UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington
D.C. 20549





Form 10-K





(Mark
      One)





þ
            
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the fiscal year ended December 31, 2009


OR


o
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


Commission
file number 000-26887





SILICON
IMAGE, INC.


(Exact
name of registrant as specified in its charter)





Delaware
            
            77-0396307(State
      or other jurisdiction of incorporation of organization)
            
            (I.R.S.
      Employer Identification Number)








1060
East Arques Avenue


Sunnyvale,
CA 94085


(Address of principal
executive offices)


(Zip
Code)





(408) 616-4000


(Registrant’s telephone
number, including area code)





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  Noþ




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 Noþ


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. YesþNo





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




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. 





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


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





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





The
aggregate market value of the Registrant’s Common Stock held by non-affiliates
of the Registrant was approximately $170,972,511 as of the last business day of
Registrant’s most recently completed second fiscal quarter, based upon the
closing sale price on the Nasdaq National Market reported on such
date.





As of
January 31, 2010, there were 75,443,625 shares of the Registrant’s Common
Stock issued and outstanding.





DOCUMENTS INCORPORATED BY
REFERENCE


Portions
of the Definitive Proxy Statement for the 2010 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
            33Item
      2
            Properties
            33Item
      3
            Legal
      Proceedings
            33Item
      4
            Submission of Matters to a Vote
      of Securities Holders
            33PART IIItem
      5
            Market for
      Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            34Item
      6
            Selected
      Financial Data
            35Item
      7
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            36Item
      7A
            Quantitative and Qualitative Disclosures About Market
      Risk
            56Item
      8
            Financial
      Statements and Supplementary Data
            57Item
      9
            Changes in
      and Disagreements with Accountants on Accounting and Financial
      Disclosure
            57Item
      9A
            Controls and
      Procedures
            58Item
      9B
            Other
      Information
            60PART IIIItem
      10
            Directors, Executive Officers and Corporate
      Governance
            60Item
      11
            Executive
      Compensation
            60Item
      12
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            60Item
      13
            Certain
      Relationships and Related Transactions and Director
      Independence
            60Item
      14
            Principal
      Accountant Fees and Services
            60PART IVItem
      15
            Exhibits
      and Financial Statement Schedules
            61Signatures
            107Index to
      Exhibits Filed Together with this Annual Report
            108


EXHIBIT 21.01


EXHIBIT 23.01


EXHIBIT 31.01


EXHIBIT 31.02


EXHIBIT 32.01


EXHIBIT 32.02




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.




-
2 -
 
 Table
of Contents
 PART I





Item 1.Business





General





Silicon
Image, Inc. is a technology innovator and a global leader developing
high-bandwidth semiconductor and intellectual property (IP) solutions based on
our innovative, digital interconnect technology. Our goal 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 (HD) content in 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), mobile and storage
markets.





We sell
integrated and discrete semiconductor products as well as license IP solutions
to consumer electronics, computing, display, storage and mobile manufacturers.
Our product and IP portfolio includes solutions for high-definition television
(HDTV), high-definition set-top boxes (STBs), high-definition Blu-ray players,
mobile devices, 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 have been, and are likely to be
in the future, significant contributors to broader standards specifications such
as the Serial Advanced Technology Attachment (SATA) specification for PC &
Enterprise storage applications.  We actively promote and participate
in working groups and consortiums to develop new standards such as the recently
announced Mobile High-Definition Interconnect (MHDI) working group chartered
with creating a new HD mobile video standard and the Serial Port Memory
Technology (SPMT) consortium which is working on serial connection standards for
dynamic random access memory (DRAM). 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, mobile, networking and storage
devices further leverages our expertise in these markets. In addition, through
Simplay Labs, LLC, our wholly owned subsidiary, we offer one of the most robust
and comprehensive test platforms in the consumer electronics industry. We
utilize independent foundries and third-party subcontractors to manufacture,
assemble and test all of our semiconductor products.





Our customers
are equipment manufacturers in each of our target markets — Consumer
Electronics, Personal Computer, Mobile and Storage. Because we leverage our
technologies across different markets, certain of our products may be
incorporated into equipment used in multiple markets. We sell our products to
original equipment manufacturers (OEMs) throughout the world using a direct
sales force and through a network of distributors and manufacturer’s
representatives. Our net revenue is generated principally by sales of our
semiconductor products, with other revenues derived from IP core licensing and
royalty fees from our standards activities. We maintain relationships with the
eco-system of companies that provide the products that drive digital content
creation and consumption, including the major Hollywood studios, consumer
electronics companies, retailers and service providers. To that end, we have
developed relationships with Hollywood studios such as Universal, Warner
Brothers, Disney and Fox and with major consumer electronics companies such as
Nokia, Panasonic, Phillips, Samsung, Sharp, Sony and Toshiba. Through these and
other relationships, we have formed a strong understanding of the requirements
for storing, distributing and presenting HD digital video and audio in the home
and mobile environments. We have also developed a substantial 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 other 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 STB, game
console and digital television (DTV) markets. More recently, we have focused our
research and development activities and are developing products based on our
innovative digital interconnect core technology for the mobile device market,
including digital still cameras, HD camcorders, portable media players and smart
phones.





We are a Delaware
corporation headquartered in Sunnyvale, California. Our Internet website address
is www.SiliconImage.com.




-
3 -





We are
not including the information contained on our website 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.




Strategy
and Core Technologies





Our mission
is to develop interoperable products and technologies that deliver digital
content 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 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 the transfer of data between a computer and
mass storage devices such as hard disk drives, optical drives and flash based
storage subsystems. The main advantages over the older parallel ATA
interface are faster data transfer, the ability to remove or add devices while
operating (hot swapping), native command queuing (NCQ) and out of order data
retrieval, 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 6.0 gigabits per second (Gbps) per device.





There is a
special connector (eSATA) specified for external devices, and an optionally
implemented provision for clips to hold internal connectors firmly in
place.





-
4 -





LiquidHDTM





LiquidHDTMis
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 that 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 the requisite 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.





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 HDTVs. 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 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 technology that Silicon Image and other leading semiconductor
companies are currently promoting. 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, and lower power requirements resulting in savings on overall
system cost.





InstaPortTM
Technology





InstaportTM
technology was developed by Silicon Image to reduce HDMI port switch time from
5-7 seconds to about 1 second.  InstaPort is now featured in port
processor products from Silicon Image that have implemented HDMI 1.3 or HDMI
1.4.






-
5 -





Standards
Activity





We have been
directly involved in the following standards efforts:





Mobile
High-Definition Interconnect (MHDI) Working Group





On September
28, 2009 Nokia, Samsung, Silicon Image, Sony, and Toshiba, announced the
formation of the Mobile High-Definition Interface Working Group (MHDI) that
intends to create an industry standard for an audio/video interface to connect
mobile phones or portable consumer electronics (CE) devices directly to
high-definition televisions (HDTVs) and displays. This new mobile connectivity
standard, based on Silicon Image’s Mobile High-Definition Link (MHLTM)
technology, will be defined, promoted and marketed by the Working Group as an
industry standard open to anyone desiring to be an adopter and enable the
development of mobile products that adhere to this new standard across a broad
connectivity ecosystem.





The Working
Group’s vision for the next generation of mobile connectivity is to provide an
easy and cost-effective implementation for manufacturers while offering
consumers a simple and reliable mobile connectivity experience. A single-cable
with a low pin count interface will be able to support up to 1080p
high-definition (HD) digital video and HD audio in addition to delivering power
to a portable device.





The Working
Group is expected to organize a Consortium of founding members who will develop
a mobile connectivity technology standard specification that governs
transmission and reception of high-definition content between portable devices
and display devices, to support connectivity in accordance with the new
specification.





Serial Port
Memory Technology (SPMT) Consortium





SPMT is a
first-of-its-kind memory standard for dynamic random access memory (DRAM). SPMT
will enable extended battery life, bandwidth flexibility, reduced pin count, and
lower power demand for mobile and portable devices.  Demand by mobile
service providers for solutions enabling them to give consumers more
data-intensive, media-rich capabilities drove the formation of the SPMT
Consortium.  The SPMT consortium was established by Silicon Image,
ARM, Hynix Semiconductor, LG Electronics, and Samsung Electronics in
2009.




High-Definition
Multimedia Interface (HDMI) Consortium





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.





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 research firm In-Stat estimates that approximately
400 million HDMI-enabled products shipped worldwide in 2009 contributing to
an installed base of over 1 billion HDMI enabled products. In addition,
approximately 900 companies around the world have become HDMI
adopters.





Digital
Visual Interface (DVI)





In 1998,
together with Intel, Compaq, IBM, Hewlett-Packard, NEC and Fujitsu, Silicon
Image 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 152 million DVI-enabled products were
expected to ship in 2009. Today, in many applications, DVI is being replaced by
the more feature-rich HDMI interface. In the PC market, DVI faces competition
from DisplayPort, which is a 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. A number of
companies have introduced products based on the DisplayPort standard including
Apple, Dell, AMD, ST 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.




- 6 -





Products
and Services





We sell our
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 31,2009
            
            
            2008
            
            
            2007Consumer
      Electronics
            
            $
            102,391
            
            
            $
            167,599
            
            
            $
            212,910Personal
      Computers
            
            
            8,905
            
            
            
            40,141
            
            
            
            34,283Storage
      products
            
            
            11,372
            
            
            
            25,461
            
            
            
            25,181Licensing
            
            
            27,921
            
            
            
            41,214
            
            
            
            48,129$
            150,589
            
            
            $
            274,415
            
            
            $
            320,503




CE
(DTV & Mobile)





In 2009,
HDMI specification revision 1.4 (HDMI 1.4) was released. We were the first
company to introduce full-featured HDMI 1.4 products with a full complement of
advanced HDMI 1.4 features such as the HDMI Ethernet Channel (HEC), Audio Return
Channel (ARC), 3D, advanced audio formats and content bits.  These
features allow our customers to design truly differentiated products while also
simplifying the end consumer experience by reducing the number of cables
necessary to interconnect CE devices. In 2009, we launched the SiI938x family of
port processors that includes five HDMI 1.4 ports, support for HEC (HDMI
Ethernet Channel), 3D,  and ARC (Audio Return Channel) and also
includes support for MHL technology, and InstaportTM. Our SiI938x family of port
processors expands the number of HDMI ports available to consumers and augments
the HDMI functionality with quick, high-definition port switching.  We
expect volume shipments of SiI938x HDIM 1.4 port processors to begin in
2010.





During
2009, we also began volume shipments of our first port processor with InstaPortTM
technology, the SiI9287. This port processor has been designed-in to many
tier-1 DTV manufacturers. We believe the SiI9287 delivers outstanding HDMI
audio/video quality coupled with the industry leading innovation of InstaPort
fast switching between any of its 4 HDMI ports.





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 allowing OEMs to significantly reduce cross-platform compatibility
issues.





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 and
recorders, Blu-Ray players, HD 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 DTVs, projectors, PC monitors as well as A/V receivers (AVR’s).
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.





-
7 -


PC





While the
PC market has become an increasingly smaller portion of our business, the growth
of DTVs 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.





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.








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.





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 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. 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.





In 2009
we introduced the third generation of SteelVine Storage processors, the SiI5823,
specifically targeted at mainstream PC motherboards.  This third
generation provides a 30% performance increase over previous generations while
simultaneously reducing the overall Bill of Materials cost of the solution by
over 40%.








-
8 -


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 and consumer quality of experience are of significant concern
to retailers and consumers in the HD market. Devices that pass the Simplay HD
testing program are verified to meet HDMI and HDCP specifications and have
demonstrated interoperability through empirical testing against “peer” devices
maintained by Simplay Labs. We have service centers operating in the US, South
Korea and China, providing interoperability, quality of experience and
performance global testing centers. By December 31, 2009, more than 500
product lines have been Simplay HD-verified and 100 manufacturers 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. A number of products use the SimplayHD logo on product labels, within
product literature and on website promotions.





In
November of 2009, the Simplay Explorer HDMI-CEC R&D development tool was
approved as an official HDMI Authorized Test Center (ATC) test tool. 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.





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 technology 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 2009, the HDMI consortium launched version 1.4 of the HDMI
specification into the marketplace.  Moreover, in 2009, 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, 2009, 898 manufacturing companies were licensees of the HDMI
specification from the HDMI Licensing, LLC.  The adoption of HDMI
specifications by additional manufacturers during 2009 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 estimated
that approximately 405 million HDMI-enabled devices would be shipped in
2009, with over 474 million devices expected to ship in 2010 and an
installed base of nearly 1.5 billion HDMI-enabled devices projected by the
end of 2010.





-
9 -


Markets
and Customers





We focus
our sales and marketing efforts on achieving design wins with original equipment
manufacturers (OEMs) of CE, PC Mobile 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 44.2%, 55.1% and 57.7%, of our revenue in 2009, 2008 and
2007, respectively. For the year ended December 31, 2009, shipments to
Microtek, Inc. generated 11.9% of our revenue and shipments to Weikeng
Industrial generated 10.3% 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 59.9%,
60.2% and 60.2% of our total revenue in 2009, 2008 and 2007,
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, 2009, 2008 and 2007, approximately 79.4%,
83.4% and 79.8% 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 CE (including DTV), PC,
mobile 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, 2009, we
had been issued more than 140 United States patents and had in excess of 70
United States patent applications pending. Our U.S. issued patents expire
in 2025 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
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
$68.2 million, $84.8 million and $78.0 million, in 2009, 2008 and
2007, respectively, including stock-based compensation expense of
$6.3 million, $7.1 million and 8.4 million for 2009, 2008 and
2007, respectively.




Sales
and Marketing





We sell
our products using a direct sales support and marketing 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.






-
10 -


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
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.





-11 -





CE





In the
consumer electronics market, our digital interface products are used to connect
a variety of devices to DTVs including set-top boxes, A/V receivers, game
consoles, digital/personal video recorders (DVR), DVD and Blu-Ray players and a
growing number of mobile devices such as smart phones, camcorders and cameras.
These products incorporate DVI, HDMI or Mobile High-Definition Link technology
optionally with HDCP support. Companies competing for sales of HDMI and DVI
solutions include among others, Analog Devices, Analogix, Broadcom,
STMicroelectronics, Mstar, NXP, Texas Instruments and Trident. We also compete
in some instances against in-house semiconductor 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
companies such as Analog Devices, Broadcom, National Semiconductor, nVidia,
Pixelworks, SIS, ST and Texas Instruments. In addition, Intel and other
competitors may have integrated HDMI into their PC chips sets. Our HDMI products
may also face competition from DisplayPort, which is a 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. Other companies have introduced products based on the DisplayPort
including Apple, Dell, AMD, ST 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 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 Panasonic, Sony 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, 2009, we had a total of 526 employees, including 218
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 works 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.





As part
of our restructuring plans announced in the last quarter of 2009, 121 employees
will be terminated in the first half of 2010. Excluding these 121 employees, our
effective head count is 405. The 121 employees have been informed of the
restructuring plan prior to December 31, 2009.








-
12 -
 Table of
Contents








Item 1A.Risk
Factors





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





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





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




•
            the
      growth, evolution and rate of adoption of industry standards for our key
      markets, including consumer electronics, digital-ready PCs and displays
      and storage devices and systems;•
            the
      fact that our licensing revenue is heavily dependent on a few key
      licensing transactions being completed for any given period, the timing of
      which is not always predictable and is especially susceptible to delay
      beyond the period in which completion is expected and our concentrated
      dependence on a few licensees in any period for substantial portions of
      our expected licensing revenue and
profits;




•
            the
      fact that our licensing revenue has been uneven and unpredictable over
      time and is expected to continue to be uneven and unpredictable for the
      foreseeable future, resulting in considerable fluctuation in the amount of
      revenue recognized in a particular quarter;•
            competitive
      pressures, such as the ability of competitors to successfully introduce
      products that are more cost-effective or that offer greater functionality
      than our products, including integration into their products of
      functionality offered by our products, the prices set by competitors for
      their products and the potential for alliances, combinations, mergers and
      acquisitions among our competitors;




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




•
            government
      regulations regarding the timing and extent to which digital content must
      be made available to consumers;•
            the
      availability of other semiconductors or other key components that are
      required to produce a complete solution for thecustomer;
      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.•
            fluctuations
      in market demand, one-time sales opportunities and sales goals, sometimes
      results in heightened sales efforts during a given period that may
      adversely affect our sales in future
periods.





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





-13 -





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





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





•
            our
      ability to manage product introductions and transitions, develop necessary
      sales and marketing channels and manage other matters necessary to enter
      new market segments;•
            our
      ability to successfully manage our business in multiple markets such as
      CE, PC and storage, which may involve additional research and development,
      marketing or other costs and
expenses;


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


•
            our
      ability to engineer customer solutions that adhere to industry standards
      in a timely and cost-effective manner;•
            our
      ability to achieve acceptable manufacturing yields and develop automated
      test programs within a reasonable time frame for our new
      products;


•
            our
      ability to manage joint ventures and projects, design services and our
      supply chain partners; •
              our
      ability to monitor the activities of our licensees to ensure compliance
      with license restrictions and remittance of
      royalties; •
                our
      ability to structure our organization to enable achievement of our
      operating objectives and to meet the needs of our customers and
      markets; •
                  the
      success of the distribution and partner channels through which we choose
      to sell our products and •
                    our
      ability to manage expenses and inventory
      levels; and, •
                      our
      ability to successfully maintain certain structural and various compliance
      activities in support of our global structure which in the long run, will
      result in certain operational benefits as well as achieve an overall lower
      tax rate. If we fail to
effectively manage our business, this could adversely affect our results of
operations.





