWeighted
      average grant date fair value
            
            $
            1.77
            
            
            $
            2.06
            
            
            $
            4.41





69
 Table of Contents




Stock-based
compensation expense




The
following table shows total stock-based compensation expense included in the
Consolidated Statements of Income for the years ended December 31, 2008,
2007 and 2006 (in thousands):


Year Ended
December 31,2008
            
            
            2007
            
            
            2006Cost
      of sales
            
            $
            1,445
            
            
            $
            1,597
            
            
            $
            2,427Research
      and development
            
            
            7,134
            
            
            
            8,411
            
            
            
            11,108Selling,
      general and administrative
            
            
            10,893
            
            
            
            9,442
            
            
            
            13,696Restructuring
      expense
            
            
            14
            
            
            
            —
            
            
            
            —$
            19,486
            
            
            $
            19,450
            
            
            $
            27,231





As
required by SFAS No. 123R, management estimated the expected
forfeitures and recognizes stock-based compensation expense only for those
equity awards expected to vest.





At
December 31, 2008, the total stock-based compensation expense related to
unvested stock options granted to employees under the stock option plans but not
yet recognized was approximately $20.2 million, after estimated
forfeitures. This cost will generally be recognized on a straight-line basis
over an estimated weighted-average period of approximately 2.3 years and
will be adjusted if necessary, in subsequent periods, if actual forfeitures
differ from those estimates.





As of
December 31, 2008, the Company had $4.4 million of total unrecognized
compensation expense, net of estimated forfeitures, related to RSUs. The
unamortized compensation expense will be recognized on a straight-line basis,
and the weighted average estimated remaining life is 2.21 years.





At
December 31, 2008, the total stock-based compensation expense related to
options to purchase common shares under the ESPP but not yet recognized was
approximately $129,000. This expense will be recognized on a straight-line basis
over a weighted-average period of approximately 0.13 years.





For the
year ended December 31 2008 and 2007, we recorded $0.5 million and
$2.5 million of excess tax benefits from equity-based compensation plans as
a financing cash inflow.





Stock
Options and Awards Activity





The
following table summarizes the Company’s options outstanding with respect to its
Stock Option Plans, including options granted outside of the Plans, excluding
restricted stock units (RSU’s) (in thousands except per share
data):





Number
      of Option Shares
            
            
            
            
            
            
            
            WeightedOutstanding
            
            
            
            
            
            Weighted
            
            AverageNon-Stockholder
            
            
            
            
            
            Average
            
            RemainingStockholder
            
            
            Approved
            
            
            
            
            
            Exercise
            
            Contractual
            AggregateApproved
            
            
            Plans
      From
            
            
            Non-
            
            
            
            
            
            Price
      per
            
            Terms
      in
            IntrinsicPlan
            
            
            Acquisitions
            
            
            Plan*
            
            
            Total
            
            
            Share
            
            Years
            ValueAt
      January 1, 2006
            
            
            16,136
            
            
            
            3,638
            
            
            
            910
            
            
            
            20,684
            
            
            $
            7.98Granted
            
            
            2,539
            
            
            
            —
            
            
            
            —
            
            
            
            2,539
            
            
            
            10.67Canceled
            
            
            (1,253
            )
            
            
            (145
            )
            
            
            —
            
            
            
            (1,398
            )
            
            
            10.97Exercised
            
            
            (3,979
            )
            
            
            (1,213
            )
            
            
            (379
            )
            
            
            (5,571
            )
            
            
            5.59At
      December 31, 2006
            
            
            13,443
            
            
            
            2,280
            
            
            
            531
            
            
            
            16,254
            
            
            $
            8.95Granted
            
            
            3,723
            
            
            
            —
            
            
            
            —
            
            
            
            3,723
            
            
            
            8.69Canceled
            
            
            (3,528
            )
            
            
            (94
            )
            
            
            —
            
            
            
            (3,622
            )
            
            
            12.01Exercised
            
            
            (1,635
            )
            
            
            (489
            )
            
            
            (201
            )
            
            
            (2,325
            )
            
            
            4.03At
      December 31, 2007
            
            
            12,003
            
            
            
            1,697
            
            
            
            330
            
            
            
            14,030
            
            
            $
            8.92Granted
            
            
            1,384
            
            
            
            —
            
            
            
            —
            
            
            
            1,384
            
            
            
            5.10Canceled
            
            
            (1,009
            )
            
            
            (69
            )
            
            
            —
            
            
            
            (1,078
            )
            
            
            9.96Exercised
            
            
            (267
            )
            
            
            (220
            )
            
            
            —
            
            
            
            (487
            )
            
            
            3.51At
      December 31, 2008
            
            
            12,111
            
            
            
            1,408
            
            
            
            330
            
            
            
            13,849
            
            
            $
            8.65
            
            6.09
            $2,396Vested
      and expected to vest at December 31, 2008
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            13,094
            
            
            $
            8.72
            
            5.97
            $2,394Exercisable
      at December 31, 2008
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            9,877
            
            
            $
            8.96
            
            5.33
            $2,387




*    primarily
used as inducements for new officers


70
 Table of Contents




The
aggregate intrinsic value of options exercised under the Company’s stock option
plans during the years ended December 31, 2008, 2007 and 2006 was $1.5 million,
$10.0 million and $30.7 million, respectively.  The
intrinsic value is calculated as the difference between the exercise price of
the underlying award and the quoted price of the Company’s common stock at the
date of option exercise.





Information
with respect to options outstanding at December 31, 2008 is as
follows:


Options Outstanding
              
              
              Options ExercisableRanges of Exercise Prices
              
              
              Number
      of
                Shares
              
              
              Weighted
                Average
                Exercise
                Price
              
              
              Weighted
                Average
                Remaining
                Contractual Life
              
              
              Number
      of
                Shares
              
              
              Weighted
                Average
                ExercisPrice(In
      thousands)
              
              
              
              
              
              (In Years)
              
              
              (In
      thousands)$
              0.25 -
      $  1.14
              
              
              
              328
              
              
              $
              1.03
              
              
              
              2.35
              
              
              
              328
              
              
              $
              1.03$
              1.37 -
      $  2.53
              
              
              
              368
              
              
              
              1.72
              
              
              
              2.96
              
              
              
              368
              
              
              
              1.72$
              2.63 -
      $  3.34
              
              
              
              306
              
              
              
              3.06
              
              
              
              1.86
              
              
              
              306
              
              
              
              3.06$
              3.58 -
      $  4.44
              
              
              
              711
              
              
              
              4.17
              
              
              
              3.59
              
              
              
              676
              
              
              
              4.18$
              4.45 -
      $  5.15
              
              
              
              1,214
              
              
              
              4.64
              
              
              