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





Global credit
and financial markets continue to experience disruptions, including diminished
liquidity and credit availability, declines in consumer confidence, declines in
economic growth, increases in unemployment rates, and continued uncertainty
about economic stability. Despite signs of improvement, there can be no
assurance that there will not be renewed 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
continued or further 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 68.0%, 61.1% and 66.4% of total revenue for the years
ended December 31, 2009, 2008 and 2007, 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. As a result
of the recent recession experience by the US economy and other economies around
the world, the demand for overall consumer electronics has been and may continue
to be adversely affected. As a result, the 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 -
 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, as
competitors reduce prices and offer products with greater levels of integration,
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 and SoCs 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, NXP, Broadcom, Intel, National Semiconductor and Texas
Instruments and CE manufacturers, such as Panasonic, Sony, Samsung and
Toshiba, may compete against us in the future. Some of our competitors could
merge, which may enhance their market presence. Existing or new competitors may
also develop technologies that more effectively address our markets with
products that offer enhanced features and functionality, lower power
requirements, greater levels of integration or lower cost. Increased competition
has resulted in and is likely to continue to result in price reductions and loss
of market share in certain markets. We cannot assure you that we can compete
successfully against current or potential competitors, or that competition will
not reduce our revenue and gross margins.





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





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





-
15 -


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 HDMI port processors and products based
on our new Mobile High-Definition Link Technology.  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.





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.





-
16 -
 Our products
typically have lengthy sales cycles. A customer may decide to cancel or
change its
product plans, which could cause us to lose anticipated sales. In addition, our
average product life cycles tend to be short and, as a result, we may
hold excess
or obsolete inventory that could adversely affect our operating
results.





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





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




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





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





- 17 -


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, 2009,
shipments to Microtek, Inc. and Weikeng Industrial generated 11.9% and
10.3% of our revenue, respectively.  For the year ended December 31,
2008, shipments to World Peace Industrial generated 14.6% of our revenue,
shipments to Microtek, Inc. 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.  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 59.9% of our revenue for the year
ended December 31, 2009, 60.2% of our revenue for the years ended December 31,
2008 and 2007. Selling through distributors reduces our ability to forecast
sales and increases the complexity of our business, requiring us
to:





•
            manage
      a more complex supply chain;•
            monitor
      and manage the level of inventory of our products at each
      distributor;


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


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




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





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





-
18 -


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 and
      SPMT;•
            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; correctly anticipating
      the market windows that will maximize acceptance of our products and then
      delivering the products to the markets within the required
      windows;


•
            management
      of product life cycles; •
            use
      of leading-edge foundry processes, when use of such processes are required
      and achievement of high manufacturing yields and low cost
      testing; •
            market
      acceptance of new
  products; and, •
            market
      acceptance of new architectures such as our input
      processors.




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





-
19 -


There
are risks to our global strategy.





We maintain
operations in various countries around the world where we 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.





Governmental
action against companies located in offshore jurisdictions may lead to a
reduction in the demand for our common shares.





Recent
federal and state legislation has been proposed, and additional legislation may
be proposed in the future which, if enacted, could have an adverse tax impact on
both us and our shareholders. For example, the ability to defer taxes as a
result of permanent investments offshore could be limited, thus raising our
effective tax rate.





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




Our growth
depends upon market growth and our ability to enhance our existing products and
introduce new products on a timely basis. Acquisitions of companies or
intangible assets is a strategy we may use to develop new products and enter new
markets. 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 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.





For example,
in January 2007, we completed the acquisition of sci-worx, now Silicon Image,
GmbH.  In 2009, because of our decision to focus on discrete
semiconductor products and related intellectual property, we decided to
restructure our research and development operations resulting in the closure of
our two sites in Germany.





-
20 -


Industry
cycles may strain our management and resources.





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





•
            improve
      operational and financial systems;•
            train
      and manage our employee base;


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


•
            attract,
      develop, motivate and retain qualified personnel with relevant
      experience; and•
            adjust
      spending levels according to prevailing market
      conditions.




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





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





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




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; and,


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





-
21 -


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.





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.





-
22 -
 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, 2009, 2008 and 2007, approximately 79.4%, 83.4% and
79.8% of our total revenue respectively, was generated from customers and
distributors located outside of United States, primarily in Asia. We anticipate
that sales outside of the United States will continue to account for a
substantial portion of our revenue in future periods. In addition, we undertake
various sales and marketing activities through regional offices in several other
countries and we have significantly expanded our research and development
operations outside of the United States. We intend to continue to expand our
international business activities. Accordingly, we are subject to international
risks, including, but not limited to:




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


•
            natural
      disasters and public health emergencies;•
            nationalization
      of business and blocking of cash
flows;


•
            trade
      and travel restrictions; •
            the
      imposition of governmental controls and
  restrictions;


•
            burdens
      of complying with a variety of foreign
  laws; •
              import
      and export license requirements and restrictions of the United States and
      each other country in which we
  operate; •
                unexpected
      changes in regulatory
requirements; •
                  foreign
      technical standards; •
                    changes
      in taxation and tariffs; •
                      difficulties
      in staffing and managing international
    operations; •
                        fluctuations
      in currency exchange rates; •
                          difficulties
      in collecting receivables from foreign entities or delayed revenue
      recognition; •
                            expense
      and difficulties in protecting our intellectual property in foreign
      jurisdictions; •
                              exposure
      to possible litigation or claims in foreign
      jurisdictions; and, •
                                potentially
      adverse tax consequences. 
 Any of the
factors described above may have a material adverse effect on our ability to
increase or maintain our foreign sales. In addition, original equipment
manufacturers that design our semiconductors into their products sell them
outside of the United States. This exposes us indirectly to foreign risks.
Because sales of our products are denominated exclusively in United States
dollars, relative increases in the value of the United States dollar will
increase the foreign currency price equivalent of our products, which could lead
to a change in the competitive nature of these products in the marketplace. This
in turn could lead to a reduction in sales and
profits.





-
23 -
 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.





-
24 -
 Our
participation in working groups for the development and promotion of industry
standards in our target markets, including the Digital Visual Interface and HDMI
specifications, requires us to license some of our intellectual property for
free or under specified terms and conditions, which may make it easier for
others to compete with us in such markets.





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


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


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





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





We have
entered into and expect to continue to enter into strategic partnerships with
third parties.  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.





Strategic
partnerships that we enter into with third parties may not result in the
anticipated results. For example, in February 2007, we entered into a
licensing agreement with Sunplus Technology Co., Ltd. (Sunplus), which granted
us the rights to use and further develop advanced IP technology. Previously, we
believed that the IP licensed under this agreement enhanced our ability to
develop DTV technology and other related consumer product offerings. Based on
the Company’s product strategy as of October 2009, we realized the IP obtained
through the Sunplus agreement did not align with our product roadmap and during
October 2009, we decided to write off our investment in Sunplus IP. This
decision was prompted by a change in our product strategy due to market place
and related competitive dynamics. Please also refer to Note 12 in our
consolidated financial statements.





Our
business may be impacted as a result of the adoption of competing standards and
technologies by the broader market
  The success
of our business has been significantly related to our participation
in standard setting organizations. Specifically, HDMI related revenues
amounted to more than 75% of our total revenues for 2009. From
time to time, competing standards have been established which negatively
impact the success of existing standards or jeopardize the creation of a new
standard. DisplayPort is an example of a competing standard on a different
technology base which has created an alternative high definition connectivity
methodology in the PC space. This standard has been adopted by several large PC
manufactures. While currently not as widely recognized as the HDMI standard,
DisplayPort does represent a viable alternative to the HDMI standard.  If
DisplayPort should gain broader adoption, our HDMI business could be negatively
impacted and our revenues could be reduced.


-
25 -
 Our business is
dependent on the continued adoption and widespread implementation of
the HDMI specification.
  Our success is largely dependent
upon the continued adoption and widespread implementation of the HDMI
specification. More than 75% of our revenue is derived from the sale of HDMI
enabled products and the licensing of our HDMI technology. Our leadership in the
market for HDMI-enabled products and intellectual property has been based on our
ability to introduce first-to-market semiconductor and IP solutions to our
customers and to continue to innovate within the standard. Therefore, our
inability to be first to market with our HDMI enabled products and intellectual
property or to continue to drive innovation in the HDMI specification could have
an adverse impact on our business going forward. In addition, the establishment
and adoption by the markets we sell into of a competing digital
interconnect technology could have an adverse impact on our ability to sell our
products and license our intellectual property and therefore our revenues and
business.
  We also derive revenue from the
license fees and royalties paid by the adopters of the HDMI technology. Any
development that has the effect of lowering the number of adopters of the HDMI
standard will negatively impact these license fees and royalties. Also, when the
HDMI consortium was first formed, we received 100% of the royalties collected
from HDMI adopters. During 2007, at a founders meeting, the founders decided to
share the HDMI adopter’s royalty revenues among the various founders, such that
we no longer receive all of the royalties. The allocation of license fees and
royalty revenue among the HDMI founders is an issue that is reviewed and
discussed by the founders from time to time. There can be no assurance that
going forward we will continue to receive the share of HDMI license fees and
royalties that we currently receive. If our share of these license fees and
royalties is reduced, this decision will have a negative impact on our
revenues.
 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 PC and storage
and is a growing presence in the CE market. We have a multi-faceted relationship
with Intel that is complex and requires significant management attention,
including:





•
            Intel
      and Silicon Image have been parties to business cooperation
      agreements;•
            Intel
      and Silicon Image are parties to a patent
  cross-license;


•
            Intel
      and Silicon Image worked together to develop
  HDCP;


•
            an
      Intel subsidiary has the exclusive right to license HDCP, of which we are
      a licensee;•
            Intel
      and Silicon Image were two of the promoters of the
    DDWG;










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


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


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


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


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


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


•
            Intel’s
      technology, including its 845G and later chipsets, 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.





New
Releases of Microsoft Windows® and Apple Mac OS® operating systems may render
our chips inoperable





ICs targeted
to PC, laptop, or netbook designs (whether running Microsoft Windows ®, Apple
Mac OS® or Linux operating systems) often require device driver software to
operate.  This software is difficult to produce and requires various
certifications such as Microsoft’s Windows Hardware Quality Labs (WHQL) before
being released.  Each new revision of an operating system may require
a new software driver and associated testing/certification.  Failure
to produce this software can have a negative impact on our relation with
Microsoft and/or Apple and may damage our reputation as a quality supplier of
SATA and HDMI products in the eyes of end consumers.




-
26 -
 We
have granted Intel rights with respect to our intellectual property, which could
allow Intel to develop products that compete with ours or otherwise reduce the
value of our intellectual property.





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





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





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





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.




-
27 -


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, FASB ASC No. 718-10,
Stock Compensation,
requires us to record compensation expense for options granted to employees. To
the extent that new regulations make it more difficult or expensive to grant
options to employees, we may incur increased cash compensation costs or find it
difficult to attract, retain and motivate employees, either of which could harm
our business.





-
28 -





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





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







-
29 -
 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 and
executive officers in recent quarters, including the following:




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


•
            In
      February 2007, David Hodges advised our board of directors of his decision
      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, Rob Valiton resigned from his position as vice president of
      worldwide sales and Sal Cobar was appointed as his
      successor. •
            In
      July 2007, Paul Dal Santo was appointed as chief operating
      officer. •
            In
      October 2007, Robert Freeman resigned from his position as chief financial
      officer. •
            In
      October 2007, Harold L. Covert was appointed as chief financial
      officer. •
            In
      December 2008, Dale Zimmerman resigned from his position as vice president
      of worldwide marketing. •
            In
      March 2009, Paul Dal Santo resigned from his position as chief operating
      officer. •
            In
      September 2009, Steve Tirado resigned from his positions as chief
      executive officer and director and Hal Covert was appointed as president
      and chief operating officer. •
            In
      January 2010, Camillo Martino was appointed as chief executive officer and
      director. •
            In
      January 2010, Harold Covert, who was appointed president and chief
      operating officer on September 25, 2009 while we undertook a search for a
      new chief executive officer, agreed to continue in his capacity
      as our president (but to no longer serve as chief financial officer or
      chief operating officer) during a transitional period from January 6, 2010
      through September 30, 2010.  On January 5, 2010, our Board of
      Directors also elected Mr. Covert to the Board, effective January 15, 2010
      and through September 30, 2010.






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.





-
30 -


Our
operations and the operations of our significant customers, third-party wafer
foundries and third-party assembly and test subcontractors are located in are as
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, 2009,
2008 and 2007 customers and distributors located in Japan generated 27.1%, 24.0%
and 35.3%,of our revenue, respectively, and customers and distributors located
in Taiwan generated 25.2%, 19.8% and 16.7% of our revenue, respectively. Both
Taiwan and Japan are susceptible to earthquakes, typhoons and other natural
disasters.





Our business,
including a potential reduction of revenues, would be negatively affected
if any of the following occurred:





•
            an
      earthquake or other disaster in the San Francisco Bay Area or the Los
      Angeles area damaged our facilities or disrupted the supply of water
      or electricity to our headquarters or our Irvine
  facility;•
            an
      earthquake, typhoon or other disaster in Taiwan or Japan resulted in
      shortages of water, electricity or transportation, limiting the production
      capacity of our outside foundries or the ability of ASE to provide
      assembly and test services;


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


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





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





The United
States has taken and continues to take, military action against terrorism and
currently has troops in Iraq and in Afghanistan. In addition, the current
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.





-
31 -


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;•
            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.




-
32 -
 
 Table of
Contents
 
 
 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, of which
we ceased to use 33,766 square feet in 2010. We have approximately
25,981 square feet of space in Irvine, California, which is leased through
November 30, 2012, which we creased to use in 2009 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 Japan, Korea, and Taiwan. 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.




-
33 -
 
 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
            
            
            Low2009Fourth
      Quarter
            
            $
            2.70
            
            
            $
            2.11Third
      Quarter
            
            
            3.39
            
            
            
            2.23Second
      Quarter
            
            
            3.19
            
            
            
            2.17First
      Quarter
            
            $
            4.44
            
            
            $
            2.042008Fourth
      Quarter
            
            $
            5.11
            
            
            $
            3.08Third
      Quarter
            
            
            7.40
            
            
            
            4.95Second
      Quarter
            
            
            7.66
            
            
            
            5.00First
      Quarter
            
            $
            5.08
            
            
            $
            3.87





As
January 29, 2010, we had approximately 89 holders of record of our common
stock and the closing price of our common stock was $2.41. 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.




-
34 -
 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 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              
              2005(In
      thousands, except employees and per share data)Statements
      of Operations Data:Revenue
              
              $
              150,589
              
              
              $
              274,415
              
              
              $
              320,503
              
              
              $
              294,958
              
              
              $
              212,399Cost
      of revenue (1)
              
              
              69,786
              
              
              
              113,726
              
              
              
              140,443
              
              
              
              121,247
              
              
              
              83,105Gross
      margin
              
              
              80,803
              
              
              
              160,689
              
              
              
              180,060
              
              
              
              173,711
              
              
              
              129,294%
      of revenue
              
              
              53.7
              %
              
              
              58.6
              %
              
              
              56.2
              %
              
              
              58.9
              %
              
              
              60.9
              %Research
      and development (2)
              
              $
              68,229
              
              
              $
              84,819
              
              
              $
              77,994
              
              
              $
              63,598
              
              
              $
              44,860%
      of revenue
              
              
              45.3
              %
              
              
              30.9
              %
              
              
              24.3
              %
              
              
              21.6
              %
              
              
              21.1
              %Selling,
      general and administrative (3)
              
              $
              55,000
              
              
              $
              71,719
              
              
              $
              70,340
              
              
              $
              67,597
              
              
              $
              31,438%
      of revenue
              
              
              36.5
              %
              
              
              26.1
              %
              
              
              21.9
              %
              
              
              22.9
              %
              
              
              14.8
              %Restructuring
      expense (4)
              
              $
              22,907
              
              
              $
              5,858
              
              
              $
              -
              
              
              $
              -
              
              
              $
              (220
              )%
      of revenue
              
              
              15.2
              %
              
              
              2.1
              %
              
              
              -
              
              
              
              -
              
              
              
              (0.1
              )%Impairment
      of goodwill
              
              $
              19,210
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -%
      of revenue
              
              
              12.8
              %
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Impairment
      of intangible assets
              
              $
              28,296
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -
              
              
              $
              -%
      of revenue
              
              
              18.8
              %
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Income
      (loss) from operations
              
              $
              (117,317
              )
              
              $
              (8,055
              )
              
              $
              28,155
              
              
              $
              47,252
              
              
              $
              51,572Net
      income (loss)
              
              $
              (129,109
              )
              
              $
              10,063
              
              
              $
              19,001
              
              
              $
              42,465
              
              
              $
              49,549Net
      income (loss) per share:Basic
              
              $
              (1.72
              )
              
              $
              0.13
              
              
              $
              0.22
              
              
              $
              0.51
              
              
              $
              0.63Diluted
              
              $
              (1.72
              )
              
              $
              0.13
              
              
              $
              0.22
              
              
              $
              0.49
              
              
              $
              0.59Weighted
      average shares - basic
              
              
              74,912
              
              
              
              75,570
              
              
              
              85,557
              
              
              
              82,787
              
              
              
              79,254Weighted
      average shares - diluted
              
              
              74,912
              
              
              
              76,626
              
              
              
              87,388
              
              
              
              86,791
              
              
              
              83,957Consolidated
      Balance Sheet and Other Data as of Year End:Cash
      and cash equivalents
              
              $
              29,756
              
              
              $
              95,414
              
              
              $
              137,822
              
              
              $
              81,921
              
              
              $
              77,877Short-term
      investments
              
              
              120,866
              
              
              
              89,591
              
              
              
              111,889
              
              
              
              168,724
              
              
              
              73,685Working
      capital
              
              
              163,482
              
              
              
              186,112
              
              
              
              223,688
              
              
              
              262,080
              
              
              
              152,204Total
      assets
              
              
              225,438
              
              
              
              326,541
              
              
              
              412,948
              
              
              
              380,231
              
              
              
              233,021Other
      long-term liabilities
              
              
              9,573
              
              
              
              8,064
              
              
              
              13,910
              
              
              
              538
              
              
              
              6,867Total
      stockholders' equity
              
              
              171,519
              
              
              
              278,947
              
              
              
              313,847
              
              
              
              305,222
              
              
              
              176,546Regular
      full-time employees
              
              
              526
              
              
              
              610
              
              
              
              635
              
              
              
              442
              
              
              
              384(1)
      Includes stock-based compensation expense (benefit)
              
              $
              986
              
              
              $
              1,445
              
              
              $
              1,597
              
              
              $
              2,427
              
              
              $
              (1,383
              )(2)
      Includes stock-based compensation expense (benefit)
              
              
              6,252
              
              
              
              7,134
              
              
              
              8,411
              
              
              
              11,108
              
              
              
              (3,851
              )(3)
      Includes stock-based compensation expense (benefit)
              
              
              10,863
              
              
              
              10,893
              
              
              
              9,442
              
              
              
              13,696
              
              
              
              (3,297
              )(4)
      Includes stock-based compensation expense (benefit)
              
              
              -
              
              
              
              14
              
              
              
              -
              
              
              
              -
              
              
              
              -


-
35 -
 Table of
Contents





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 storage, distribution and presentation of
high-definition content in home and mobile environments.  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





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 are not entitled to
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. All
shipping costs are charged to cost of product revenue.





Revenue from
products sold to distributors with agreements allowing for stock
rotations are generally recognized upon shipment.  Reserves for
stock rotations are estimated based primarily on historical experience and
provided for at the time of shipment.





For products
sold to distributors with agreements allowing for price concessions and stock
rotation rights/product returns, we recognize revenue based on when the
distributor reports that it has sold the product to its customer. Our
recognition of such distributor sell-through is based on point of sales reports
received from the distributor which establishes a customer, quantity and final
price. Revenue is not recognized upon our shipment of product to the
distributor, since, due to certain forms of price concessions, the sales price
is not substantially fixed or determinable at the time of shipment. Price
concessions are recorded when incurred, which is generally at the time the
distributor sells the product to its customer. Additionally, these distributors
have stock rotation rights permitting them to return products to us, up to a
specified amount for a given period of time. When the distributor reports that
it has sold product to its customer, our sales price to the distributor is
fixed. Once we receive the point of sales reports from a distributor, it has
satisfied all the requirements for revenue recognition with respect to the
product reported as sold and any product returns/stock rotation and price
concession rights that the distributor has under its distributor agreement with
Silicon Image lapsed at that time. Pursuant to our distributor agreements,
older, end-of-life and certain other products are generally sold with no right
of return and are not eligible for price concessions. For these products,
revenue is recognized upon shipment and title transfer assuming all other
revenue recognition criteria are met.




-
36 -
 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, until revenue is recognized, record the gross margin in “deferred margin on
sale to distributors,” a component of current liabilities in our consolidated
balance sheets. Deferred margin on the sale to distributor effectively
represents the gross margin on the sale to the distributor. However, the amount
of gross margin we recognize in future periods will be less than the originally
recorded deferred margin on sales to distributor as a result of negotiated price
concessions. We sell each item in 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
is priced at a discount from list price. Often, under these circumstances, we
remit back to the distributor a portion of their original purchase price after
the resale transaction is completed. Thus, a portion of the “deferred margin on
the sale to distributor” balance represents a portion of distributors’ original
purchase price that will be remitted back to the distributor in the future. The
wide range and variability of negotiated price concessions granted to
distributors does not allow us to accurately estimate the portion of the balance
in the deferred margin on the sale to distributors line item that will be
remitted back to the distributors. In addition to the above, we also reduce the
deferred margin by anticipated or determinable future price protections based on
revised price lists, if any.





We derive
revenue from license of its internally developed intellectual property (IP). We
enter into IP licensing agreements that generally provide licensees the right to
incorporate 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 Financial Accounting Standards Board (FASB) Accounting Standards
Codification No. 605-25-25, Multiple-Element Arrangements
Recognition, previously discussed in Emerging Issues Task Force
(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 revenue criteria mentioned above.





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





Certain
licensing agreements provide for royalty payments based on agreed upon royalty
rates. Such rates can be fixed or variable depending on the terms of the
agreement. The amount of revenue we recognize is determined based on a time
period or on the agreed-upon royalty rate, extended by the number of units
shipped by the customer. To determine the number of units shipped, 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.
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 FASB ASC No. 605-35-25, Construction-Type and
Production-Type Contracts Recognition, previously discussed in Statement
Of Position (SOP) 81-1, Accounting for Performance
of Construction-Type and
Certain Production-Type Contracts.Revenues derived from such license
contracts are accounted for using the percentage-of-completion
method.





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




-
37 -
 Financial
Instruments





We account
for our investments in debt securities under FASB ASC No. 320-10-25, Investments in Debt and Equity
Securities Recognition, previously discussed in Statement of Financial
Accounting Standards (SFAS) No. 115, Accounting for Certain Investments
in Debt and Equity Securities. 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 adopted the guidance provided by FASB ASC No.
320-10-65, Transition Related
to Recognition and Presentation of Other-Than-Temporary Impairments,previously referred to
as FASB Staff Position (FSP) FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairmentseffective April 1, 2009 and use the
guidance therein to assess whether our investments with unrealized loss
positions are other than temporarily impaired. Other-than-temporary
impairment charges exists when the entity has the intent to sell the security,
it will more likely than not be required to sell the security before anticipated
recovery or it does not expect to recover the entire amortized cost basis of the
security. Other than temporary impairments are determined based on the specific
identification method and are reported in the consolidated statements of
operations.





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. Historically, unrealized losses have been due to changes in interest rates
and bond yields.  Due to the high credit quality of such investments,
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 FASB ASC No. 305-10-20, Cash and Cash Equivalents
Glossary, previously discussed in 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.




Derivative
Instruments





We recognize
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. We account for derivative instruments in accordance with FASB ASC
No. 815-20-25, Derivatives and
Hedging Recognition, previously discussed in SFAS 133, Accounting for Derivative
Instruments and Hedging Activities. 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 derivative gain (loss) is
reported in each reporting period in other income (expense) on the Company’s
consolidated statement of operations.





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. While we endeavor to accurately estimate the
allowance, we may record unanticipated write-offs in the future.




-
38 -


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 operations 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 (unless specific facts and circumstances warrant no
write-down or a write-down to a different value) 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





Goodwill is
recorded as the difference, if any, between the aggregate consideration paid for
a business acquisition and the fair value of the tangible and intangible assets
acquired.





We
periodically review the carrying value of intangible assets not subject to
amortization, including goodwill, to determine whether impairment may exist.
FASB ASC No. 350-20-35, Subsequent Measurement of
Goodwill, and FASB ASC No. 350-30-35, Subsequent Measurement of General
Intangibles Other Than Goodwill(“ASC 350-30-35”), whose provisions were
previously discussed in SFAS No. 142, Goodwill and Other Intangible
Assets, require that goodwill be assessed annually for impairment using
fair value measurement techniques. Specifically, goodwill impairment is
determined using a two-step process. The first step of the goodwill impairment
test is used to identify potential impairment by comparing the fair value of a
reporting unit with its carrying amount, including goodwill.  We have
determined based on the criteria of FASB ASC No. 280-10-50, Segment Reporting Disclosure,
previously discussed in SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information,that we have one reporting unit. 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. We generally determine the fair value of the reporting unit using
generally accepted valuation methodology which considers market capitalization
and market premiums. 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.





For certain
long-lived assets, primarily fixed assets and identifiable intangible assets,
for example the IP we acquired from Sunplus (refer to Note 12 below), we are
required to estimate the useful life of its asset and recognize the cost as an
expense over the estimated 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 FASB ASC No. 360-10-35, Subsequent Measurement of Property,
Plant and Equipment,paragraphs 15-49, Impairment or Disposal of
Long-Lived Assets, previously discussed in 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 to our statement
of operations 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 amortize
purchased intangible assets over their estimated useful lives unless these lives
are determined to be indefinite. Significant assumptions are inherent and highly
subjective in this process.





We assign 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 $9.0 million, $10.3 million and $9.5 million for the years ended
December 31, 2009, 2008 and 2007, respectively.




- 39 -
 Income
Taxes





We account
for income taxes in accordance with the FASB ASC No. 740 (“ASC 740”), previously
discussed in SFAS No. 109, Accounting for Income
Taxes.





We 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.





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 realization of the
deferred tax assets quarterly and will continue to assess the need for valuation
allowances. In accordance with ASC 740, we 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. The provisions under ASC 740 were previously discussed in FIN 48,
Accounting for Uncertainty in
Income Taxes — an Interpretation of FASB Statement
No. 109.




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.





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.







-
40 -
 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 FASB ASC No. 712-10-25, Nonretirement Postemployment
Benefits Recognition, previously discussed in SFAS No. 112, Employers’ Accounting for
Postemployment Benefits. One-time termination benefits and contract
settlement and lease costs are recorded in accordance with FASB ASC No.
420-10-25, Exit or Disposal
Cost Obligations Recognition, previously discussed in SFAS 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. Restructuring expense accruals related to future lease
commitments on exited facilities 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
operations.





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 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
operations.





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 44.2%, 55.1% and 57.7% of our revenue in 2009,
2008 and 2007, 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 2009, 59.9% of our revenue was generated through distributors,
compared to 60.2% in 2008 and 2007. Microtek comprised 11.9%, 11.8% and 14.2% of
our revenue in 2009, 2008 and 2007, respectively. Weikeng Industrial generated
10.3% and 11.5% of our revenue in 2009 and 2008,
respectively.  Revenue from World Peace Inc. comprised 14.6% and 13.6%
of our revenue in 2008 and 2007, respectively.  Innotech Corporation
comprised 10.5% and 15.6% of our revenue in 2008 and 2007,
respectively.


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
67.3%, 71.2% and 71.7% of our revenue in 2009, 2008 and 2007, 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.




-
41 -
 Recent
Accounting Pronouncements





In June 2009,
the Financial Accounting Standards Board (“FASB”) issued Accounting Standard
Codification (“ASC”) No. 105, Generally Accepted Accounting
Principles (“GAAP”) (“ASC 105” or “FASB Codification”), previously
referred to as  Statement of Financial Accounting Standard (“SFAS”)
No. 168, The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles - a replacement of FASB Statement No 162(“SFAS 168”).The effective date for
use of the FASB Codification is for interim and annual periods ending after
September 15, 2009. Companies should account for the adoption of the
guidance on a prospective basis. Effective July 1, 2009, the Company adopted the
FASB Codification and its adoption did not have a material impact on its
consolidated financial statements. The Company has appropriately updated its
disclosures with the appropriate FASB Codification references for the year
ended December 31, 2009.  As such, all the notes to the condensed
consolidated financial statements as well as the critical accounting policies in
the Management’s Discussion and Analysis section have been updated with the
appropriate FASB Codification references.





In December
2007, the FASB issued ASC No. 805, Business Combinations (“ASC
805”), previously referred to as  SFAS 141 (revised 2007), Business Combinations. ASC 805 will
significantly change current practices regarding business combinations. Among
the more significant changes, ASC 805 expands the definition of a business and a
business combination; requires the acquirer to recognize the assets acquired,
liabilities assumed and noncontrolling interests (including goodwill), measured
at fair value at the acquisition date; requires acquisition-related expenses and
restructuring costs to be recognized separately from the business combination;
and requires in-process research and development to be capitalized at fair value
as an indefinite-lived intangible asset. ASC 805 is effective for financial
statements issued for fiscal years beginning after December 15, 2008. The
Company adopted the provisions of ASC 805 on January 1, 2009 and the
adoption did not have a significant impact on the Company’s consolidated
financial statements. However, if the Company enters into material business
combinations in the future, a transaction may significantly impact the Company’s
consolidated financial statements as compared to the Company’s previous
acquisitions accounted for under prior GAAP requirements, due to the changes
described above.





In December
2007, the FASB issued ASC No. 810-10-65, Transition Related to Noncontrolling
Interests in Consolidated Financial Statement(“ASC 810-10-65”),
previously referred to asSFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements — an amendment of Accounting Research Bulletin
(“ARB”) No. 51. ASC 810-10-65 is effective for financial statements
issued for fiscal years beginning after December 15, 2008. The Company adopted
provisions under ASC 810-10-65 on January 1, 2009.  The Company
does not currently have any non-controlling interests in its subsidiaries, and
accordingly the adoption of this standard did not have a material impact on the
Company’s consolidated financial statements.





In March
2008, the FASB issued ASC No. 815-10-65, Transition Related to Disclosures
about Derivative Instruments and Hedging Activities (“ASC 815-10-65”),
previously referred to as SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133, which requires additional disclosures about the objectives
of using derivative instruments, the method by which the derivative instruments
and related hedged items are accounted for under ASC No. 815, Derivatives and Hedging(“ASC
815”), previously referred to as 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. ASC 815 also
requires disclosure of the fair values of derivative instruments and their gains
and losses in a tabular format. Per ASC 815-10-65, the additional disclosures
about derivatives and hedging activities mentioned above are required for
financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early adoption
encouraged.  The Company adopted the provisions mentioned above
effective January 1, 2009 and its  adoption did not have a material
impact on its consolidated financial statements.




In April
2009, the FASB issued ASC No. 320-10-65, Transition Related to Recognition
and Presentation of Other-Than-Temporary Impairments(“ASC 320-10-65”),
previously referred to as  FASB Staff Position (“FSP”) FAS 115-2 and
FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments. ASC 320-10-65 amends
the other-than-temporary impairment guidance for debt securities to make the
guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments in the financial statements. The most
significant change ASC 320-10-65 brings is a revision to the amount of
other-than-temporary loss of a debt security recorded in earnings. ASC 320-10-65
is effective for interim and annual reporting periods ending after June 15,
2009. The Company adopted this FSP effective April 1, 2009 and the Company’s
adoption did not have a material impact on its consolidated financial
statements.




-
42 -
 In April 2009, the FASB
issued ASC No. 820-10-35, Fair
Value Measurements and Disclosures – Subsequent Measurement (“ASC
820-10-35”), which discusses the provisions related to the determination
of fair value when the volume and level of activity for the asset or liability
have significantly decreased, which was previously discussed in FSP SFAS 157-4,
Determining Fair Value When
the Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly. ASC
820-10-35 provides additional guidance for estimating fair value when the volume
and level of activity for the asset or liability have significantly decreased.
ASC 820-10-35 also includes guidance on identifying circumstances that indicate
a transaction is not orderly. ASC 820-10-35 emphasizes that even if there has
been a significant decrease in the volume and level of activity for the asset or
liability and regardless of the valuation technique(s) used, the objective of a
fair value measurement remains the same. Fair value is the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed sale) between
market participants at the measurement date under current market conditions. In
accordance with FASB ASC No. 820-10-65, Transition Related to FASB Statement
No. 157-4,” the above provisions are effective for interim and annual
reporting periods ending after June 15, 2009, and is applied
prospectively.  The Company adopted the provisions relating to
determining the fair value when the volume and level of activity for the asset
or liability have significantly decreased and identifying transactions that are
not orderly under ASC 820-10-35  effective April 1, 2009 and its
adoption did not have a material impact on its consolidated financial
statements.





In April
2009, the FASB issued ASC No. 805-10-35, Business Combinations Subsequent
Measurement (“ASC 805-10-35”), which discusses the accounting for assets
acquired and liabilities assumed in a business combination that arise from
contingencies, which was previously discussed in FSP FAS 141(R)-1, Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies. ASC 805-10-35 addresses application issues on initial
recognition and measurement, subsequent measurement and accounting, and
disclosure of assets and liabilities arising from contingencies in a business
combination. The provisions under ASC 805-10-35 relating to assets acquired and
liabilities assumed in a business combination that arise from contingencies are
effective for business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.  The Company adopted the provisions of ASC 805 on
January 1, 2009 and the adoption did not have a significant impact on the
Company’s consolidated financial statements. However, if the Company enters into
material business combinations in the future, a transaction may significantly
impact the Company’s consolidated financial statements as compared to the
Company’s previous acquisitions, accounted for under prior GAAP requirements,
due to the changes described above.





In May 2009,
the FASB issued ASC No. 855, Subsequent Events(“ASC
855”), previously referred to as SFAS No. 165, Subsequent Events. ASC 855
should be applied to the accounting for and disclosure of subsequent events.
This Statement does not apply to subsequent events or transactions that are
within the scope of other applicable GAAP that provide different guidance on the
accounting treatment for subsequent events or transactions.  ASC 855
would apply to both interim financial statements and annual financial
statements. The objective of ASC 855 is to establish general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. In
particular, this Statement sets forth: 1) The period after the balance sheet
date during which management of a reporting entity should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements; 2) The circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its
financial statements; and, 3) The disclosures that an entity should make about
events or transactions that occurred after the balance sheet date. ASC 855 is
effective for interim or annual financial periods ending after June 15, 2009.
The Company adopted this standard effective April 1, 2009 and the Company’s
adoption did not have a material impact on its consolidated financial
statements.