              8.85
              
              
              
              143
              
              
              
              5.02$
              5.20 -
      $  6.16
              
              
              
              1,318
              
              
              
              5.89
              
              
              
              6.16
              
              
              
              794
              
              
              
              5.97$
              6.21 -
      $ 9.03
              
              
              
              2,240
              
              
              
              7.30
              
              
              
              5.54
              
              
              
              1,672
              
              
              
              7.24$
              9.05 -
      $10.06
              
              
              
              3,095
              
              
              
              9.50
              
              
              
              6.96
              
              
              
              2,037
              
              
              
              9.55$
              10.07 -
      $11.75
              
              
              
              1,481
              
              
              
              10.78
              
              
              
              6.49
              
              
              
              1,180
              
              
              
              10.77$
              11.80 -
      $17.01
              
              
              
              2,788
              
              
              
              14.25
              
              
              
              6.09
              
              
              
              2,373
              
              
              
              14.37$
              0.25 -
      $17.01
              
              
              
              13,849
              
              
              $
              8.65
              
              
              
              6.09
              
              
              
              9,877
              
              
              $
              8.96




Restricted
Stock Units





Restricted
Stock Units (RSUs) granted to non-executive employees vest over a period of four
years subject to the employee’s continuing service to the Company over that
period. Vesting of RSUs to executives is dependent on continuing service over a
period of one to two years as well as achieving certain performance conditions.
RSUs are converted into shares of the Company’s common stock upon vesting on a
one-for-one basis. The cost of the RSUs is determined using the fair value of
the Company’s common stock on the date of the grant, and RSU’s that are based on
certain performance conditions assume that the performance conditions are
achieved. If the conditions are not achieved, no compensation cost is recognized
and any recognized compensation is reversed.  Compensation is
recognized on a straight-line basis over the requisite service period of each
grant adjusted for estimated forfeitures.  Each RSU award granted from
the 2008 plan will reduce the number of options available for issuance by 1.5
shares.





A summary
of the RSUs outstanding as of December 31, 2008 was as follows: (in
thousands):







Number
      of RSUs
            
            
            Weighted
      Average Remaining Contractual Term in Years
            
            
            Aggregate
      Intrinsic ValueOutstanding
      at January 1, 2008
            
            
            —
            
            
            
            
            
            
            —Granted
            
            
            3,805
            
            
            
            
            
            
            —Cancellations
            
            
            (93
            )
            
            
            
            
            
            —Outstanding
      at December 31, 2008
            
            
            3,712
            
            
            
            1.24
            
            
            $
            15,591Ending
      vested and expected to vest at December 31, 2008
            
            
            1,330
            
            
            
            1.42
            
            
            $
            5,587




71
 Table of Contents


The
following table summarizes securities available for future issuance with
respect to the Company’s Equity Incentive Plans, including options granted
outside of the Plans, (in thousands except per share data):


Securities Available
      for Future IssuanceNon-StockholderApproved
      PlansFrom Acquisitions2008
      Plan               1995
      and 1999 Plans
              
              
              CMDPlan
              
              
              SCLPlan
              
              
              TWNPlan
              
              
              TotalAt
      January 1, 2006
              
              
              —
              
              
              
              2,375
              
              
              
              27
              
              
              
              16
              
              
              
              37
              
              
              
              2,455Authorized
              
              
              —
              
              
              
              4,025
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              4,025Granted
              
              
              —
              
              
              
              (2,539
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (2,539
              )Canceled
              
              
              —
              
              
              
              1,253
              
              
              
              69
              
              
              
              32
              
              
              
              44
              
              
              
              1,398At
      December 31, 2006
              
              
              —
              
              
              
              5,114
              
              
              
              96
              
              
              
              48
              
              
              
              81
              
              
              
              5,339Authorized
              
              
              —
              
              
              
              4,324
              
              
              
              —
              
              
              
              
              
              
              
              —
              
              
              
              4,324Granted
              
              
              —
              
              
              
              (3,723
              )
              
              
              —
              
              
              
              
              
              
              
              —
              
              
              
              (3,723
              )Canceled
              
              
              —
              
              
              
              3,528
              
              
              
              17
              
              
              
              50
              
              
              
              26
              
              
              
              3,621At
      December 31, 2007
              
              
              —
              
              
              
              9,243
              
              
              
              113
              
              
              
              98
              
              
              
              107
              
              
              
              9,561Authorized
              
              
              4,000
              
              
              
              4,216
              
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              8,216Granted
              
              
              (472
              )
              
              
              (4,764
              )
              
              
              —
              
              
              
              —
              
              
              
              —
              
              
              
              (5,236
              )Canceled
              
              
              12
              
              
              
              1,094
              
              
              
              48
              
              
              
              11
              
              
              
              9
              
              
              
              1,174At
      December 31, 2008
              
              
              3,540
              
              
              
              9,789
              
              
              
              161
              
              
              
              109
              
              
              
              116
              
              
              
              13,715




Employee
Stock Purchase Plan





In
October 1999, the Company adopted the 1999 Employee Stock Purchase Plan (the
“Purchase Plan”) and reserved 500,000 shares of common stock for issuance
under the Purchase Plan. The Purchase Plan authorizes the granting of stock
purchase rights to eligible employees during two-year offering periods with
exercise dates every six months. Shares are purchased using employee payroll
deductions at purchase prices equal to 85% of the lesser of the fair market
value of our common stock at either the first day of each offering period or the
date of purchase. In June 2007, the Company’s Board of Directors approved
amendments to the 1999 Employee Stock Purchase Plan. The ESPP was amended and
restated primarily to extend coverage of the plan to eligible employees of its
participating subsidiaries including the adoption of a Sub-Plan for employees in
the United Kingdom. Additionally, the offering periods were amended to begin on
February 16 and August 16 of each year from February 1 and August 1 previously.
On December 13, 2006, the Company’s Board of Directors approved amendments
to the 1999 Employee Stock Purchase Plan. The ESPP was amended and restated
primarily to effect the following changes: (i) terminate ongoing offering
periods as of January 31, 2007, (ii) reduce the length of offering
periods to six months, beginning with the offering period that commences on
February 1, 2007, (iii) provide that participants may effect only one
decrease and no increases, in payroll contribution percentages during an
offering period, (iv) provide that if the Registrant is dissolved or
liquidated, the Compensation Committee of the Board has discretion to either
designate a new date on which to conduct a purchase prior to such time or
terminate all offerings and refund contributions to participants without
conducting a purchase, (v) provide that in the event of certain specified
change in control transactions, the Compensation Committee of the Board will
designate a final purchase date for all offerings in lieu of keeping the ESPP in
place after the closing of such a transaction and (vi) provide that the
purchase date of an offering period is delayed if the ESPP must be submitted for
stockholder approval with respect to shares that are to be made available for
purchase in that offering period, provided that if as a result a purchase date
would occur more than twenty-seven months after commencement of the offering
period to which it relates, then such offering period will terminate without the
purchase of shares and participants in such offering period will be refunded
their contributions. In May 2008, the Purchase Plan was amended by the Company’s
stockholders to extend the term of the Purchase Plan to August 15,
2018.   In 2008, 2007 and 2006, 808,308, 504,337 and
421,534 shares of common stock, respectively, were sold under the Purchase
Plan at average prices of $3.77, $7.04 and $9.29, per share, respectively. A
total of approximately 2.1 million shares were reserved for future issuance
at December 31, 2008. The number of shares reserved for issuance under the
Purchase Plan is increased automatically on January 1 of each year by an amount
equal to 1% of our total outstanding common shares as of the immediately
preceding December 31.