In October
2009, the FASB issued Accounting Standard Update No. 2009-13 on Topic 605, Revenue Recognition– Multiple
Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task
Force.The objective of this Update is to address the accounting for
multiple-deliverable arrangements to enable vendors to account for products or
services (deliverables) separately rather than as a combined unit. Vendors often
provide multiple products or services to their customers. Those deliverables
often are provided at different points in time or over different time periods.
This Update provides amendments to the criteria in Subtopic 605-25 for
separating consideration in multiple-deliverable arrangements. The amendments in
this Update establish a selling price hierarchy for determining the selling
price of a deliverable. The selling price used for each deliverable will be
based on vendor specific objective evidence if available, third-party evidence
if vendor-specific objective evidence is not available, or estimated selling
price if neither vendor specific objective evidence nor third-party evidence is
available. The amendments in this Update also will replace the term fair value
in the revenue allocation guidance with selling price to clarify that the
allocation of revenue is based on entity-specific assumptions rather than
assumptions of a marketplace participant. This update is effective for fiscal
years beginning on or after June 15, 2010.  The Company is currently
evaluating the impact of this new accounting update on its consolidated
financial statements.





In November
2009, FASB issued Accounting Standard Update No. 2009-14 on Topic 985, Certain Revenue Arrangements That
Include Software Elements,previously included in American Iinstitute of
Certified Public Accountants SOP No. 97-2, Software Revenue
Recognition.  Topic 985 focuses on determining which
arrangements are within the scope of the software revenue guidance and which are
not. This topic removes tangible products from the scope of the software revenue
guidance if the products contain
both software and nonsoftware components that function together to deliver a
product’s essential functionality and provides guidance on determining whether
software deliverables in an arrangement that includes a tangible product are
within the scope of the software revenue guidance. This update is effective for
fiscal years beginning on or after June 15, 2010.  The Company is
currently evaluating the impact of this new accounting update on its
consolidated financial statements.




-
43 -
 Annual
Results of Operations





Revenue by
product line was as follows:




2009
              
              
              Change
              
              
              2008
              
              
              Change
              
              
              2007(Dollars
      in thousands)Consumer
      Electronics
              
              $
              102,391
              
              
              
              (38.9
              )%
              
              $
              167,599
              
              
              
              (21.3
              )%
              
              $
              212,910Personal
      Computer
              
              
              8,905
              
              
              
              (77.8
              )%
              
              
              40,141
              
              
              
              17.1
              %
              
              
              34,283Storage
              
              
              11,372
              
              
              
              (55.3
              )%
              
              
              25,461
              
              
              
              1.1
              %
              
              
              25,181Total
      product revenue
              
              $
              122,668
              
              
              
              (47.4
              )%
              
              $
              233,201
              
              
              
              (14.4
              )%
              
              $
              272,374Percentage
      of total revenue
              
              
              81.5
              %
              
              
              
              
              
              
              85.0
              %
              
              
              
              
              
              
              85.0
              %Licensing
      revenue
              
              $
              27,921
              
              
              
              (32.3
              )%
              
              $
              41,214
              
              
              
              (14.4
              )%
              
              $
              48,129Percentage
      of total revenue
              
              
              18.5
              %
              
              
              
              
              
              
              15.0
              %
              
              
              
              
              
              
              15.0
              %Total
      revenue
              
              $
              150,589
              
              
              
              (45.1
              )%
              
              $
              274,415
              
              
              
              (14.4
              )%
              
              $
              320,503
  Revenue
(including development, licensing and royalty revenues (collectively, “licensing
revenue”), by product line):




2009
              
              
              Change
              
              
              2008
              
              
              Change
              
              
              2007(Dollars
      in thousands)Consumer
      Electronics
              
              $
              129,178
              
              
              
              (35.3
              )%
              
              $
              199,591
              
              
              
              (19.3
              )%
              
              $
              247,205Personal
      Computer
              
              
              8,957
              
              
              
              (79.8
              )%
              
              
              44,311
              
              
              
              8.7
              %
              
              
              40,767Storage
      Products
              
              
              12,454
              
              
              
              (59.2
              )%
              
              
              30,513
              
              
              
              (6.2
              )%
              
              
              32,531Total
      revenue
              
              $
              150,589
              
              
              
              (45.1
              )%
              
              $
              274,415
              
              
              
              (14.4
              )%
              
              $
              320,503


Total revenue
for 2009 was $150.6 million and represented a decline of 45.1% from 2008
levels. Revenue from all our product lines in 2009 decreased when compared to
revenues generated in 2008. Revenues in 2009 from Consumer Electronics (“CE”),
Personal Computers (“PC”), storage and licensing decreased by 38.9%, 77.8%,
55.3% and 32.3%, respectively, when compared to the revenues generated in these
product lines in 2008. Revenues from our product lines decreased by $110.5
million or 47.4% from $233.2 million in 2008 to $122.7 million in 2009. Product
shipments in 2009 decreased by approximately 31.1% and average selling
price declined by approximately 24.8% when compared to the shipments and
average selling prices in 2008, primarily due to the ongoing global recession,
increased competition, product mix changes in the DTV market and our ongoing
product transition as customers transition from HDMI receivers to more cost
effective Port Processors.  Another factor that caused the unit shipments
to decrease from fiscal year 2008 to 2009 was the HDMI and SATA integration into
PC chip sets.





We also
experienced significant declines in our licensing revenues for the year ended
December 31, 2009 as compared to the licensing revenues generated in 2008. 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 18.5%, 15.0% and 15.0% of our
total revenues for the years ended December 31, 2009, 2008 and 2007,
respectively. The decrease in licensing revenues in 2009 as compared to 2008 was
due primarily to the overall softening of demand for consumer products as a
result of the deterioration of the global economic climate.





During the
first quarter of fiscal year 2010, we expect our revenues to decrease
sequentially.





-
44 -
 From time to
time, we enter into “direct
agreements” for certain of our products for certain identified end
customers with our distributors who previously had the rights for price
concessions and product returns. The “direct agreements” convert
the previously existing distributor relationship for these products and
identified customers into a direct customer whereby the distributor does not
have price protection or return rights. Revenue for such sales is recorded at
the time of shipment.  For the years ended December 31, 2009, December
31, 2008 and December 31, 2007, we recorded $40.1million, $21.2 million and $31.0 million in revenue
under such direct arrangements, respectively.


Also during
the year 2009, as part of our strategic realignment of our distributor
relationships, we entered into “sell- in agreements” with
some of our distributors for certain products for identified end customers.
These “sell-in
agreements” do not provide for price protection, but allow limited stock
rotation rights. Additionally, at the time of entering into the “sell- in agreements”, the
distributors are allowed to convert products which had been previously shipped
under the distributor agreement into products under the “sell- in agreements”. As a
result of such conversion, the distributors sacrifice the right of price
protection, therefore resulting in the price for such products becoming fixed.
Products sold to the distributors under the sell-in agreements are recorded as
revenue upon shipment (or, in the case of a conversion to sell-in, upon
conversion) with an appropriate reserve for expected stock rotation returns
recorded at the time of shipment (or at the time of conversion for conversions
to sell-in).  The primary reason for the strategic realignment of our
distributor relationships towards a direct revenue model and away from the
distributor model was to leverage the benefits of the direct model, such as
better risk management and increased operational and transactional processing
efficiencies.  For the year ended December 31, 2009, we recorded $5.6
million in revenue under sell in arrangements.
 Total revenue
for 2008 was $274.4 million and represented a decline of 14.4% from 2007
levels and was primarily driven by declines in sales of our Consumer
Electronics 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 included approximately
$6.7 million of product revenue and cost of revenue included 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.








-
45 -


COST
OF REVENUE AND GROSS MARGIN




2009
              
              
              Change
              
              
              2008
              
              
              Change
              
              
              2007(Dollars
      in thousands)Cost
      of product revenue(1)
              
              $
              68,574
              
              
              
              (39.1
              )%
              
              $
              112,539
              
              
              
              (16.7
              )%
              
              $
              135,168Cost
      of licensing revenue(1)
              
              $
              1,212
              
              
              
              2.1
              %
              
              $
              1,187
              
              
              
              (77.5
              )%
              
              $
              5,275Total
      cost of revenue
              
              $
              69,786
              
              
              
              (38.6
              )%
              
              $
              113,726
              
              
              
              (19.0
              )%
              
              $
              140,443Total
      gross margin
              
              $
              80,803
              
              
              
              (49.7
              )%
              
              $
              160,689
              
              
              
              (10.8
              )%
              
              $
              180,060Gross
      margin as a percentage of total revenue
              
              
              53.7
              %
              
              
              
              
              
              
              58.6
              %
              
              
              
              
              
              
              56.2
              %(1)
      Includes stock-based  compensation expense
              
              $
              986
              
              
              
              (31.8
              )%
              
              $
              1,445
              
              
              
              (9.5
              )%
              
              $
              1,597





Cost of
revenue consists primarily of costs incurred to manufacture, assemble and test
our products, and costs to license our technology which involves modification,
customization or engineering services, as well as other overhead costs relating
to the aforementioned costs including stock-based compensation expense. 
Gross margin was 53.7%, 58.6% and 56.2% for the years ended December 31, 2009,
2008 and 2007, respectively.  Product mix, unfavorable variances and
the impact of fixed overhead with lower revenue volume during the year
ended December 31, 2009 were the primary reasons for the decrease in cost of
revenue and the decrease in gross margin as percentage of revenue.
Increased competition in all business lines as reflected in the decline in the
average selling price also contributed to the overall decrease in the gross
margin in 2009 when compared to 2008.





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.








-
46 -





OPERATING
EXPENSES





Research
      and development
            
            2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007(Dollars
      in thousands)Research
      and development(1)
            
            $
            68,229
            
            
            
            (19.6
            )%
            
            $
            84,819
            
            
            
            8.8
            %
            
            $
            77,994Percentage
      of total revenue
            
            
            45.3
            %
            
            
            
            
            
            
            30.9
            %
            
            
            
            
            
            
            24.3
            %(1)
      Includes stock-based  compensation expense
            
            
            6,252
            
            
            
            
            
            
            
            7,134
            
            
            
            
            
            
            
            8,411





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 $68.2 million, or 45.3% of revenue for 2009 compared to
$84.8 million, or 30.9% of revenue for 2008 and $78.0 million, or
24.3% of revenue for 2007. R&D expense for the year ended December 31, 2009
included stock-based compensation expense of approximately $6.3 million as
compared to $7.1 million for the same period in 2008. For the year ended
December 31, 2009, approximately $1.1 million of the $6.3 million stock-based
compensation expense was related to the cumulative adjustment pertaining to the
errors we identified with respect to the stock-based compensation expense as
calculated by our third-party software (refer to discussion in Note 5 of our
Notes to Consolidated Financial Statements under Item 1 of Part
IV).





R&D
expenses decreased by $16.6 million or 19.6% in the year ended December 31, 2009
as compared to the comparable period in 2008, primarily due to lower
compensation related expenses as a result of lower headcount due to
restructuring activities and lower R&D project related and tape-out
expenses, partially offset by the $1.1 million stock-based compensation
cumulative adjustment previously mentioned.





R&D
expenses increased $6.8 million or 8.8% 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.








-
47 -




Selling
      general and administrative
            
            2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007(Dollars
      in thousands)Selling,
      general and administrative (1)
            
            $
            55,000
            
            
            
            (23.3
            )%
            
            $
            71,719
            
            
            
            2.0
            %
            
            $
            70,340Percentage
      of total revenue
            
            
            36.5
            %
            
            
            
            
            
            
            26.1
            %
            
            
            
            
            
            
            21.9
            %(1)
      Includes stock-based  compensation expense
            
            
            10,863
            
            
            
            
            
            
            
            10,893
            
            
            
            
            
            
            
            9,442




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. SG&A expense,
including stock-based compensation expense, was $55.0 million, or 36.5% of
revenue for 2009 compared to $71.7 million, or 26.1% of revenue for 2008
and $70.3 million, or 21.9% of revenue for 2007. SG&A expense for the
years ended December 31, 2009 and 2008 included stock-based compensation expense
of approximately $10.9 million. For the year ended December 31, 2009,
approximately $2.8 million of the $10.9 million stock-based compensation expense
was related to the cumulative adjustment pertaining to the errors we identified
with respect to the stock-based compensation expense as calculated by our
third-party software (refer to discussion in Note 5 of our Notes to Consolidated
Financial Statements under Item 1 of Part IV). SG&A expense for the year
ended December 31, 2009 also included $2.0 million professional fees associated
with a potential strategic acquisition which we evaluated but decided
not to pursue and $1.2 million compensation package provided to the Chief
Executive Officer (“CEO”) upon his resignation





SG&A
expense for the year ended December 31, 2009 was $16.7 million or 23.3% lower
than in the year ended December 31, 2008 due to lower compensation related
expenses and legal expenses, partially offset by the $2.8 million stock-based
compensation cumulative adjustment, $2.0 million professional fees and $1.2
million compensation given to the CEO. Had it not been for these one time
expenses, SG&A expense for the year ended December 31, 2009 could have been
lower by $22.7 million or 31.7% when compared to the SG&A expense for the
same period in 2008. The decrease in SG&A expense was mainly attributable to
the decrease in head count because of the reduction in forces completed in 2009
and 2008.





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.






-
48 -


Amortization
      of intangible assets
            
            2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007(Dollars
      in thousands)Amortization
      of intangible assets
            
            $
            4,478
            
            
            
            (29.5
            )%
            
            $
            6,348
            
            
            
            78.9
            %
            
            $
            3,549Percentage
      of total revenue
            
            
            3.0
            %
            
            
            
            
            
            
            2.3
            %
            
            
            
            
            
            
            1.1
            %




Amortization of intangible
assets.  Amortization of intangible assets was $4.5 million for
the year ended December 31, 2009, as compared to $6.3 million for the same
period in 2008. The decrease in the amortization of intangible assets was
primarily due to the complete amortization of certain intangible assets related
to the sci-worx acquisition in 2007 and write-off of the investment in an
intellectual property (refer to the impairment discussion in Note 12 of our
Notes to Consolidated Financial Statements under Item 1 of Part
IV).





Amortization
of intangible assets was $6.3 million for the year 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 investment in an intellectual property in the fourth quarter
of 2007 (see further discussion about this investment in Note 12 of our
Notes to Consolidated Financial Statements under Item I of Part
IV).




Restructuring
            
            2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007(Dollars
      in thousands)Restructuring
      expense(1)
            
            $
            22,907
            
            
            
            291.0
            %
            
            $
            5,858
            
            
            
            100.0
            %
            
            $
            -Percentage
      of total revenue
            
            
            15.2
            %
            
            
            
            
            
            
            2.1
            %
            
            
            
            
            
            
            -(1)
      Includes stock-based  compensation expense
            
            $
            -
            
            
            
            
            
            
            $
            14
            
            
            
            
            
            
            $
            -





In
June and October 2009, we announced restructuring plans to realign and
focus our resources on our core competencies and in order to better align its
revenues and expenses. The restructuring expense for the year ended December 31,
2009, consists primarily of $22.1 million related to employee severance and
benefit arrangements primarily due to the closure of the two Germany sites, a
charge of $0.6 million relating to retirement of certain assets and a charge of
$0.2 million relating to operating lease termination costs. In October 2009, we
decided to restructure our research and development operations resulting in the
planned closure of our two sites in Germany (see more discussion about our
restructuring activities in Note 10 of our Notes to Consolidated Financial
Statements under Item I of Part IV).





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 year 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 (see more discussion about
our restructuring activities in Note 10 of our Notes to Consolidated
Financial Statements under Item I of Part IV).




-
49 -
 Impairment of intangible
assets.  On October 18, 2009, we determined that, in light of
certain changes to out product strategy, the intellectual property licensed from
Sunplus Technology Co., Ltd in February 2007 (the “Sunplus IP”) no longer
aligned with our product roadmap and therefore would not be used. In connection
with the decision to discontinue the use of the Sunplus IP, the Company
wrote-off the unamortized balance of the investment in Sunplus IP of $28.3
million and recognized a pre-tax impairment charge of $28.3 million in the
consolidated statement of operations under operating expense, “Impairment of
Intangible Assets.”   See more discussion about this impairment
in Note 12 of our Notes to Consolidated Financial Statements under Item I
of Part IV).





Impairment of
Goodwill.  During the three months ended March 31, 2009,
we assessed goodwill for impairment and noted indicators of impairment including
a sustained and significant decline in our stock price, depressed market
conditions and declining industry trends. Our stock price had been in a period
of sustained decline and the business climate had deteriorated substantially in
light of the economic crisis. Based on the result of the impairment analysis
that we performed, we determined that the goodwill was impaired. As such, we
wrote off the entire goodwill balance and recognized goodwill impairment charge
of approximately $19.2 million in the consolidated statement of operations under
operating expense, “Impairment of Goodwill.” See more discussion about this
impairment in Note 13 of our Notes to Consolidated Financial Statements
under Item I of Part IV).




Interest
      income and other, net
            
            2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007(Dollars
      in thousands)Interest
      income and other, net
            
            $
            3,005
            
            
            
            (51.9
            )%
            
            $
            6,245
            
            
            
            (45.2
            )%
            
            $
            11,397Percentage
      of total revenue
            
            
            2.0
            %
            
            
            
            
            
            
            2.3
            %
            
            
            
            
            
            
            3.6
            %





Interest income and other,
net.Interest income and other, net, which principally
includes interest income, in 2009 decreased by 51.9% when compared to the same
period in 2008. Interest income and other decreased by 45.2% for the year ended
December 31, 2008 when compared to the same period in 2007. The decrease in
interest income from 2007 to 2008 and 2008 to 2009 was primarily driven by the
lower average total cash balances as a result of the cash used in operations in
2009 and the stock repurchase payments made during the first nine months
of 2008. The decline in interest rates also contributed to the sequential
decrease in interest income.




Provision
      (benefit) for income taxes
            
            2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007(Dollars
      in thousands)Provision
      (benefit) for income taxes
            
            $
            14,797
            
            
            
            (224.6
            )%
            
            $
            (11,873
            )
            
            
            (157.8
            )%
            
            $
            20,551Percentage
      of total revenue
            
            
            9.8
            %
            
            
            
            
            
            
            (4.3
            )%
            
            
            
            
            
            
            6.4
            %





Provision (benefit) for income
taxes.  For the year ended December 31, 2009, we recorded
an income tax provision of $14.8 million, compared to income tax benefit of
$11.9 million in 2008 and income tax provision of $20.6 million in
2007. Our effective income tax rate was 13% in 2009. In 2009, the difference
between the expense for income taxes and the income tax benefit determined by
applying the statutory federal income tax rate of 35% was due primarily to the
following items: (1) $43.0 million of  tax expense related to a
valuation allowance being recorded to offset deferred taxes recorded on the
balance sheet, (2) $3.8 million of expense associated with the geographic and
tax jurisdictional mix of earnings within the Company’s global business
structure, (3) $7.6 million of tax expense associated with stock-based
compensation expense being reversed for tax purposes, (4) $5.3 million expense
of foreign unbenefited  losses, and (5) $3.8 million tax expense
associated with non-deductible goodwill write-off for book
purposes.  Offsetting these expenses are benefits of: (1) $5.6 million
related to a worthless stock deduction for its investment in the Company’s
German subsidiary, and (2) $3.2 million related to federal and state research
and development tax credits generated during 2009.





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. 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.




-
50 -
 Liquidity
and Capital Resources





2009
            
            
            Change
            
            
            2008
            
            
            Change
            
            
            2007(Dollars
      in thousands)Cash
      and cash equivalents
            
            $
            29,756
            
            
            $
            (65,658
            )
            
            $
            95,414
            
            
            $
            (42,408
            )
            
            $
            137,822Short
      term investments
            
            
            120,866
            
            
            
            31,275
            
            
            
            89,591
            
            
            
            (22,298
            )
            
            
            111,889Total
      cash, cash equivalents and short term investments
            
            $
            150,622
            
            
            $
            (34,383
            )
            
            $
            185,005
            
            
            $
            (64,706
            )
            
            $
            249,711Percentage
      of total assets
            
            
            66.8
            %
            
            
            
            
            
            
            56.6
            %
            
            
            
            
            
            
            60.5
            %Total
      current assets
            
            $
            207,828
            
            
            
            (17,814
            )
            
            $
            225,642
            
            
            $
            (83,237
            )
            
            $
            308,879Total
      current liabilities
            
            
            (44,346
            )
            
            
            (4,816
            )
            
            
            (39,530
            )
            
            
            45,661
            
            
            
            (85,191
            )Working
      capital
            
            $
            163,482
            
            
            $
            (22,630
            )
            
            $
            186,112
            
            
            $
            (37,576
            )
            
            $
            223,688Cash
      provided by (used in) operating activities
            
            $
            (29,664
            )
            
            $
            (55,305
            )
            
            $
            25,641
            
            
            $
            (41,502
            )
            
            $
            67,143Cash
      provided by (used in) investing activities
            
            
            (38,066
            )
            
            
            (52,891
            )
            
            
            14,825
            
            
            
            3,009
            
            
            
            11,816Cash
      (used in) provided by financing activities
            
            
            1,354
            
            
            
            83,506
            
            
            
            (82,152
            )
            
            
            (58,980
            )
            
            
            (23,172
            )Effect
      of exchange rate changes on cash & cash
    equivalents
            
            
            718
            
            
            
            1,440
            
            
            
            (722
            )
            
            
            (836
            )
            
            
            114Net  increase
      (decrease) in cash and cash equivalents
            
            $
            (65,658
            )
            
            $
            (23,250
            )
            
            $
            (42,408
            )
            
            $
            (98,309
            )
            
            $
            55,901





At
December 31, 2009, we had $163.5 million of working capital including
$150.6 million of cash, cash equivalents and short-term investments. Cash
and cash equivalents and short-term investments decreased by $34.4 million
from $185.0 million in 2008 to $150.6 million in 2009 primarily due to the cash
used in operating and investment activities for the year ended December 31,
2009.





The
significant components of our working capital are cash and cash equivalents,
short-term investments, accounts receivable, prepaid expenses and other current
assets, inventories and deferred income taxes reduced by accounts payable,
accrued and other current liabilities, deferred license revenue, and deferred
margin on sales to distributors. Working capital at December 31, 2009 decreased
by approximately $22.6 million when compared to the working capital at December
31, 2008 primarily due to the decreases in cash and cash equivalents and
short-term investments, the increase in operating assets, such as accounts
receivable and prepaid expenses and other current assets and the decrease in
deferred margin on sales to distributors, partially offset by the decrease in
inventories and the increase in operating liabilities, such as accounts payable
and accrued and other liabilities.





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 $100.0 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, 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 $62.0 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
(‘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 $1.0 million received as part of other income
in the consolidated statement of income in the second and third quarters of
2008.





During 2009,
we did not repurchase shares of stock.





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 for at least the next twelve
months.





-
51 -





Operating
Activities





The $29.7
million cash used in operating activities during the year ended
December 31, 2009 was primarily due to the cash used for working capital as
a result of the increase in operating assets, such as accounts receivable and
prepaid expenses and other current assets and decrease in deferred margin on
sales to distributors, partially offset by the decrease in inventories and the
increase in operating liabilities, such as accounts payable and accrued
liabilities and other current liabilities.





Net accounts
receivable increased to $21.7 million at December 31, 2009 as compared to $5.9
million at December 31, 2008 primarily due to the timing of invoicing,
distributor price protection credits and collection. Prepaid expenses and other
current assets increased by $11.8 million primarily due to income tax receivable
and prepayment for certain R&D engineering services. Deferred margin on
sales to distributors decreased by $3.9 million because of lower activities with
our distributors.  Inventory decreased by $5.0 million primarily due
to our tighter inventory management and lower inventory requirements for the
first quarter of fiscal year 2010.  Accounts payable increased by $3.6
million mainly because of the timing of vendor payments. Accrued and other
liabilities increased by $6.4 million primarily due to the $13.8 million
increase in restructuring accrual, partially offset by the decreases in bonus
accrual of approximately $1.6 million, accrued payroll and other payroll related
expenses of approximately $2.6 million, accruals for software and IP liabilities
of approximately $2.5 million and other miscellaneous accruals. The decrease in
bonus accruals was due to the elimination of the bonus program in 2009 while the
decrease in accrued payroll and other payroll related expenses was primarily due
to (1) decrease in accrued commissions due to lower sales; and, (2) decrease in
ESPP liability due to lower participation in 2009 compared to 2008.





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 distributor price protection
credits 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.





-
52 -





Investing
Activities





The $38.1
million cash used in investing activities during the year ended
December 31, 2009 was due primarily to net purchases of short-term
investments of approximately $34.0 million and net investment in property and
equipment of approximately $4.1 million. During the year ended December 31,
2009, we purchased $165.1 million and sold $131.1 million short-term
investments.





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.





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 2009,
2008 and 2007 related mainly to testing equipment, leasehold improvements and
information technology infrastructure.





Financing
Activities





The $1.4
million cash generated from our financing activities during the year ended
December 31, 2009 was primarily due to the proceeds from issuances of
common stock of approximately $2.8 million, partially offset by payments to
vendor of financed purchases of software and intangibles of approximately
$1.2 million and cash used to repurchase restricted stock units for income tax
withholding of approximately $0.3 million.





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  in connection with the financing of intangibles and software
purchased, partially offset by the 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 ESPP of
$12.9 million.






-
53 -
 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 $11.6 million in
commitments for fiscal years including and beyond 2010 as disclosed in the
operating lease and other commitments table below.





Lease
and Other Obligations





In December
2009, we entered into an R&D Engineering Services Agreement with an
engineering services firm. The Company will pay the R&D engineering services
firm a total fee of up to 6 million Euros ($8.6 million) over a two-year period
from December 2009 to December 2011.





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, and Taiwan.





Rent expense
totaled $4.1 million, $5.1 million and $3.8 million in 2009, 2008
and 2007, 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.





Our future
operating lease and R&D engineering services commitments at
December 31, 2009 are as follows (in thousands):




Payments
      Due InTotal
            
            
            Less
      Than
              1
      Year
            
            
            1-3
      Years
            
            
            3-5
      Years
            
            
            More
      Than
              5
      YearsContractual Obligations:Engineering
      services commitments
            
            $
            7,508
            
            
            $
            4,290
            
            
            $
            3,218
            
            
            $
            -
            
            
            $
            -Operating
      lease obligations
            
            
            4,108
            
            
            
            2,643
            
            
            
            1,465
            
            
            
            -
            
            
            
            -Total
            
            $
            11,616
            
            
            $
            6,933
            
            
            $
            4,683
            
            
            $
            -
            
            
            $
            -





The amounts
above exclude liabilities under FASB ASC 740-10, “Income Taxes – Recognition
section,” previously contained in FIN 48 “Accounting for Uncertainty in
Income Taxes,” as the Company is unable to reasonably estimate the
ultimate amount or timing of settlement. See Note 3, “Income Taxes,” above
for further discussion.




-
54 -
 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 experienced extreme disruptions since mid 2008,
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.





-
55 -
 Table of
Contents








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, 2009, we had
an investment portfolio of securities as reported in short-term investments,
including those classified as cash equivalents of approximately
$150.6 million. A sensitivity analysis was performed on our investment
portfolio as of December 31, 2009. This sensitivity analysis was based on a
modeling technique that measures the hypothetical market value changes that
would result from a parallel shift in the yield curve of plus 50, 100, or
150 basis points over a twelve-month time horizon.





The following
represents the potential change to the value of our investments given a
shift in the yield curve used in our sensitivity analysis.





0.5%
            
            
            
            1.0%
            
            
            
            1.5%$
            427,000
            
            
            $
            854,000
            
            
            $
            1,281,000





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. 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%$
            250,000
            
            
            $
            500,000
            
            
            $
            751,000





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
a 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.




-
56 -
 Table of Contents




Foreign
Currency Exchange Risk





A
majority of our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars. However, certain operating expenditures and
capital purchases are incurred in or exposed to other currencies, primarily the
Euro, British Pound, the South Korean Won, Taiwan Dollar and the Chinese Yuan.
Additionally, many of our foreign distributors price our products in the local
currency of the countries in which they sell. Therefore, significant
strengthening or weakening of the U.S. dollar relative to those foreign
currencies could result in reduced demand or lower U.S. dollar prices or
vice versa, for our products, which would negatively affect our operating
results. Cash balances held in foreign countries are subject to local banking
laws and may bear higher or lower risk than cash deposited in the United States.
The following represents the potential impact of a change in the value of
the U.S. dollar compared to the foreign currencies which we use in
our operations.  As of December 31, 2009 and 2008, cash held in
foreign countries was approximately $8.4 million and $1.2 million,
respectively. The following represents the potential impact of a change in
the value of the U.S. dollar compared to the Euro, British Pound, Japanese Yen,
Chinese Yuan, Taiwan Dollar and Korean Won for the years ended December 31, 2009
and 2008.  This sensitivity analysis aggregates our annual activity in
these currencies, translated to U.S. dollars, and applies a change in the
U.S. dollar value of 5%, 7.5% and 10%.





Fiscal
Year 2009




5.0%
            
            
            
            7.5%
            
            
            
            10.0%$1.9
      million
            
            
            $2.9
      million
            
            
            $3.9
      million








Fiscal
Year 2008





5%
            
            
            
            7.5%
            
            
            
            10.0%$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.





-
57 -
 
 Table of
Contents
 
 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 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, 2009 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, 2009, our internal control
over financial reporting was effective.





The
effectiveness of the Company’s internal control over financial reporting as of
December 31, 2009 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 2009 fiscal year that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.




-
58 -


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, 2009, based on criteria
established in Internal
Control — Integrated Frameworkissued 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, 2009, based on the criteria
established in Internal
Control — Integrated Frameworkissued 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, 2009 of the Company and our report dated
February 12, 2010 expressed an unqualified opinion on those financial
statements.


/s/
DELOITTE & TOUCHE LLP




San Jose,
California


February
12, 2010




-
59 -
 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 2010 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 2010 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 2010 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 2010 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 2010 Annual Meeting of
Stockholders.






-
60 -
 Table of
Contents


PART IV





Item 15.Exhibits and Financial
Statement Schedules





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




Financial Statements:


PageConsolidated Balance Sheets at December 31, 2009
      and December 31, 2008
            62Consolidated Statements of Operations for each of
      the three years ended December 31, 2009
            63Consolidated Statements of
      Stockholders’ Equity for each of the three years ended December 31,
      2009
            64Consolidated Statements of Cash Flows for each
      of the three years ended December 31, 2009
            65Notes to the
      Consolidated Financial Statements
            66Unaudited Selected Quarterly Financial Data for the
      two years ended December 31, 2009
            105Report of
      Deloitte & Touche LLP, Independent Registered Public Accounting
      Firm
            106





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.




- 61 -
 
 Part
IV Table of Contents


SILICON
IMAGE, INC.





CONSOLIDATED BALANCE
SHEETS








December
      31,2009
            
            
            2008(In
      thousands, except shareand
      per share amounts)AssetsCurrent
      Assets:Cash
      and cash equivalents
            
            $
            29,756
            
            
            $
            95,414Short-term
      investments
            
            
            120,866
            
            
            
            89,591Accounts
      receivable, net of allowances for doubtful accounts
              of
      $1,428 at December 31, 2009 and $1,778 at December 31,
      2008
            
            
            21,664
            
            
            
            5,922Inventories
            
            
            7,746
            
            
            
            12,775Prepaid
      expenses and other current assets
            
            
            27,512
            
            
            
            15,275Deferred
      income taxes
            
            
            284
            
            
            
            6,665Total
      current assets
            
            
            207,828
            
            
            
            225,642Property
      and equipment, net
            
            
            14,449
            
            
            
            19,394Deferred
      income taxes, non-current
            
            
            2,336
            
            
            
            28,193Intangible
      assets, net
            
            
            150
            
            
            
            32,921Goodwill
            
            
            -
            
            
            
            19,210Other
      assets
            
            
            675
            
            
            
            1,181Total
      assets
            
            $
            225,438
            
            
            $
            326,541Liabilities
      and Stockholders’ EquityCurrent
      Liabilities:Accounts
      payable
            
            $
            10,141
            
            
            $
            7,278Accrued
      and other current liabilities
            
            
            28,150
            
            
            
            23,023Deferred
      license revenue
            
            
            3,111
            
            
            
            2,348Deferred
      margin on sales to distributors
            
            
            2,944
            
            
            
            6,881Total
      current liabilities
            
            
            44,346
            
            
            
            39,530Other
      long-term liabilities
            
            
            9,573
            
            
            
            8,064Total
      liabilities
            
            
            53,919
            
            
            
            47,594Commitments
      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: 75,419,173 - 2009 and 74,070,293 - 2008
            
            
            93
            
            
            
            92Additional
      paid-in capital
            
            
            463,189
            
            
            
            442,228Treasury
      stock
            
            
            (106,562
            )
            
            
            (106,276
            )Accumulated
      deficit
            
            
            (186,139
            )
            
            
            (57,030
            )Accumulated
      other comprehensive income (loss)
            
            
            938
            
            
            
            (67
            )Total
      stockholders’ equity
            
            
            171,519
            
            
            
            278,947Total
      liabilities and stockholders’ equity
            
            $
            225,438
            
            
            $
            326,541




See
accompanying Notes to Consolidated Financial Statements.




-
62 -
 
 Part IV Table of Contents





SILICON
IMAGE, INC.