72
 Table of Contents


Option
Grants to Non-employees





Non
employees are primarily independent contractors. During 2008, 2007 and 2006, we
did not grant any options to non-employees. There was no stock-based
compensation expense related to non-employee option grants in
2008.  The total stock-based compensation (benefit) expense recognized
for the years ended December 31, 2007 and 2006, for option grants to
non-employees was ($407,000) and $1.9 million, respectively. The
non-employee options are recorded at fair value and adjusted to market over the
performance period.


NOTE 6 —
SEGMENT AND GEOGRAPHIC INFORMATION


The
Company operates in one reportable operating segment, semiconductors and IP
solutions for the secure storage, distribution and presentation of
high-definition content. SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, or
SFAS 131, establishes standards for the way public business enterprises
report information about operating segments in annual consolidated financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports. SFAS 131 also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company’s Chief Executive Officer, who is considered to
be our chief operating decision maker, reviews financial information presented
on one operating segment basis for purposes of making operating decisions and
assessing financial performance. The Company had only one operating segment in
each of the years ended December 31, 2008, 2007 and 2006 and it operates in
only one reportable operating segment, semiconductor and IP solutions for
high-definition content.
 
 Revenue
by geographic area was as follows (in thousands):
 
 Year Ended
December 31,2008
              
              
              2007
              
              
              2006Taiwan
              
              $
              54,434
              
              
              $
              53,608
              
              
              $
              59,865Japan
              
              
              65,824
              
              
              
              113,107
              
              
              
              103,140United
      States
              
              
              45,479
              
              
              
              64,610
              
              
              
              63,253Hong
      Kong
              
              
              32,000
              
              
              
              20,809
              
              
              
              11,293Korea
              
              
              11,858
              
              
              
              17,607
              
              
              
              20,867Europe
              
              
              32,960
              
              
              
              25,965
              
              
              
              18,496Other
              
              
              31,860
              
              
              
              24,797
              
              
              
              18,044$
              274,415
              
              
              $
              320,503
              
              
              $
              294,958
 
 Revenue
by product line was as follows (in thousands):
 Year Ended
December 31,2008
              
              
              2007
              
              
              2006Consumer
      electronics
              
              $
              167,599
              
              
              $
              212,910
              
              
              $
              173,884Personal
      computers
              
              
              40,141
              
              
              
              34,283
              
              
              
              45,320Storage
              
              
              25,461
              
              
              
              25,181
              
              
              
              33,098Licensing
              
              
              41,214
              
              
              
              48,129
              
              
              
              42,656$
              274,415
              
              
              $
              320,503
              
              
              $
              294,958
 
 Revenue
by product line, including licensing was as follows (in thousands):
 Year Ended
December 31,2008
              
              
              2007
              
              
              2006Consumer
      electronics
              
              $
              199,591
              
              
              $
              247,205
              
              
              $
              198,803Personal
      computers
              
              
              44,311
              
              
              
              40,767
              
              
              
              54,680Storage
              
              
              30,513
              
              
              
              32,531
              
              
              
              41,475$
              274,415
              
              
              $
              320,503
              
              
              $
              294,958
 
 Location
of long lived assets comprised of property plant and equipment was as follows
(in thousands):
 
 December 31, 2008
              
              
              December 31, 2007Long-lived
      assets:US
              
              
              15,960
              
              
              
              20,927Germany
              
              
              1,587
              
              
              
              1,501Other
      foreign countries
              
              
              1,847
              
              
              
              1,763Total
              
              
              19,394
              
              
              
              24,191


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In 2008, four customers generated 14.6%, 11.8%, 11.5% and 10.5% of the Company’s
total revenue, and at December 31, 2008, three customers represented 12.3%,
12.2% and 10.2% of gross accounts receivable.  In 2007, three
customers generated 15.6%, 14.2% and 13.6% of the Company’s total revenue and at
December 31, 2007, two customers represented 24.0% and 12.4% of gross
accounts receivable. In 2006, three customers generated 16.3%, 15.7% and 11.6%
of the Company’s total revenue and at December 31, 2006, two customers
represented 22.8% and 16.1% of gross accounts receivable. The Company’s top five
customers, including distributors, generated 55.1%, 57.7% and 57.3% of the
Company’s revenue in 2008, 2007 and 2006, respectively.





NOTE 7 —
LEGAL PROCEEDINGS





On
December 7, 2001, the Company and certain of its officers and directors were
named as defendants, along with the underwriters of the Company’s initial public
offering, in a securities class action lawsuit. The lawsuit alleges that the
defendants participated in a scheme to inflate the price of the Company’s stock
in its initial public offering and in the aftermarket through a series of
misstatements and omissions associated with the offering. The lawsuit is one of
several hundred similar cases pending in the Southern District of New York that
have been consolidated by the court. In February 2003, the District Court issued
an order denying a motion to dismiss by all defendants on common issues of law.
In July 2003, the Company, along with over 300 other issuers named as
defendants, agreed to a settlement of this litigation with plaintiffs. While the
parties’ request for court approval of the settlement was pending, in December
2006 the United States Court of Appeals for the Second Circuit reversed the
District Court’s determination that six focus cases could be certified as class
actions. In April 2007, the Second Circuit denied plaintiffs’ petition for
rehearing, but acknowledged that the District Court might certify a more limited
class. At a June 26, 2007 status conference, the Court terminated the proposed
settlement as stipulated among the parties. Plaintiffs filed an amended
complaint on August 14, 2007. On September 27, 2007, plaintiffs filed a motion
for class certification in the six focus cases. The court has not yet decided
the class certification motion. On November 13, 2007 defendants in the six focus
cases filed a motion to dismiss the complaint for failure to state a claim,
which the district court denied on March 8, 2008.





On July
31, 2007, the Company received a demand on behalf of alleged shareholder Vanessa
Simmonds that its board of directors prosecute a claim against the underwriters
of its initial public offering, in addition to certain unidentified officers,
directors and principal shareholders as identified in our IPO prospectus, for
violations of sections 16(a) and 16(b) of the Securities Exchange Act of 1934.
In October 2007, a lawsuit was filed in the United States District Court for the
Western District of Washington by Ms. Simmonds against certain of the
underwriters of the Company’s initial public offering. The plaintiff alleges
that the underwriters engaged in short-swing trades and seeks disgorgement of
profits in amounts to be proven at trial from the underwriters. On February 25,
2008, Ms. Simmonds filed an amended complaint. The suit names the Company as a
nominal defendant, contains no claims against the Company and seeks no relief
from it.  This lawsuit is one of more than fifty similar actions filed
in the same court.  On July 25, 2008, the underwriter defendants in
the various actions filed a joint motion to dismiss the complaints for failure
to state a claim.  In addition, certain issuer defendants in the
various actions filed a joint motion to dismiss the complaints for failure to
state a claim.  The parties entered into a stipulation, entered as an
order by the court that the Company is not required to answer or otherwise
respond to the amended complaint.  Accordingly, the Company did not
join the motion to dismiss filed by certain issuers.  The court has
yet to rule on either motion to dismiss.





In
January 2005, the Company and certain of its officers were named as defendants
in a securities class action captioned “Curry v. Silicon Image, Inc., Steve
Tirado and Robert Gargus.” Plaintiffs filed the action on behalf of a putative
class of stockholders who purchased Silicon Image stock between October 19, 2004
and January 24, 2005. The lawsuit alleged that the Company and certain of its
officers and directors made alleged misstatements of material facts and violated
certain provisions of Sections 20(a) and 10(b) of the Securities Exchange Act of
1934 and Rule 10b-5 promulgated thereunder. Final judgment was entered in favor
of defendants on September 25, 2007. On October 19, 2007, plaintiffs filed
notice of appeal of the court’s final judgment to the United States Court of
Appeals for the Ninth Circuit. Appellants’ opening brief was filed February 28,
2008 and the Company’s responsive pleading was filed April 14, 2008. Appellants
filed a reply brief on May 16, 2008. The court has not yet set a date for a
hearing on the appeal.





On
January 31, 2007, the Company filed a lawsuit in the United States District
Court for the Northern District of California against Analogix Semiconductor,
Inc. (“Analogix”). The complaint charged Analogix with copyright infringement,
misappropriation of trade secrets and unfair competition under California law.
The lawsuit alleged that Analogix, without authorization and in violation of the
Company’s intellectual property rights, copied and used the Company’s
proprietary register maps by gaining unauthorized access to its proprietary and
confidential information, violated its copyright protection and unfairly
competed with the Company in the marketplace.  In addition to seeking
monetary damages, the Company sought an injunction barring Analogix from the
misappropriation of its trade secrets.  On June 18, 2007, Analogix
filed a counterclaim alleging that the Company breached a confidentiality
agreement by purportedly disclosing Analogix’s confidential information within
Silicon Image.


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On June
11, 2008, Analogix filed a lawsuit in the United States District Court for the
Northern District of California against the Company that alleged violations of
the Sherman Act Sections 1 and 2, Cartwright Act, and Section 17200 of the
California Business and Professions Code.  The complaint sought
monetary damages and injunctive relief.  The complaint alleged that
the Company, and co-defendants HDMI Licensing, LLC and Simplay Labs, LLC,
conspired with the founders of the HDMI Consortium in violation of the antitrust
laws.





Following
a mediation on November 21, 2008, the Company and Analogix entered into a
settlement agreement in which they agreed to dismiss the two outstanding
lawsuits between them and to release all claims.  As part of the
settlement Analogix agreed effective immediately, not to market or sell HDMI
semiconductors worldwide that are pin- or register-compatible with Silicon
Image’s HDMI-enabled products, except as necessary to fulfill certain existing
customer obligations.  The Company also granted Analogix a license to
selected HDMI-related patents and other technology, on terms that the Company
and Analogix agreed to keep confidential.  In addition, Analogix
dropped with prejudice its antitrust suit against HDMI Licensing, LLC and
Simplay Labs, LLC.





On
January 14, 2005, the Company received a preliminary notification that the
Securities and Exchange Commission had commenced a formal investigation
involving trading in its securities. On February 14, 2005, through the Company’s
legal counsel, it received a formal notification of that investigation and
associated subpoenas. On January 18, 2006, the SEC announced that it filed a
civil complaint (Case No. CV 06-0256 DSF, C.D. Cal.) for insider trading against
Deog Kyoon Jeong, a co-founder and consultant to the Company, and that it was
also entering into a consent judgment with Mr. Jeong. The SEC stated that Mr.
Jeong had agreed to pay a civil penalty of $56,000 and to disgorge profits of
$56,000, without admitting or denying the allegations in the SEC complaint. The
Company is not aware of any further actions taken by the SEC in this matter. The
Company intends to continue to fully cooperate with the SEC in the event that
any further actions are necessary.





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





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





NOTE 8 —
STOCK REPURCHASE





In
February 2007, our Board of Directors authorized a stock repurchase program
under which we were authorized to purchase up to $100.0 million of common stock,
on the open market, or in negotiated or block transactions, over a 36 month
period. As of December 31, 2007, the Company had repurchased a total of 5.0
million shares at a total cost of $38.1 million. In February 2008, the Company’s
Board of Directors authorized an additional $100.0 million stock repurchase
program, under which shares may be repurchased over a period of three years, to
commence following completion of the Company’s accelerated stock repurchase plan
(“ASR”) (see below). Purchases under this program may be increased, decreased or
discontinued at any time without prior notice.





In
February 2008, the Company entered into an accelerated stock repurchase
agreement (ASR) with Credit Suisse International (Credit Suisse), to purchase
shares of common stock for an aggregate purchase price of approximately $62.0
million paid in February 2008.  The Company received 11.5 million
shares under the agreement, based on a predetermined price, which was subject to
an adjustment based on the volume weighted average price during the term of the
ASR. In accordance with the ASR agreement, on June 25, 2008, the Company chose
to settle the arrangement in cash (rather than shares) and made a final payment
of approximately $6.2 million for the purchase of shares.  The ASR
terminated on June 30, 2008 (‘termination date’) with final settlement taking
place in July 2008 (“settlement date”). On the settlement date, Credit Suisse
returned approximately $1.0 million based on the volume weighted average share
price during the period. In accordance with the relevant accounting guidance, we
reflected the 11.5 million shares repurchased and the $68.2 million paid to
Credit Suisse as treasury stock and recorded the $1.0 million received as part
of other income in the consolidated statement of income in the second and third
quarters of 2008.