CONSOLIDATED STATEMENTS OF
OPERATIONS








Year
      Ended December 31,2009
            
            
            2008
            
            
            2007(In
      thousands, except per share amounts)Revenue:Product
            
            $
            122,668
            
            
            $
            233,201
            
            
            $
            272,374Licensing
            
            
            27,921
            
            
            
            41,214
            
            
            
            48,129Total
      revenue
            
            
            150,589
            
            
            
            274,415
            
            
            
            320,503Cost
      of revenue and operating expenses:Cost
      of product revenue (1)
            
            
            68,574
            
            
            
            112,539
            
            
            
            135,168Cost
      of licensing revenue
            
            
            1,212
            
            
            
            1,187
            
            
            
            5,275Research
      and development (2)
            
            
            68,229
            
            
            
            84,819
            
            
            
            77,994Selling,
      general and administrative (3)
            
            
            55,000
            
            
            
            71,719
            
            
            
            70,340Restructuring
      expense (4) (Note 10)
            
            
            22,907
            
            
            
            5,858
            
            
            
            -Impairment
      of intangible assets (Note 12)
            
            
            28,296
            
            
            
            -
            
            
            
            -Impairment
      of goodwill (Note 13)
            
            
            19,210
            
            
            
            -
            
            
            
            -Amortization
      of intangible assets
            
            
            4,478
            
            
            
            6,348
            
            
            
            3,549Patent
      assertion costs, net
            
            
            -
            
            
            
            -
            
            
            
            22Total
      cost of revenue and operating expenses
            
            
            267,906
            
            
            
            282,470
            
            
            
            292,348Income
      (loss) from operations
            
            
            (117,317
            )
            
            
            (8,055
            )
            
            
            28,155Interest
      income
            
            
            2,874
            
            
            
            4,660
            
            
            
            11,346Other
      income, net
            
            
            131
            
            
            
            1,585
            
            
            
            51Income
      (loss) before provision for income taxes
            
            
            (114,312
            )
            
            
            (1,810
            )
            
            
            39,552Income
      tax  expense (benefit)
            
            
            14,797
            
            
            
            (11,873
            )
            
            
            20,551Net
      income (loss)
            
            $
            (129,109
            )
            
            $
            10,063
            
            
            $
            19,001Net
      income (loss) per share – basic  and diluted
            
            $
            (1.72
            )
            
            $
            0.13
            
            
            $
            0.22Weighted
      average shares – basic
            
            
            74,912
            
            
            
            75,570
            
            
            
            85,557Weighted
      average shares – diluted
            
            
            74,912
            
            
            
            76,626
            
            
            
            87,388(1)
      Includes stock-based compensation expense
            
            $
            986
            
            
            $
            1,445
            
            
            $
            1,597(2)
      Includes stock-based compensation expense
            
            
            6,252
            
            
            
            7,134
            
            
            
            8,411(3)
      Includes stock-based compensation expense
            
            
            10,863
            
            
            
            10,893
            
            
            
            9,442(4)
      Includes stock-based compensation expense
            
            
            -
            
            
            
            14
            
            
            
            -





See
accompanying Notes to Consolidated Financial Statements.





- 63 -
 Part IV
Table of Contents





SILICON
IMAGE, INC.





CONSOLIDATED STATEMENTS
OF STOCKHOLDERS’ EQUITY







(In thousands)AccumulatedAdditional
            
            
            
            
            
            
            
            
            OtherCommon
      Stock
            
            
            Paid-In
            
            
            Treasury
            
            
            Accumulated
            
            
            ComprehensiveShares
            
            
            Amount
            
            
            Capital
            
            
            Stock
            
            
            Deficit
            
            
            Income
      (Loss)
            
            
            TotalBalance
      at January 1, 2007
            
            
            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 adoption of a new income tax accounting standard
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (5,130
            )
            
            
            -
            
            
            
            (5,130
            )Common
      stock issued under stock option plans
            
            
            2,324
            
            
            
            2
            
            
            
            9,358
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            9,360Common
      stock issued for ESPP
            
            
            505
            
            
            
            1
            
            
            
            3,548
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,549Repurchase
      of common stock
            
            
            (5,000
            )
            
            
            -
            
            
            
            -
            
            
            
            (38,096
            )
            
            
            -
            
            
            
            -
            
            
            
            (38,096
            )Tax
      benefit from employee stock-based compensation plans
            
            
            -
            
            
            
            -
            
            
            
            182
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            182Stock-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
            
            
            
            -
            
            
            
            10,063Unrealized
      net gain on available-for-sale investments, net of tax
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            219
            
            
            
            219Foreign
      currency translation adjustments, net of tax
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (436
            )
            
            
            (436
            )Total
      comprehensive income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            9,846Common
      stock issued under stock option plans
            
            
            487
            
            
            
            1
            
            
            
            1,711
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,712Common
      stock issued for ESPP
            
            
            808
            
            
            
            1
            
            
            
            3,045
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,046Repurchase
      of common stock
            
            
            (11,538
            )
            
            
            -
            
            
            
            -
            
            
            
            (68,180
            )
            
            
            -
            
            
            
            -
            
            
            
            (68,180
            )Tax
      deficiency from employee stock-based compensation plans
            
            
            -
            
            
            
            -
            
            
            
            (810
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (810
            )Stock-based
      compensation expense
            
            
            -
            
            
            
            -
            
            
            
            19,486
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            19,486Balance
      at December 31, 2008
            
            
            74,070
            
            
            
            92
            
            
            
            442,228
            
            
            
            (106,276
            )
            
            
            (57,030
            )
            
            
            (67
            )
            
            
            278,947Net
      loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (129,109
            )
            
            
            -
            
            
            
            (129,109
            )Unrealized
      net gain on available-for-sale investments, net of tax
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            251
            
            
            
            251Foreign
      currency translation adjustments, net of tax
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            754
            
            
            
            754Total
      comprehensive loss
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (128,104
            )Common
      stock issued under stock option plans
            
            
            295
            
            
            
            -
            
            
            
            403
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            403Issuances
      of restricted stock units
            
            
            261
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Repurchase
      of restricted stock units for tax withholding
            
            
            (94
            )
            
            
            -
            
            
            
            -
            
            
            
            (286
            )
            
            
            -
            
            
            
            -
            
            
            
            (286
            )Common
      stock issued for ESPP
            
            
            887
            
            
            
            1
            
            
            
            2,401
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            2,402Tax
      benefit from employee stock-based compensation plans
            
            
            -
            
            
            
            -
            
            
            
            56
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            56Stock-based
      compensation expense
            
            
            -
            
            
            
            -
            
            
            
            18,101
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            18,101Balance
      at December 31, 2009
            
            
            75,419
            
            
            $
            93
            
            
            $
            463,189
            
            
            $
            (106,562
            )
            
            $
            (186,139
            )
            
            $
            938
            
            
            $
            171,519




See
accompanying Notes to Consolidated Financial Statements


-
64 -
 Part IV
Table of Contents


SILICON
IMAGE, INC.





CONSOLIDATED STATEMENTS
OF CASH FLOWS





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Cash
      flows from operating activities:
            
            (In
      thousands)Net
      income (loss)
            
            $
            (129,109
            )
            
            $
            10,063
            
            
            $
            19,001Adjustments
      to reconcile net income (loss) to cash provided by (used in) operating
      activities:Deferred
      income taxes
            
            
            32,238
            
            
            
            (10,896
            )
            
            
            1,195Impairment
      of intangible assets
            
            
            28,296
            
            
            
            -
            
            
            
            -Impairment
      of goodwill
            
            
            19,210
            
            
            
            -
            
            
            
            -Stock-based
      compensation expense
            
            
            18,101
            
            
            
            19,486
            
            
            
            19,450Depreciation
            
            
            8,960
            
            
            
            10,349
            
            
            
            9,464Amortization
      of intangible assets
            
            
            4,478
            
            
            
            6,348
            
            
            
            3,549Amortization/(Accretion)
      of investment premium/(discount)
            
            
            3,045
            
            
            
            1,189
            
            
            
            (524
            )Loss
      on asset write-downs due to restructuring
            
            
            649
            
            
            
            1,063
            
            
            
            -Loss
      on disposal and retirement of property and equipment
            
            
            180
            
            
            
            554
            
            
            
            1,270Tax
      benefit (deficiency) from employee stock-based compensation
      plans
            
            
            56
            
            
            
            (810
            )
            
            
            182Provision
      for doubtful accounts
            
            
            23
            
            
            
            1,218
            
            
            
            334Excess
      tax benefits from employee stock-based transactions
            
            
            (85
            )
            
            
            (548
            )
            
            
            (2,543
            )Realized
      loss (gain) on sale of short-term investments
            
            
            (7
            )
            
            
            (301
            )
            
            
            18Changes
      in assets and liabilities:Accounts
      receivable
            
            
            (15,756
            )
            
            
            14,114
            
            
            
            21,430Inventories
            
            
            5,029
            
            
            
            7,423
            
            
            
            8,280Prepaid
      expenses and other current assets
            
            
            (11,768
            )
            
            
            (1,303
            )
            
            
            (7,999
            )Accounts
      payable
            
            
            3,600
            
            
            
            (10,684
            )
            
            
            1,857Accrued
      and other liabilities
            
            
            6,370
            
            
            
            (550
            )
            
            
            (14,227
            )Deferred
      license revenue
            
            
            763
            
            
            
            (1,512
            )
            
            
            (2,325
            )Deferred
      margin on sales to distributors
            
            
            (3,937
            )
            
            
            (19,562
            )
            
            
            8,731Cash provided by (used in) operating activities
            
            
            (29,664
            )
            
            
            25,641
            
            
            
            67,143Cash
      flows from investing activities:Purchases
      of short-term investments
            
            
            (165,144
            )
            
            
            (224,499
            )
            
            
            (79,473
            )Proceeds
      from sales of short-term investments
            
            
            131,082
            
            
            
            246,370
            
            
            
            137,135Purchases
      of property and equipment
            
            
            (4,124
            )
            
            
            (7,046
            )
            
            
            (13,388
            )Proceeds
      from sale of property and equipment
            
            
            120
            
            
            
            -
            
            
            
            43Payments
      for intellectual property
            
            
            -
            
            
            
            -
            
            
            
            (18,750
            )Business
      combination, net of cash acquired
            
            
            -
            
            
            
            -
            
            
            
            (13,751
            )Cash  provided by (used in) investing activities
            
            
            (38,066
            )
            
            
            14,825
            
            
            
            11,816Cash
      flows from financing activities:Proceeds
      from issuances of common stock
            
            
            2,805
            
            
            
            4,758
            
            
            
            12,909Excess
      tax benefits from employee stock-based transactions
            
            
            85
            
            
            
            548
            
            
            
            2,543Payments
      for vendor financed purchases of software and intangibles
            
            
            (1,250
            )
            
            
            (19,278
            )
            
            
            (528
            )Repurchase
      of restricted stock units for income tax withholding
            
            
            (286
            )
            
            
            -
            
            
            
            -Payments
      to acquire treasury stock
            
            
            -
            
            
            
            (68,180
            )
            
            
            (38,096
            )Cash provided by (used in) financing activities
            
            
            1,354
            
            
            
            (82,152
            )
            
            
            (23,172
            )Effect
      of exchange rate changes on cash and cash equivalents
            
            
            718
            
            
            
            (722
            )
            
            
            114Net
      increase (decrease) in cash and cash equivalents
            
            
            (65,658
            )
            
            
            (42,408
            )
            
            
            55,901Cash
      and cash equivalents - beginning of year
            
            
            95,414
            
            
            
            137,822
            
            
            
            81,921Cash
      and cash equivalents - end of year
            
            $
            29,756
            
            
            $
            95,414
            
            
            $
            137,822Supplemental
      cash flow information:Refund
      (cash payment) for income taxes
            
            $
            8,236
            
            
            $
            (3,624
            )
            
            $
            (36,316
            )Restricted
      stock units vested
            
            $
            793
            
            
            $
            -
            
            
            $
            -Property
      and equipment purchased but not paid for
            
            $
            779
            
            
            $
            79
            
            
            $
            1,566Unrealized
      net gain on short-term investments
            
            $
            251
            
            
            $
            219
            
            
            $
            204Intangibles
      purchased not paid for
            
            $
            -
            
            
            $
            -
            
            
            $
            21,250





See
accompanying Notes to Consolidated Financial Statements.


-
65 -
 
 Part IV 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 legal
matters. The consolidated financial statements include the accounts of Silicon
Image, Inc. and its subsidiaries after elimination of intercompany balances and
transactions.





Revenue
Recognition





The Company
recognizes 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 are not entitled to
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. All
shipping costs are charged to cost of product revenue.





Revenue from
products sold to distributors with agreements allowing for stock
rotations is generally recognized upon shipment.  Reserves for
stock rotations are estimated based primarily on historical experience and
provided for at the time of shipment.





For products
sold to distributors with agreements allowing for price concessions and stock
rotation rights/product returns, the Company recognizes revenue based on when
the distributor reports that it has sold the product to its customer. The
Company’s recognition of such distributor sell-through is based on point of
sales reports received from the distributor which establishes a customer,
quantity and final price. Revenue is not recognized upon the Company’s shipment
of the product to the distributor, since, due to certain forms of price
concessions, the sales price is not substantially fixed or determinable at the
time of shipment. Price concessions are recorded when incurred, which is
generally at the time the distributor sells the product to its customer.
Additionally, these distributors have stock rotation rights permitting them to
return products to the Company, up to a specified amount for a given period of
time. When the distributor reports that it has sold product to its customer, our
sales price to the distributor is fixed. Once the Company receives the point of
sales reports from the distributor, it has satisfied all the requirements for
revenue recognition with respect to the product reported as sold and any product
returns/stock rotation and price concession rights that the distributor has
under its distributor agreement with the Company lapsed at that time. Pursuant
to the Company’s distributor agreements, older, end-of-life and certain other
products are generally sold with no right of return and are not eligible for
price concessions. For these products, revenue is recognized upon shipment and
title transfer assuming all other revenue recognition criteria are
met.





-
66 -


Revenue for
2007 included 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 was 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, until revenue is recognized, 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 the 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 distributor’s 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 the distributors does not
allow the Company to accurately estimate the portion of the balance in the
deferred margin on the sale to distributors that will be remitted back to the
distributors. In addition to the above, the Company also reduces the deferred
margin by anticipated or determinable future price protections based on revised
price lists, if any.





The Company
derives revenue from the 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 licensing revenue. The Company’s
license fee arrangements generally include multiple deliverables and for
multiple deliverable arrangements it follows the guidance in FASB ASC No.
605-25-25, Multiple-Element
Arrangements Revenue Recognition, previously discussed in Emerging Issues
Task Force (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 revenue recognition
criteria mentioned above.





-
67 -
 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 relies
upon estimates in lieu of actual royalty reports when it has a sufficient
history of receiving royalties from a specific customer for it to make an
estimate based on available information from the licensee such as quantities
held, manufactured and other information. These estimates for royalties
necessarily involve the application of management judgment. As a result of the
Company’s use of estimates, period-to-period numbers are “trued-up” in the
following period to reflect actual units shipped. In cases where royalty reports
and other information are not available to allow the Company to estimate royalty
revenue, the Company recognizes revenue only when royalty reports are
received.





For contracts
related to licenses of the Company’s technology that involve significant
modification, customization or engineering services, the Company recognizes
revenue in accordance with the provisions of FASB ASC No. 605-35-25, Construction-Type and
Production-Type Contracts Revenue  Recognition, previously
discussed in Statement of Position (SOP) 81-1, Accounting for Performance
of Construction-Type and
Certain Production-Type Contracts.Revenues derived from such license
contracts are accounted for using the percentage-of-completion
method.





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





Stock-based
Compensation





The Company
accounts for stock-based compensation in accordance with the provisions of FASB
ASC No.  718-10-30, Stock Compensation Initial
Measurement,previously discussed in SFAS No. 123R,
“Share-Based Payment,”
which requires the measurement and recognition of compensation expense for all
stock-based awards made to employees, directors including employee stock
options, restricted stock units (“RSUs”), performance share awards and employee
stock purchases under the Company’s Employee Stock Purchase Plan (“ESPP”) based
on estimated fair values.  Following the provisions of FASB ASC No.
718-50-25, Employee Share
Purchase Plans Recognition,previously discussed inSFAS 123R,  the Company’s
ESPP is considered a compensatory plan, therefore, the Company is required to
recognize compensation cost for grants made under the ESPP.   The
Company estimates the fair value of stock options granted using the
Black-Scholes-Merton option-pricing formula and a single option award approach,
which incorporates various assumptions including volatility, risk-free interest
rate, expected life, and dividend yield. Management estimates volatility for a
given option grant by evaluating the historical volatility of the period
immediately preceding the option grant date that is at least equal in length to
the option’s expected term. Consideration is also given to unusual events
(either historical or projected) or other factors that might suggest that
historical volatility will not be a good indicator of future volatility. The
expected life of an award is based on historical experience and on the terms and
conditions of the stock awards granted to employees, as well as the potential
effect from options that had not been exercised at the time. In accordance with
FASB ASC No. 718-10-35,
Subsequent Measurement of Stock Compensation,previously discussed in
SFAS 123R,the
Company recognizes stock-based compensation expense, net of estimated
forfeitures, on a straight-line basis for all share-based payment awards over
the requisite service periods of the awards, which is generally the vesting
period or the remaining service (vesting) period.




-
68 -
 Financial
Instruments





The Company
accounts for its investments in debt securities under FASB ASC No. 320-10-25,
Investments in Debt and Equity
Securities Recognition, previously discussed in SFAS No. 115, Accounting for Certain Investments
in Debt and Equity Securities. 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. The Company adopted the guidance provided by FASB
ASC No. 320-10-65, Transition
Related to Recognition and Presentation of Other-Than-Temporary
Impairments,previously referred to
as FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairmentseffective April 1, 2009 and uses the
guidance therein to assess whether its investments with unrealized loss
positions are other than temporarily impaired. Other-than-temporary
impairment charges exists when the entity has the intent to sell the security,
it will more likely than not be required to sell the security before anticipated
recovery or it does not expect to recover the entire amortized cost basis of the
security. Other than temporary impairments are determined based on the specific
identification method and are reported in the consolidated statements of
operations.





The
classification of the Company’s investments into cash equivalents and short term
investments is in accordance with FASB ASC No. 305-10-20, Cash and Cash Equivalents Glossary,previously discussed in SFAS 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.





The Company
complies with the provisions of FASB ASC No. 820, Fair Value Measurements and
Disclosures(“ASC 820”), previously referred to as SFAS No. 157, Fair Value Measurements in
measuring fair value and in disclosing fair value measurements as adopted
effective on January 1, 2008.   ASC 820 defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements required under other accounting pronouncements. FASB ASC
No. 820-10-35, Fair Value
Measurements and Disclosures- Subsequent Measurement(“ASC 820-10-35”),
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. ASC 820-10-35-3 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.