With the
above mentioned repurchase, the Company completed its original stock repurchase
program and repurchased approximately $5.0 million of its stock under the new
$100.0 million stock repurchase program approved by the Board of Directors in
February 2008.


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NOTE 9 —
RELATED PARTY TRANSACTIONS





On
March 24, 2006, the Company’s previous Chief Executive Officer and Chairman
of the Board of Directors of Simplay Labs, LLC, a wholly-owned subsidiary of
Silicon Image, resigned as an employee of Silicon Image and Simplay Labs, LLC.
Prior to his resignation, Mr. Lee held an investment position and
directorship in Synerchip Co. Ltd. (Synerchip). Sunplus Technology Co. Ltd
(Sunplus) a long-time customer and vendor of Silicon Image also maintained Board
representation and an investment position in Synerchip creating a related party
relationship between Silicon Image and Sunplus. The related party relationship
ceased with Dr. Lee’s resignation. During 2006 Silicon Image paid a total
of $363,000 to Sunplus and $221,000 to Synerchip for the purchase of integrated
semiconductors. In addition, Sunplus paid $132,000 to Silicon Image for royalty
and subscription fees for the year ended December 31, 2006.





NOTE 10 — BUSINESS
ACQUISITION





The
following acquisition was accounted for under Statement of Financial Accounting
Standards No. 141, “Business Combinations.” Accordingly, the results of
operations are included in the accompanying Consolidated Statement of Income
since the acquisition date and the related assets and liabilities were recorded
based upon their relative fair values at the date of acquisition. Pro forma
financial information has not been presented as their historical operations were
not material to our consolidated financial statements.





On
January 2, 2007, the Company acquired sci-worx GmbH (sci-worx), now Silicon
Image GmbH, for a gross cash consideration of approximately $15.8 million
(net cash consideration of $13.8 million) for 100% of the outstanding
shares of common stock. In addition, the Company incurred approximately $410,000
in costs directly related to the consummation of this transaction. These costs
were included in the total purchase price consideration. The results of
sci-worx, have been included in the Consolidated Financial Statements for the
years ended December 31, 2008 and 2007.





Net
tangible assets acquired, as adjusted, is as follows: (in
thousands)





January 3, 2007Cash
            
            $
            2,015Accounts
      receivable, net of allowances for doubtful accounts
            
            
            2,598Unbilled
      accounts receivable
            
            
            1,077Inventories,
      net
            
            
            191Other
      current assets
            
            
            661Property
      and equipment, net
            
            
            1,583Other
      long-term assets
            
            
            38Deferred
      tax assets
            
            
            1,910Accounts
      payable
            
            
            (548
            )Accrued
      liabilities
            
            
            (1,210
            )Other
      current liabilities
            
            
            (1,509
            )Net
      tangible assets acquired
            
            $
            6,806





The
allocation of the purchase price to the tangible and intangible assets acquired
and liabilities assumed at the time of the acquisition is as follows (in
thousands):





Net
      tangible assets acquired
            
            $
            6,806Goodwill
            
            
            6,189Others
            
            
            41Intangible
      assets and other:Core
      developed technology
            
            
            970Customer
      relationships
            
            
            810Contractual
      backlog
            
            
            1,36016,176Direct
      acquisition costs
            
            
            (410
            )Purchase
      price
            
            $
            15,766





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NOTE 11 — RESTRUCTURING
AND ASSET IMPAIRMENT CHARGES





During
2008, the Company’s management approved restructuring plans to improve the
effectiveness and efficiency of its operating model as part of its program to
pursue continuous improvement. A portion of these programs involve other action
which does not result in restructuring charges, such as better utilization of
assets, reduced spending, and organizational efficiencies. During the year ended
December 31, 2008, the Company incurred $5.9 million in restructuring charges.
These charges included $4.6 million related to employee severance and
benefit arrangements due to the termination of employees and a charge of $1.1
million to accelerate the depreciation of certain long-lived assets as a result
of its decision to discontinue the use of such assets. The Company’s expects to
complete the payouts under the restructuring programs by approximately
September 2009.




The
following table presents restructuring activity for the year ended December
31, 2008 (in thousands):




Employee
      Severance and benefits
            
            
            Fixed
      Assets
            
            
            Operating
      Lease Termination and other costs
            
            
            TotalAccrued
      restructuring balance as of January 1, 2008
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —Additional
      accruals
            
            
            4,606
            
            
            
            1,063
            
            
            
            189
            
            
            
            5,858Cash
      payments
            
            
            (1,340
            )
            
            
            —
            
            
            
            —
            
            
            
            (1,340
            )Non-cash
      settlements
            
            
            (14
            )
            
            
            (1,063
            )
            
            
            11
            
            
            
            (1,066
            )Accrued
      restructuring balance as of December 31, 2008
            
            $
            3,252
            
            
            $
            —
            
            
            $
            200
            
            
            $
            3,452




The
operating accruals have been reflected as restructuring expense in the
consolidated statements of income. The remaining accrual, as of December 31,
2008, relates to severance benefits the Company expects to payout in the next
9 months and operating lease termination costs over the remaining lease
terms of between 2 and 3 years.





NOTE 12 —
INVESTMENT IN INTELLECTUAL PROPERTY





In
February 2007, the Company entered into an agreement with Sunplus Technology
Co., Ltd. (Sunplus) to license certain technology (Sunplus IP) from Sunplus for
$40.0 million. The purpose of this licensing agreement is to obtain advanced
technology for development of our future products. The agreement provides for
the Company to pay an aggregate of $40.0 million to Sunplus, $35.0 million of
which is payable in consideration for the Sunplus IP and related deliverables,
and $5.0 million of which is payable in consideration for Sunplus support and
maintenance obligations. Through December 31, 2008, the Company has paid Sunplus
$37.5 million of the consideration for the licensed technology and related
deliverables and support. The Company is required to pay the remaining $2.5
million over the first and second quarter of 2009.





NOTE 13
— FAIR VALUE MEASUREMENTS





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





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





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





The
following table sets forth our cash and cash equivalents and short-term
investments as of December 31, 2008, which are measured at fair value on a
recurring basis by level within the fair value hierarchy. As required by SFAS
No. 157, these are classified based on the lowest level of input that is
significant to the fair value measurement.


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Fair
      value measurements using
            
            
            Assets(dollars
      In thousands)
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            at
      fair valueCash
      and cash equivalents and Short-term investments
            
            $
            16,387
            
            
            $
            89,591
            
            
            $
            —
            
            
            $
            105,978Total
      Assets
            
            $
            16,387
            
            
            $
            89,591
            
            
            $
            —
            
            
            $
            105,978




Cash and
cash equivalents and short term investments in the above table excludes $79.0
million in cash held by the Company or in its accounts or with investment fund
managers as of December 31, 2008. During the twelve months ended December 31,
2008, the Company held no direct investments in auction rate securities,
collateralized debt obligations, structured investment vehicles or
mortgage-backed securities.





NOTE 14
— UNAUDITED SELECTED QUARTERLY FINANCIAL
DATA





The
following table sets forth the Company’s consolidated statements of income data
for the eight quarters ended December 31, 2007. This unaudited quarterly
information has been prepared on the same basis as the Company’s audited
consolidated financial statements and, in the opinion of management, includes
all adjustments, consisting only of normal recurring adjustments, necessary for
the fair presentation of this data.





Three Months EndedMar 31
            
            
            Jun 30
            
            
            Sep 30(5)
            
            
            Dec 31(5)(6)(In
      thousands, except per share amounts)2008Total
      revenue
            
            $
            67,113
            
            
            $
            70,083
            
            
            $
            77,776
            
            
            $
            59,443Gross
      margin(1)
            
            
            38,976
            
            
            
            40,976
            
            
            
            46,035
            
            
            
            34,702Income
      / (loss) from operations(2)
            
            
            (2,471
            )
            
            
            (1,976
            )
            
            
            4,390
            
            
            
            (7,998
            )Net
      income / (loss)
            
            
            (562
            )
            
            
            (462
            )
            
            
            6,074
            
            
            
            5,013Net
      income / (loss) per share — basic
            
            $
            (0.01
            )
            
            $
            (0.01
            )
            
            $
            0.08
            
            
            $
            0.07Net
      income / (loss) per share — diluted
            
            $
            (0.01
            )
            
            $
            (0.01
            )
            
            $
            0.08
            
            
            $
            0.07Weighted
      average shares — basic
            
            
            80,987
            
            
            
            73,399
            
            
            
            73,861
            
            
            
            74,068Weighted
      average shares — diluted
            
            
            80,987
            
            
            
            73,399
            
            
            
            75,334
            
            
            
            74,9402007Total
      revenue
            
            $
            69,119
            
            
            $
            79,771
            
            
            $
            86,282
            
            
            $
            85,331Gross
      margin(3)
            
            
            38,361
            
            
            
            42,833
            
            
            
            48,782
            
            
            
            50,084Income
      from operations(4)
            
            
            3,407
            
            
            
            6,120
            
            
            
            10,926
            
            
            
            7,702Net
      income
            
            
            2,916
            
            
            
            4,372
            
            
            
            4,110
            
            
            
            7,603Net
      income per share — basic
            
            $
            0.03
            
            
            $
            0.05
            
            
            $
            0.05
            
            
            $
            0.09Net
      income per share — diluted
            
            $
            0.03
            
            
            $
            0.05
            
            
            $
            0.05
            
            
            $
            0.09Weighted
      average shares — basic
            
            
            86,825
            
            
            
            86,737
            
            
            
            84,489
            
            
            
            84,218Weighted
      average shares — diluted
            
            
            89,549
            
            
            
            88,817
            
            
            
            85,937
            
            
            
            85,228


__________





(1)
      Includes stock-based compensation expense
            
            $
            350
            
            
            $
            431
            
            
            $
            351
            
            
            $
            313(2)
      Includes stock-based compensation expense
            
            $
            3,673
            
            
            $
            5,827
            
            
            $
            3,757
            
            
            $
            4,784(3)
      Includes stock-based compensation expense
            
            $
            346
            
            
            $
            443
            
            
            $
            421
            
            
            $
            387(4)
      Includes stock-based compensation expense
            
            $
            3,686
            
            
            $
            4,743
            
            
            $
            4,912
            
            
            $
            4,512





(5)
            During
      2008, the Company’s management approved restructuring plans to improve the
      effectiveness and efficiency of its operating model as part of its program
      to pursue continuous improvement. In the quarters ended December 31,
      2008 and September 30, 2008, we incurred expenses related to restructuring
      programs of $4.0 million and $1.9 million, respectively.  See
      note 11 of our notes to consolidated financial statements for further
      details on our restructure plans.





(6)
            In
      the fourth quarter of 2008, the Company recorded an income tax benefit of
      $11.9 million. This was due primarily to the following items: (a)
      $5.0 million of tax benefits related to the geographic and tax
      jurisdictional mix of earnings within the Company’s global business
      structure, (b) $4.2 million of tax benefits associated with research and
      development tax credits and related FIN 48 reserves re-evaluated by the
      Company during the fourth quarter of 2008 upon completion of a study of
      credits claimed through 2007, (c) $1.6 million of tax benefits related to
      federal and state research and development tax credits generated during
      2008, and (d) $0.9 million of tax benefits associated with tax exempt
      interest income.





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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM


To the
Board of Directors and Stockholders of Silicon Image, Inc.




Sunnyvale,
California




We have
audited the accompanying consolidated balance sheets of Silicon Image, Inc. and
subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the
related consolidated statements of income, stockholders’ equity, and cash flows
for each of the three years in the period ended December 31,
2008. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on the financial
statements based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.




In our
opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of Silicon Image, Inc. and subsidiaries as of
December 31, 2008 and 2007, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2008, in
conformity with accounting principles generally accepted in the United States of
America.




As
discussed in Note 1 to the consolidated financial statements, effective
January 1, 2008, the Company adopted Statement of Financial Accounting
Standards No. 157, Fair
Value Measurements.As discussed in Note 3 to the consolidated
financial statements, effective January 1, 2007, the Company adopted
Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income
Taxes — an interpretation of FASB No. 109. As discussed in Note
1 to the consolidated financial statements, effective January 1, 2006, the
Company adopted Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based
Payment.




We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company’s internal control over financial
reporting as of December 31, 2008, based on the criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated February 13, 2009 expressed an
unqualified opinion on the Company’s internal control over financial
reporting.




/s/  DELOITTE &
TOUCHE LLP





San Jose,
California


February 13,
2009




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SIGNATURES







Pursuant
to the requirements of Section 13 or 15(d) 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.





SILICON IMAGE,
INC.