ASC 820-10-35
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 1measurements) and the lowest priority to unobservable inputs
(level 3 measurements). The three levels of the fair value hierarchy under ASC
820-10-35  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.





When the
Company determines that the volume of activity for the asset or liability has
significantly decreased and/or it has identified transactions that are not
orderly, the Company complies with the provisions of ASC 820-10-65-4, previously
referred to as FSP FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly.





Further
information about the Company financial instruments can be found in Note 11
below.





- 69 -
 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
FASB ASC No. 815-20-25, Derivatives and Hedging
Recognition, previously discussed in SFAS 133, Accounting for Derivative
Instruments and Hedging Activities. 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 derivative gain (loss) is
reported in each reporting period in other income (expense) on the Company’s
consolidated statement of operations.





Concentration
of Credit Risk





The Company’s
customer base for its products is concentrated with a small number of
distributors. Financial instruments, which potentially subject the Company to
concentrations of credit risk, are primarily accounts receivable, cash
equivalents and short-term investments. The Company performs ongoing credit
evaluations of its customers’ financial condition and, generally, requires no
collateral from its customers. The allowance for doubtful accounts is based upon
the expected collectability of all accounts receivable. The Company places its
cash equivalents and short-term investments in investment-grade, highly liquid
debt instruments and limits the amount of credit exposure to any one
issuer.





Supplier
Concentration





Certain of
the raw materials and components used by the Company in the manufacture of its
products are available from a limited number of suppliers. Shortages could occur
in these essential materials and components due to an interruption of supply or
increased demand in the industry. If the Company were unable to procure certain
of such materials or components, it would be required to reduce its
manufacturing operations, which could have a material adverse effect on its
results of operations.





Allowance
for Doubtful Accounts





The Company
reviews collectability of accounts receivable on an on-going basis and provides
an allowance for amounts it estimates may 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. The table below presents
the changes in the allowance for doubtful accounts for the years ended December
31, 2009, 2008 and 2007.





2009
            
            
            2008
            
            
            2007(In
      thousands)Balance
      at January 1
            
            $
            1,778
            
            
            $
            1,565
            
            
            $
            235Provision
      for doubtful accounts
            
            
            552
            
            
            
            1,218
            
            
            
            1,868Write
      offs/recoveries
            
            
            (902
            )
            
            
            (1,005
            )
            
            
            (538
            )Balance
      at December 31
            
            $
            1,428
            
            
            $
            1,778
            
            
            $
            1,565





-
70 -
 Inventories





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





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 (unless specific facts and
circumstances warrant no write-down or a write-down to a different value) 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 the Company forecasts
demand for the product.





Goodwill,
Intangible and Long-lived Assets





Goodwill is
recorded as the difference, if any, between the aggregate consideration paid for
an acquisition and the fair value of tangible and intangible assets
acquired.





The Company
periodically reviews the carrying value of intangible assets not subject to
amortization, including goodwill, to determine whether impairment may exist.
FASB ASC No. 350-20-35, Subsequent Measurement of
Goodwill, and FASB ASC No. 350-30-35, Subsequent Measurement of General
Intangibles Other Than Goodwill(“ASC 350-30-35”), whose provisions were
previously discussed in SFAS No. 142, Goodwill and Other Intangible
Assets, require that goodwill 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 FASB ASC No. 280-10-50, Segment Reporting Disclosure,
previously discussed in SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information,that it has one reporting unit (see
Note 6). 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. The Company generally determines the fair
value of the reporting unit using generally accepted valuation methodology which
considers market capitalization and market premiums. 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.





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), the
Company is required to estimate the useful life of its asset and recognize the
cost as an expense over the estimated useful life. The Company uses the
straight-line method to depreciate long-lived assets. The Company evaluates the
recoverability of its long-lived assets in accordance with FASB ASC No.
360-10-35, Subsequent
Measurement of Property, Plant and Equipment,paragraphs 15-49, Impairment or Disposal of
Long-Lived Assets, previously discussed in 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 to its statement of operations 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 $9.0 million, $10.3 million and $9.5 million for the years
ended December 31, 2009, 2008 and 2007, respectively.





- 71 -
 Income
Taxes





The Company
accounts for income taxes in accordance with the FASB ASC No. 740(“ASC 740”), previously
discussed in SFAS No. 109, Accounting for Income
Taxes.





The Company
makes 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.





The Company
uses an asset and liability approach for accounting of deferred taxes, 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 realization of the deferred tax
assets quarterly and will continue to assess the need for valuation allowances.
In accordance with ASC 740, 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. The provisions under ASC 740 were previously discussed in FIN
48, Accounting for Uncertainty
in Income Taxes — an Interpretation of FASB Statement
No. 109.





At
December 31, 2009, 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, net operating loss, and
tax credit carry forwards of $45.6 million, which have been offset by a $43.0
million of valuation allowance. 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.





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 accrual and the
related expense for known issues were not significant during the periods
presented. Due to product testing and the short time typically between product
shipment and the detection and correction of product failures, and considering
the historical rate of payments on indemnification claims, the accrual and
related expense for estimated incurred but unidentified issues were not
significant during the periods presented.





-
72 -


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 FASB ASC No. 712-10-25, Nonretirement Postemployment
Benefits Recognition, previously discussed in SFAS No. 112, Employers’ Accounting for
Postemployment Benefits. One-time termination benefits and contract
settlement and lease costs are recorded in accordance with FASB ASC No.
420-10-25, Exit or Disposal
Cost Obligations Recognition, previously discussed in SFAS 146, Accounting for Costs Associated with
Exit or Disposal Activities. At each reporting date, the Company
evaluates its accruals related to workforce reduction charges, contract
settlement and lease costs to ensure that these accruals are still appropriate.
Restructuring expense accruals related to future lease commitments on exited
facilities include 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 operations.





Foreign
Currency Translation





The Company
accounts for foreign currency transactions in accordance with FASB ASC No.
830-20, Foreign Currency
Transactions,and FASB ASC No. 830-30, Translation of Financial
Statements, previously discussed in 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
country’s currency. Consequently, revenues and expenses of operations outside
United States are translated into United States dollars (“USD”) using the
average exchange rate, while assets and liabilities of operations outside United
States are translated into USD using the exchange rate in effect on the balance
sheet date. The effect of these foreign currency translation adjustments are
recorded in stockholders’ equity as a component of accumulated other
comprehensive income (loss) in the consolidated balance sheets. Monetary balance
sheet items of the Company and its subsidiaries denominated in a foreign
currency other than the applicable functional currency are re-measured using the
exchange rate in effect on the balance sheet date and any adjustments arising
from re-measurements are included in other income (expense) in the consolidated
statements of operations.




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, 2009 and 2008, the Company recorded a reduction to research
and development expense totaling approximately $0.3 million and $0.5 million,
respectively, related to funding received from outside parties for one
engineering project. There was no funding received in 2007.





-
73 -
 Net
Income (Loss) Per Share





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




Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Numerator:Net
      income (loss)
            
            $
            (129,109
            )
            
            $
            10,063
            
            
            $
            19,001Denominator:Weighted-average
      shares - basic
            
            
            74,912
            
            
            
            75,570
            
            
            
            85,557Weighted-average
      shares - diluted
            
            
            74,912
            
            
            
            76,626
            
            
            
            87,388Net
      income (loss) per share - basic and diluted
            
            $
            (1.72
            )
            
            $
            0.13
            
            
            $
            0.22





The table
below is a reconciliation of the weighted-average common shares used to
calculate basic net income (loss) per share to the weighted-average common
shares used to calculate diluted net income (loss) per share (in
thousands):




Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Weighted-average
      common shares for basic net income (loss) per share
            
            
            74,912
            
            
            
            75,570
            
            
            
            85,557Weighted-average
      dilutive stock options and restricted stock units outstanding under the
      treasury stock method
            
            
            -
            
            
            
            1,056
            
            
            
            1,831Weighted-average
      shares - diluted
            
            
            74,912
            
            
            
            76,626
            
            
            
            87,388





The
weighted-average securities that were anti-dilutive and excluded from the net
loss per share calculations were approximately 13.4 million for the year ended
December 31, 2009. For the years ended December 31, 2008 and 2007, approximately
12.4 million and 11.3 million weighted-average securities were excluded
from the calculation of diluted net income per share, respectively, because
their inclusion would have been anti-dilutive.





-
74 -
 Recent
Accounting Pronouncements





In June 2009,
the FASB issued ASC No. 105, Generally Accepted Accounting
Principles (“GAAP”) (“ASC 105” or “FASB Codification”), previously
referred to as   SFAS No. 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles - a replacement of FASB Statement No 162(“SFAS
168”).The
effective date for use of the FASB Codification is for interim and annual
periods ending after September 15, 2009. Companies should account for the
adoption of the guidance on a prospective basis. Effective July 1, 2009, the
Company adopted the FASB Codification and its adoption did not have a material
impact on its consolidated financial statements. The Company has appropriately
updated its disclosures with the appropriate FASB Codification
references.  As such, all the notes to the condensed consolidated
financial statements have been updated with the appropriate FASB Codification
references.





In December
2007, the FASB issued ASC No. 805, Business Combinations (“ASC
805”), previously referred to as  SFAS 141 (revised 2007), Business Combinations. ASC 805 significantly
changed current practices regarding business combinations. Among the more
significant changes, ASC 805 expands the definition of a business and a business
combination; requires the acquirer to recognize the assets acquired, liabilities
assumed and noncontrolling interests (including goodwill), measured at fair
value at the acquisition date; requires acquisition-related expenses and
restructuring costs to be recognized separately from the business combination;
and requires in-process research and development to be capitalized at fair value
as an indefinite-lived intangible asset. ASC 805 is effective for financial
statements issued for fiscal years beginning after December 15, 2008. The
Company adopted the provisions of ASC 805 on January 1, 2009 and the
adoption did not have a significant impact on the Company’s consolidated
financial statements. However, if the Company enters into material business
combinations in the future, a transaction may significantly impact the Company’s
consolidated financial statements as compared to the Company’s previous
acquisitions accounted for under prior GAAP requirements, due to the changes
described above.





In December
2007, the FASB issued ASC No. 810-10-65, Transition Related to Noncontrolling
Interests in Consolidated Financial Statement(“ASC 810-10-65”),
previously referred to asSFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements — an amendment of Accounting Research Bulletin
(“ARB”) No. 51. ASC 810-10-65 is effective for financial statements
issued for fiscal years beginning after December 15, 2008. The Company adopted
provisions under ASC 810-10-65 on January 1, 2009.  The Company
does not currently have any non-controlling interests in its subsidiaries, and
accordingly the adoption of this standard did not have a material impact on the
Company’s consolidated financial statements.





In March
2008, the FASB issued ASC No. 815-10-65, Transition Related to Disclosures
about Derivative Instruments and Hedging Activities (“ASC 815-10-65”),
previously referred to as SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133, which requires additional disclosures about the objectives
of using derivative instruments, the method by which the derivative instruments
and related hedged items are accounted for under ASC No. 815, Derivatives and Hedging(“ASC
815”), previously referred to as 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. ASC 815 also
requires disclosure of the fair values of derivative instruments and their gains
and losses in a tabular format. Per ASC 815-10-65, the additional disclosures
about derivatives and hedging activities mentioned above are required for
financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early adoption
encouraged.  The Company adopted the provisions mentioned above
effective January 1, 2009 and its adoption did not have a material impact
on its consolidated financial statements.




- 75 -





In April
2009, the FASB issued ASC No. 320-10-65, Transition Related to Recognition
and Presentation of Other-Than-Temporary Impairments(“ASC 320-10-65”),
previously referred to as  FASB Staff Position (“FSP”) FAS 115-2 and
FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments. ASC 320-10-65 amends
the other-than-temporary impairment guidance for debt securities to make the
guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments in the financial statements. The most
significant change ASC 320-10-65 brings is a revision to the amount of
other-than-temporary loss of a debt security recorded in earnings. ASC 320-10-65
is effective for interim and annual reporting periods ending after June 15,
2009. The Company adopted this FSP effective April 1, 2009 and the Company’s
adoption did not have a material impact on its consolidated financial
statements.




In April
2009, the FASB issued ASC No. 820-10-35, Fair Value Measurements and
Disclosures – Subsequent Measurement (“ASC 820-10-35”), which discusses
the provisions related to the determination of fair value when the volume and
level of activity for the asset or liability have significantly decreased, which
was previously discussed in FSP SFAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly. ASC
820-10-35 provides additional guidance for estimating fair value when the volume
and level of activity for the asset or liability have significantly decreased.
ASC 820-10-35 also includes guidance on identifying circumstances that indicate
a transaction is not orderly. ASC 820-10-35 emphasizes that even if there has
been a significant decrease in the volume and level of activity for the asset or
liability and regardless of the valuation technique(s) used, the objective of a
fair value measurement remains the same. Fair value is the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction (that is, not a forced liquidation or distressed sale) between
market participants at the measurement date under current market conditions. In
accordance with FASB ASC No. 820-10-65, Transition Related to FASB Statement
No. 157-4,” the above provisions are effective for interim and annual
reporting periods ending after June 15, 2009, and is applied
prospectively.  The Company adopted the provisions relating to
determining the fair value when the volume and level of activity for the asset
or liability have significantly decreased and identifying transactions that are
not orderly under ASC 820-10-35  effective April 1, 2009 and its
adoption did not have a material impact on its consolidated financial
statements.





In April
2009, the FASB issued ASC No. 805-10-35, Business Combinations Subsequent
Measurement (“ASC 805-10-35”), which discusses the accounting for assets
acquired and liabilities assumed in a business combination that arise from
contingencies, which was previously discussed in FSP FAS 141(R)-1, Accounting for Assets Acquired and
Liabilities Assumed in a Business Combination That Arise from
Contingencies. ASC 805-10-35 addresses application issues on initial
recognition and measurement, subsequent measurement and accounting, and
disclosure of assets and liabilities arising from contingencies in a business
combination. The provisions under ASC 805-10-35 relating to assets acquired and
liabilities assumed in a business combination that arise from contingencies are
effective for business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.  The Company adopted the provisions of ASC 805 on
January 1, 2009 and the adoption did not have a significant impact on the
Company’s consolidated financial statements. However, if the Company enters into
material business combinations in the future, a transaction may significantly
impact the Company’s consolidated financial statements as compared to the
Company’s previous acquisitions, accounted for under prior GAAP requirements,
due to the changes described above.





- 76 -





In May
2009, the FASB issued ASC No. 855, Subsequent Events(“ASC
855”), previously referred to as SFAS No. 165, Subsequent Events. ASC 855
should be applied to the accounting for and disclosure of subsequent events.
This Statement does not apply to subsequent events or transactions that are
within the scope of other applicable GAAP that provide different guidance on the
accounting treatment for subsequent events or transactions.  ASC 855
would apply to both interim financial statements and annual financial
statements. The objective of ASC 855 is to establish general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. In
particular, this Statement sets forth: 1) The period after the balance sheet
date during which management of a reporting entity should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements; 2) The circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in its
financial statements; and, 3) The disclosures that an entity should make about
events or transactions that occurred after the balance sheet date. ASC 855 is
effective for interim or annual financial periods ending after June 15, 2009.
The Company adopted this standard effective April 1, 2009 and the Company’s
adoption did not have a material impact on its consolidated financial
statements.





In
October 2009, the FASB issued Accounting Standard Update No. 2009-13 on Topic
605, Revenue Recognition–
Multiple Deliverable Revenue Arrangements – a consensus of the FASB Emerging
Issues Task Force.The objective of this Update is to address the
accounting for multiple-deliverable arrangements to enable vendors to account
for products or services (deliverables) separately rather than as a combined
unit. Vendors often provide multiple products or services to their customers.
Those deliverables often are provided at different points in time or over
different time periods. This Update provides amendments to the criteria in
Subtopic 605-25 for separating consideration in multiple-deliverable
arrangements. The amendments in this Update establish a selling price hierarchy
for determining the selling price of a deliverable. The selling price used for
each deliverable will be based on vendor specific objective evidence if
available, third-party evidence if vendor-specific objective evidence is not
available, or estimated selling price if neither vendor specific objective
evidence nor third-party evidence is available. The amendments in this Update
also will replace the term fair value in the revenue allocation guidance with
selling price to clarify that the allocation of revenue is based on
entity-specific assumptions rather than assumptions of a marketplace
participant. This update is effective for fiscal years beginning on or after
June 15, 2010.  The Company is currently evaluating the impact of this
new accounting update  on its consolidated financial
statements.





In
November 2009, FASB issued Accounting Standard Update No. 2009-14 on Topic 985,
Certain Revenue Arrangements
That Include Software Elements,previously included in American
Iinstitute of Certified Public Accountants SOP No. 97-2, Software Revenue
Recognition.  Topic 985 focuses on determining which
arrangements are within the scope of the software revenue guidance and which are
not. This topic removes tangible products from the scope of the software revenue
guidance if the products contain both software and nonsoftware components that
function together to deliver a product’s essential functionality and provides
guidance on determining whether software deliverables in an arrangement that
includes a tangible product are within the scope of the software revenue
guidance. This update is effective for fiscal years beginning on or after June
15, 2010.  The Company is currently evaluating the impact of this new
accounting update on its consolidated financial statements.