Dated:
      February 13, 2009
              
              By:
              /s/  STEVE TIRADOSteve
      TiradoPresident
      and Chief Executive Officer(Principal
      Executive Officer)





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Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report has been
signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated:




Signature
              Title
              Date/s/  Steve Tirado
              President
      and Chief Executive Officer
              February 13,
    2009Steve
      Tirado
              (Principal
      Executive Officer)/s/  Harold
Covert
              Chief
      Financial Officer
              February 13,
    2009Harold
      Covert
              (Principal
      Financial Officer)/s/  William
    George
              Director
              February
      13, 2009William
      George/s/  Peter Hanelt
              Director
              February 13,
    2009Peter
      Hanelt/s/  John Hodge
              Director
              February 13,
    2009John
      Hodge/s/  Masood
Jabbar
              Director
              February 13,
    2009Masood
      Jabbar/s/  William
    Raduchel
              Director
              February 13,
    2009William
      Raduchel


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INDEX TO EXHIBITS





3.01
            Second
      Amended and Restated Certificate of Incorporation of the Registrant
      (Incorporated by reference from Exhibit 3.03 of the Registrant’s
      Registration Statement on Form S-1 (File No. 333-83665), as
      amended, declared effective by the Securities and Exchange Commission on
      October 5, 1999 (the “Form S-1”)).3.02
            Restated
      Bylaws of the Registrant (Incorporated by reference from Exhibit 3.01
      of the Form 8-K filed by the Registrant on February 4,
      2005).3.03
            Certificate
      of Amendment of Second Amended and Restated Certificate of Incorporation
      of the Registrant (Incorporated by reference from Exhibit 3.04 of the
      Form 10-Q filed by Registrant on August 14,
    2001).4.01
            Form
      of Specimen Certificate for Registrant’s common stock (Incorporated by
      reference from Exhibit 4.01 of the Form S-1).10.01*
            Form
      of Indemnity Agreement entered into between the Registrant and certain of
      its directors and officers. (Incorporated by reference from
      Exhibit 10.01 of the Form 10-K filed by the Registrant on
      March 15, 2004).10.02*
            1995
      Equity Incentive Plan, as amended through July 20, 1999 and related
      forms of stock option agreements and stock option exercise agreements
      (Incorporated by reference from Exhibit 10.02 of the
      Form S-1).10.03*
            1999
      Equity Incentive Plan, as amended (including Sub-Plan for UK employees)
      and related forms of notice of grant of stock options, stock option
      agreement, stock option exercise notice and joint election (for UK
      employees) (Incorporated by reference from Exhibit 10.03 of the
      Form 10-K filed by the Registrant on March 16,
      2006).10.04*
            1999
      Employee Stock Purchase Plan (including Sub-Plan for UK employees) and
      related enrollment forms, subscription agreements, notice of suspension,
      notice of withdrawal and joint election (for UK employees) (Incorporated
      by reference from Exhibit 10.03 of the Form 10-Q filed by the
      Registrant on August 8, 2007).10.05†
            Business
      Cooperation Agreement dated September 16, 1998 between Intel
      Corporation and the Registrant, as amended October 30, 1998
      (Incorporated by reference from Exhibit 10.12 of the
      Form S-1).10.06†
            Patent
      License Agreement dated September 16, 1998 between Intel Corporation
      and the Registrant (Incorporated by reference from Exhibit 10.13 of
      the Form S-1).10.07
            Digital
      Visual Interface Specification Revision 1.0 Promoter’s Agreement dated
      January 8, 1999 (Incorporated by reference from Exhibit 10.14 of
      the Form S-1).10.08*
            Form
      of Nonqualified Stock Option Agreement entered into between Registrant and
      its officers (Incorporated by reference from Exhibit 10.21 of the
      Form S-1).10.09*
            CMD
      Technology Inc. 1991 Stock Option Plan and related form of Incentive Stock
      Option Agreement (Incorporated by reference from Exhibit 4.05 of the
      Form S-8 filed by the Registrant on June 26,
    2001).10.10*
            CMD
      Technology Inc. 1999 Stock Incentive Plan, as amended and related form of
      Stock Option Agreement (Incorporated by reference from Exhibit 10.35
      of the Form 10-Q filed by the Registrant on November 14,
      2001).10.11*
            Silicon
      Communication Lab, Inc. 1999 Stock Option Plan, as amended and related
      form of Stock Option Agreement (Incorporated by reference from
      Exhibit 10.35 of the Form 10-Q filed by the Registrant on
      November 14, 2001).10.12*
            Non-Plan
      Stock Option Agreement between Hyun Jong Shin (John Shin) and the
      Registrant dated November 6, 2001. (Incorporated by reference from
      Exhibit 10.42 of the Form 10-K filed by the Registrant on
      March 29, 2002).10.13
            Lease
      Agreement dated December 12, 2002 between iSTAR Sunnyvale Partners,
      L.P. and the Registrant. (Incorporated by reference from
      Exhibit 10.44 of the Form 10-K filed by the Registrant on
      March 27, 2003)





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10.14*
            TransWarp
      Networks, Inc. 2002 Stock Option/Stock Issuance Plan (Incorporated by
      reference from Exhibit 4.06 of the Form S-8 filed by the
      Registrant on May 23, 2003).10.15*
            Employment
      Offer Letter between J. Duane Northcutt and the Registrant dated
      February 19, 2002. (Incorporated by reference from Exhibit 10.27
      of the Form 10-K filed by the Registrant on March 15,
      2005).10.16*
            Employment
      Offer Letter between Steve Tirado and the Registrant dated
      January 24, 2005 (Incorporated by reference from Exhibit 10.36
      of the Form 10-K filed by the Registrant on March 15,
      2005).10.17*
            Employment
      Offer Letter between Shin Hyun Jong (John Shin) and the Registrant dated
      August 20, 2001. (Incorporated by reference from Exhibit 10.19
      of the Form 10-K filed by the Registrant on March 1,
      2007).10.18*
            Employment
      Offer Letter between Dale Zimmerman and the Registrant dated
      January 10, 2005. (Incorporated by reference from Exhibit 10.20
      of the Form 10-K filed by the Registrant on March 1,
      2007).10.19*
            Director
      Compensation Plan (Incorporated by reference from Exhibit 10.01 of
      the Form 10-Q filed by the Registrant on May 10,
      2005).10.20†
            Business
      Cooperation Agreement dated April 26, 2005 between Intel Corporation
      and the Registrant (Incorporated by reference from Exhibit 10.01 of
      the Form 10-Q filed by the Registrant on August 9,
      2005).10.21†/*
            Consulting
      Agreement between David Lee and the Registrant dated March 15, 2006.
      (Incorporated by reference to Exhibit 10.03 to our current report on
      Form 8-K filed March 16, 2006.10.22
            First
      Amendment to Lease dated July 23, 2003 between iStar Sunnyvale
      Partners, L.P. and the Registrant. (Incorporated by reference from
      Exhibit 10.28 of the Form 10-K filed by the Registrant on
      March 1, 2007).10.23
            Second
      Amendment to Lease dated February 17, 2004 between iStar Sunnyvale
      Partners, L.P. and the Registrant. (Incorporated by reference from
      Exhibit 10.29 of the Form 10-K filed by the Registrant on
      March 1, 2007).10.24
            Third
      Amendment to Lease dated June 1, 2004 between iStar Sunnyvale
      Partners, L.P. and the Registrant. (Incorporated by reference from
      Exhibit 10.30 of the Form 10-K filed by the Registrant on
      March 1, 2007).10.25
            Fourth
      Amendment to Lease dated May 10, 2006 between iStar Sunnyvale
      Partners, L.P. and the Registrant. (Incorporated by reference from
      Exhibit 10.31 of the Form 10-K filed by the Registrant on
      March 1, 2007).10.26*
            Employment
      Offer Letter between Edward Lopez and the Registrant dated
      December 23, 2006. (Incorporated by reference from Exhibit 10.34
      of the Form 10-K filed by the Registrant on March 1,
      2007).10.27†
            Settlement
      and License Agreement between the Registrant and Genesis Microchip Inc.
      dated December 21, 2006. (Incorporated by reference from
      Exhibit 10.35 of the Form 10-K filed by the Registrant on
      March 1, 2007).10.28***
            Sale
      and Purchase Agreement dated January 2, 2007 by and among the
      Registrant, Infineon Technologies AG and sci-worx GmbH (Incorporated by
      reference from Exhibit 10.01 to the Form 8-K filed by the
      Registrant on January 8, 2007).10.29†
            Video
      Processor Design License Agreement with Sunplus Technology Co., Ltd.
      (Incorporated by reference to Exhibit 10.02 to our Quarterly Report
      on Form 10-Q filed May 7, 2007)10.30*
            Employment
      Offer Letter between Noland Granberry and the Registrant dated
      February 14, 2006 (incorporated by reference to Exhibit 10.04 to
      our Quarterly Report on Form 10-K filed May 7,
      2007).10.31*
            Employment
      Offer Letter between Sal Cobar and the Registrant dated April 19,
      2007. (Incorporated by reference to Exhibit 10.01 to our Quarterly
      Report on Form 10-Q filed August 8, 2007)10.32*
            Silicon
      Image, Inc. Sales Compensation Plan for Vice President of Worldwide Sales
      for Fiscal Year 2007 (Incorporated by reference to Exhibit 10.02 to
      our Quarterly Report on Form 10-Q filed August 8,
      2007)10.33*
            ESPP
      1999 Plan Document including UK Sub-Plan As Amended (Incorporated by
      reference to Exhibit 10.03 to our Quarterly Report on Form 10-Q
      filed August 8, 2007)




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10.34*
              Employment
      offer letter with Paul Dal Santo dated July 23, 2007 (Incorporated by
      reference to Exhibit 10.01 to the Registrant’s current report on
      Form 8-K filed on August 20, 2007).10.35*
              Amendment
      No. 1 to Transitional Employment and Separation Agreement between
      Robert Freeman and the Registrant dated August 23, 2007 (Incorporated
      by reference to Exhibit 10.01 to the Registrant’s current report on
      Form 8-K filed on August 24, 2007).10.36*
              Employment
      offer letter with Harold Covert dated October 2, 2007 (Incorporated
      by reference to Exhibit 10.01 to the Registrant’s current report on
      Form 8-K filed on October 5, 2007).10.37*
              Form
      of Change of Control Retention Agreement. (Incorporated by reference to
      Exhibit 10.01 to the Registrant’s current report on Form 8-K
      filed on December 19, 2007).10.38*
              Silicon
      Image, Inc. 2008 Employee Bonus Plan, dated February 4,
      2008.  (Incorporated by reference to the Registrant’s current
      report on Form 8-K filed on February 8, 2008).10.39
              Accelerated
      Stock Repurchase Agreement dated February 13, 2008 between Credit
      Suisse International and the Registrant. (Incorporated by reference from
      Exhibit 10.39 of the Form 10-K filed by the Registrant on
      February  27, 2008).10.40*
              1999
      Equity Incentive Plan, as amended and restated December 14, 2007.
      (Incorporated by reference from Exhibit 10.40* of the Form 10-K
      filed by the Registrant on February  27, 2008).10.41*
              Notice
      of Grant of Restricted Stock Units to named executive officers (For U.S.
      Participants), dated February 15, 2008. (Incorporated by reference to
      Exhibit 10.01 to the Registrant’s current report on Form 8-K
      filed on February 22, 2008).10.42*
              Amendment
      to Silicon Image, Inc. 2008 Employee Bonus Plan, dated April 23, 2008.
      (Incorporated by reference to Exhibit 99.01 to the Registrant’s
      current report on Form 8-K filed on April 29,
  2008).10.43*
              2008
      Equity Incentive Plan, approved by stockholders May 21, 2008 (incorporated
      by reference to Exhibit 4.07 to the Form S-8 filed with the Commission on
      May 23, 2008).10.44*
              Amendment
      to the Registrant’s Employee Stock Purchase Plan (“ ESPP”), approved by stockholders May 21, 2008 (incorporated by
      reference to Exhibit 4.05 to the Form S-8 filed with the Commission on May
      23, 2008).10.45*
              Transitional
      Employment and Severance Agreement between Hyun Jong (John) Shin, the
      Registrant’s Vice President, Strategic Technology Initiatives and the
      Registrant, dated October 6, 2008.10.46*
              Amended
      and restated employment letter between Steve Tirado and the Registrant,
      dated October 22, 2008.10.47
              Settlement
      of litigation with Analogix Semiconductor, Inc., dated December 4, 2008
      (Incorporated by reference to Exhibit 99.01 to the Registrant’s
      current report on Form 8-K filed on December 5,
  2008).10.48*
              Separation
      and General Release Agreement between Dale Zimmerman, the Registrant’s
      Vice President, Worldwide Marketing, and the Registrant dated December 31,
      2008.21.01
              Subsidiaries
      of the Registrant.23.01
              Consent
      of Deloitte & Touche LLP.31.01
              Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.02
              Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.01**
              Certification
      of Principal Executive Officer pursuant to 18 U.S.C.
      Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.32.02**
              Certification
      of Principal Financial Officer pursuant to 18 U.S.C.
      Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.
 __________
 
 †
              Confidential
      treatment has been requested with respect to certain portions of this
      exhibit. Omitted portions have been filed separately with the Securities
      and Exchange Commission.*
              This
      exhibit is a management contract or compensatory plan or
      arrangement.**
              This
      exhibit is being furnished, rather than filed and shall not be deemed
      incorporated by reference into any filing of the Registrant, in accordance
      with Item 601 of Regulation S-K.***
              Schedules
      and exhibits have been omitted pursuant to Item 601(b)(2) of
      Regulation S-K. The Registrant hereby undertakes to furnish
      supplementally copies of any of the omitted schedules and exhibits upon
      request by the Securities and Exchange
  Commission.
 
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