-
77 -
 NOTE 2 —
CONSOLIDATED BALANCE SHEET COMPONENTS





Cash,
cash equivalents and short-term investments consisted of the following as of
December 31, 2009 (in thousands):




Gross
            
            
            GrossAmortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            EstimatedCost
            
            
            Gain
            
            
            Loss
            
            
            Fair
      ValueClassified
      as current assets:Cash
            
            $
            22,236
            
            
            $
            -
            
            
            $
            -
            
            
            $
            22,236Cash
      equivalents:Commercial
      paper
            
            
            7,500
            
            
            
            -
            
            
            
            -
            
            
            
            7,500Money
      market funds
            
            
            20
            
            
            
            -
            
            
            
            -
            
            
            
            20Total
      cash equivalents
            
            
            7,520
            
            
            
            -
            
            
            
            -
            
            
            
            7,520Total
      cash and cash equivalents
            
            
            29,756
            
            
            
            -
            
            
            
            -
            
            
            
            29,756Short-term
      investments:Municipal
      bonds
            
            $
            105,577
            
            
            $
            588
            
            
            $
            -
            
            
            $
            106,165Corporate
      securities
            
            
            10,944
            
            
            
            75
            
            
            
            -
            
            
            
            11,019United
      States government agencies
            
            
            3,371
            
            
            
            11
            
            
            
            -
            
            
            
            3,382Money
      market funds
            
            
            300
            
            
            
            -
            
            
            
            -
            
            
            
            300Total
      short-term investments
            
            
            120,192
            
            
            
            674
            
            
            
            -
            
            
            
            120,866Total
      cash and cash equivalents and short-term investments
            
            $
            149,948
            
            
            $
            674
            
            
            $
            -
            
            
            $
            150,622





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, 2009.





Market
      Value
            
            
            Amortized
      CostContractual
      maturityLess
      than 1 year
            
            $
            85,768
            
            
            $
            85,3211-5
      years
            
            
            35,098
            
            
            
            34,871Total
            
            $
            120,866
            
            
            $
            120,192





-
78 -


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




Gross
            
            
            GrossAmortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            EstimatedCost
            
            
            Gain
            
            
            Loss
            
            
            Fair
      ValueClassified
      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
      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
            
            
            
            14,972Total
            
            $
            89,591
            
            
            $
            89,168




- 79 -


Components
of inventory, prepaid expenses and other current assets and property and
equipment consisted of the following:




December
      31,2009
            
            
            2008(In
      thousands)Inventories:Raw
      materials
            
            $
            2,800
            
            
            $
            4,962Work
      in process
            
            
            916
            
            
            
            545Finished
      goods
            
            
            4,030
            
            
            
            7,268$
            7,746
            
            
            $
            12,775Prepaid
      expense and other current assets:Income
      tax receivable
            
            $
            21,405
            
            
            $
            10,372Others
            
            
            6,107
            
            
            
            4,903$
            27,512
            
            
            $
            15,275Property
      and equipment:Computers
      and software
            
            $
            21,614
            
            
            $
            24,250Equipment
            
            
            27,050
            
            
            
            25,059Furniture
      and fixtures
            
            
            2,564
            
            
            
            2,70151,228
            
            
            
            52,010Less:
      accumulated depreciation
            
            
            (36,779
            )
            
            
            (32,616
            )$
            14,449
            
            
            $
            19,394




- 80 -


The
components of intangible assets were as follows:




December
      31, 2009
              
              
              December
      31, 2008Intangible
      assets subject to amortization:
              Estimated
      Useful Lives
              
              Gross
      Carrying Amount
              
              
              Accumulated
      Amortization
              
              
              Impairment
                (Notes
      12 and 13)
              
              
              Net
      Carrying Value
              
              
              Gross
      Carrying Amount
              
              
              Accumulated
      Amortization
              
              
              Net
      Carrying Value(In Months)
              
              (In
      thousands)Acquired
      technology-Sunplus
              84
              
              $
              39,600
              
              
              $
              (11,304
              )
              
              $
              (28,296
              )
              
              $
              -
              
              
              $
              39,600
              
              
              $
              (7,065
              )
              
              $
              32,535Core/developed
      technology
              24-48
              
              
              970
              
              
              
              (890
              )
              
              
              -
              
              
              
              80
              
              
              
              970
              
              
              
              (747
              )
              
              
              223Customer
      relationship
              24-28
              
              
              810
              
              
              
              (740
              )
              
              
              -
              
              
              
              70
              
              
              
              810
              
              
              
              (647
              )
              
              
              163Contractual
      backlog
              9-12
              
              
              1,360
              
              
              
              (1,360
              )
              
              
              -
              
              
              
              -
              
              
              
              1,360
              
              
              
              (1,360
              )
              
              
              -Non-compete
      agreement
              36
              
              
              1,849
              
              
              
              (1,849
              )
              
              
              -
              
              
              
              -
              
              
              
              1,849
              
              
              
              (1,849
              )
              
              
              -Acquired
      technology
              36-48
              
              
              1,780
              
              
              
              (1,780
              )
              
              
              -
              
              
              
              -
              
              
              
              1,780
              
              
              
              (1,780
              )
              
              
              -$
              46,369
              
              
              $
              (17,923
              )
              
              $
              (28,296
              )
              
              $
              150
              
              
              $
              46,369
              
              
              $
              (13,448
              )
              
              $
              32,921Intangible
      assets not subject to amortization:Goodwill
              
              
              $
              19,210
              
              
              
              -
              
              
              $
              (19,210
              )
              
              $
              -
              
              
              $
              19,210
              
              
              $
              -
              
              
              $
              19,210
  The remaining
balance of intangible asset of $150,000 as of December 31, 2009 will be fully
amortized in 2010.





Amortization
of identifiable intangibles, totaled $4.5 million, $6.3 million and $3.5
million, for the years ended December 31, 2009, 2008 and 2007,
respectively.





In 2009, the
Company performed an impairment analysis of its goodwill with a carrying value
of $19.2 million. The carrying value of the goodwill is dependent upon a number
of internal critical management assumptions as well as external indicators, such
as the Company’s stock price, market conditions and industry and economic
trends. Based on the negative external indicators and the analysis performed by
the Company, the goodwill was determined to be impaired. As a result, the
Company recognized goodwill impairment charges of approximately $19.2 million in
the consolidated statement of operations under operating expense, “Impairment of
Goodwill” for the year ended December 31, 2009. See related discussion in Note
13.




In 2009, the
Company determined that, in light of certain changes to its product strategy,
the intellectual property licensed from Sunplus Technology Co., Ltd in February
2007 (the “Sunplus IP”) no longer aligned with the Company’s product roadmap and
therefore will not be used. In connection with the decision to discontinue the
use of the Sunplus IP, the Company wrote-off the unamortized balance of the
investment in Sunplus IP of $28.3 million and recognized a pre-tax impairment
charge of $28.3 million in the consolidated statement of operations under
operating expense, “Impairment of Intangible Assets”.  See related
discussion in Note 12.




- 81 -
 The
components of accrued liabilities and other long-term liabilities were as
follows:





December
      31,2009
            
            
            2008(In
      thousands)Accrued
      liabilities:Accrued
      restructuring (seeNote
      10)
            
            $
            17,313
            
            
            $
            3,452Accrued
      payroll and related expenses
            
            
            2,826
            
            
            
            5,359Amounts
      due to customers
            
            
            348
            
            
            
            1,966Software
      and IP liabilities
            
            
            -
            
            
            
            2,500Bonus
      accrual
            
            
            -
            
            
            
            1,556Accrued
      and other current liabilities
            
            
            7,663
            
            
            
            8,190$
            28,150
            
            
            $
            23,023Other
      long-term liabilities:Non-current
      liability for uncertain tax positions
            
            $
            9,344
            
            
            $
            7,425Other
      liabilities
            
            
            229
            
            
            
            639$
            9,573
            
            
            $
            8,064





-
82 -


NOTE 3 —
INCOME TAXES





Income (loss)
before income taxes and the income tax provision (benefit) consisted of the
following (in thousands):





Year
      Ended December 31,Income
      (loss) before provision for income taxes
            
            2009
            
            
            2008
            
            
            2007U.S.
            
            $
            (76,325
            )
            
            $
            (36,077
            )
            
            $
            54,785Non
      U.S.
            
            
            (37,987
            )
            
            
            34,267
            
            
            
            (15,233
            )Total income (loss) before provision (benefit) for income
      taxes
            
            $
            (114,312
            )
            
            $
            (1,810
            )
            
            $
            39,552




Year
      Ended December 31,Provision
      (benefit) for Taxes
            
            2009
            
            
            2008
            
            
            2007Current:Federal
            
            $
            (21,138
            )
            
            $
            (3,470
            )
            
            $
            16,590State
            
            
            184
            
            
            
            (409
            )
            
            
            733Foreign
            
            
            3,555
            
            
            
            3,811
            
            
            
            2,961Total
      current provision (benefit)
            
            
            (17,399
            )
            
            
            (68
            )
            
            
            20,284Deferred:Federal
            
            
            21,696
            
            
            
            (8,076
            )
            
            
            358State
            
            
            8,467
            
            
            
            (3,281
            )
            
            
            158Foreign
            
            
            1,977
            
            
            
            362
            
            
            
            (431
            )Total
      deferred provision (benefit)
            
            $
            32,140
            
            
            $
            (10,995
            )
            
            $
            85Charge
      (benefit) in lieu of taxes attributable to employee stock-based
      plans
            
            
            56
            
            
            
            (810
            )
            
            
            182Income
      tax provision (benefit)
            
            $
            14,797
            
            
            $
            (11,873
            )
            
            $
            20,551





The
charge in lieu of taxes represents the tax provision from deductions for
employee stock transactions, short of related amounts reported for financial
reporting purposes, that is recorded as a direct decrease to additional
paid-in capital instead of an increase to the income tax provision
(benefit).




-
83 -
 
 
 Our effective
tax rate differs from the federal statutory rate due to the following (in
thousands):




Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Tax
      provision (benefit) at federal statutory rate
            
            $
            (40,040
            )
            
            $
            (633
            )
            
            $
            13,843Impact
      of valuation allowance
            
            
            43,033
            
            
            
            -
            
            
            
            -Stock-based
      compensation expense
            
            
            7,553
            
            
            
            966
            
            
            
            954Foreign
      unbenefited losses
            
            
            5,251
            
            
            
            -
            
            
            
            5,077Foreign
      income and withholding taxes
            
            
            3,975
            
            
            
            (2,463
            )
            
            
            2,827Non-deductible
      goodwill write-off
            
            
            3,828
            
            
            
            -
            
            
            
            -Worthless
      stock deduction
            
            
            (5,579
            )
            
            
            -
            
            
            
            -Tax
      credits
            
            
            (3,185
            )
            
            
            (5,914
            )
            
            
            (3,084
            )State
      income taxes
            
            
            (162
            )
            
            
            (3,062
            )
            
            
            786Tax
      exempt income
            
            
            (941
            )
            
            
            (865
            )
            
            
            -Non-deductible
      expenses
            
            
            41
            
            
            
            77
            
            
            
            79Other
            
            
            1,023
            
            
            
            21
            
            
            
            69Income
      tax provision (benefit)
            
            $
            14,797
            
            
            $
            (11,873
            )
            
            $
            20,551





The
Company’s 2009 income tax expense includes a $43.0 million establishment of a
valuation allowance to offset deferred tax assets which are not more likely than
not to be realized. Additionally, the Company’s worthless stock deduction
related to its investment in a subsidiary in Germany has provided a $5.6 million
benefit to its tax rate.








- 84 -


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
      31,2009
            
            
            2008Net
      operating loss carryforwards
            
            $
            2,466
            
            
            $
            127Stock-based
      compensation expense
            
            
            13,760
            
            
            
            15,413Accruals
      and other reserves
            
            
            6,671
            
            
            
            3,817Depreciable
      and amortizable items
            
            
            2,247
            
            
            
            6,114Tax
      credits
            
            
            19,012
            
            
            
            7,399Inventory
      valuation
            
            
            73
            
            
            
            70Capitalized
      research and development
            
            
            323
            
            
            
            531Other
      items not currently deductible
            
            
            1,101
            
            
            
            1,387Total
      Deferred tax assets
            
            
            45,653
            
            
            
            34,858Less:
      valuation allowance
            
            
            (43,033
            )
            
            
            -Net
      deferred tax assets
            
            $
            2,620
            
            
            $
            34,858Reported
      as:Deferred
      income taxes, current
            
            $
            284
            
            
            $
            6,665Deferred
      income taxes, non-current
            
            
            2,336
            
            
            
            28,193Net
      deferred taxes
            
            $
            2,620
            
            
            $
            34,858





The Company
has recorded a $43.0 million valuation allowance (including $25.2 million for
federal deferred tax assets and $17.8 million for state and foreign deferred tax
assets) as a result of uncertainties related to the realization of its net
deferred tax assets at December 31, 2009. The valuation allowance was
established as a result of weighing all positive and negative evidence,
including the Company’s cumulative loss over the past three years and the
difficulty of forecasting sufficient future taxable income. The valuation
allowance reflects the conclusion of management that it is more likely than not
that benefits from certain deferred tax assets will not be realized. If actual
results differ from these estimates or these estimates are adjusted in future
periods, the valuation allowance may require adjustment which could materially
impact the Company’s financial position and results of operations.





As of
December 31, 2009, the Company had state net operating loss carryforwards of
approximately $40.4 million, which will start to expire in 2016, if not
utilized.





As of
December 31, 2009, the Company had research credit carryforwards for federal
purposes of approximately $7.4 million that will carryforward until 2023, when
these credits begin to expire. As of December 31, 2009, the Company had
research credit carryforwards for state purposes of approximately
$13.4 million that will carry forward indefinitely. In the event the
Company was to 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.





As of
December 31, 2009, 2008 and 2007, the Company had gross tax effected
unrecognized tax benefits of $20.3 million, $18.4 million, and $20.7 million, of
which $5.0 million, $5.8 million, and $8.4 million, respectively,  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.


-
85 -


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


Year
      Ended December 31,


2009
            
            
            2008
            
            
            2007Balance
      as of January 1
            
            $
            18,374
            
            
            $
            20,719
            
            
            $
            14,405Tax
      positions related to the current period:Gross
      increase
            
            
            2,841
            
            
            
            2,131
            
            
            
            10,775Gross
      decrease
            
            
            -
            
            
            
            -
            
            
            
            -Tax
      positions related to the prior period:Gross
      increase
            
            
            142
            
            
            
            656
            
            
            
            163Gross
      decrease
            
            
            -
            
            
            
            (5,132
            )
            
            
            (4,624
            )Settlements
            
            
            (1,087
            )
            
            
            -
            
            
            
            -Lapse
      of statute of limitations
            
            
            -
            
            
            
            -
            
            
            
            -Balance
      as of December 31
            
            $
            20,270
            
            
            $
            18,374
            
            
            $
            20,719





The
Company’s policy is to include interest and penalties related to unrecognized
tax benefits within the provision for income taxes. The Company had interest
related to unrecognized tax benefits of approximately $60,000. During the years
ended December 31, 2009, 2008 and 2007, the Company accrued approximately
$341,000,  $35,000 and $275,000, respectively of additional 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.





The
Company adopted the provisions of FASB ASC No. 740 (formerly 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 ASC 740, 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 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.  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.


-
86 -


NOTE 4 —LEASE
AND OTHER OBLIGATIONS





The
Company’s future operating lease obligations and purchase commitments at
December 31, 2009 were as follows (in thousands):




Payments
      Due InTotal
            
            
            Less
      Than
              1
      Year
            
            
            1-3
      Years
            
            
            3-5
      Years
            
            
            More
      Than
              5
      YearsContractual Obligations:Engineering
      services commitments
            
            $
            7,508
            
            
            $
            4,290
            
            
            $
            3,218
            
            
            $
            -
            
            
            $
            -Operating
      lease obligations
            
            
            4,108
            
            
            
            2,643
            
            
            
            1,465
            
            
            
            -
            
            
            
            -Total
            
            $
            11,616
            
            
            $
            6,933
            
            
            $
            4,683
            
            
            $
            -
            
            
            $
            -




In
December 2009, the entered into an R&D Engineering Services Agreement with
an engineering services firm. The Company will pay the R&D engineering
services firm a total of 6 million Euros ($8.6 million) over a two-year period
from December 2009 to December 2011.





The
amounts above exclude liabilities under FASB ASC 740-10-25, “Income Taxes – Recognition
section,”previously contained in FIN 48 “Accounting for Uncertainty in
Income Taxes,” as the Company is unable to reasonably estimate the
ultimate amount or timing of settlement. See Note 3, “Income Taxes,” above
for further discussion.








NOTE 5 —
STOCKHOLDERS’ EQUITY





1999
Equity Incentive Plan (the “1999 Plan”)





In
October 1999, the Board of Directors adopted the 1999 Equity Incentive Plan (the
“1999 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 1999 Plan, the stated exercise price shall not be less
than 100% of the fair market value of our common stock on the date of grant for
ISOs and NSOs. The number of shares reserved for issuance under the 1999 Plan
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. The plan expired in October 2009.





In June
and July 2001, in connection with the CMD Technology, Inc. (CMD) and Silicon C
Communication Lab, Inc. (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.




-
87 -


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% 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, 2009 the Plan had 1.1 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-Merton 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, 2009 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-Merton
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.





Share-based
compensation expense recognized under FASB ASC No. 718-10-30, Initial Measurement of Stock
Compensation,previously discussed in SFAS 123(R), Share-Based Payment, consists
primarily of expenses for the share-based awards discussed above.




- 88 -


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




Years
      Ended December 312009
              
              
              2008
              
              
              2007Employee
      Stock Options Plans:Expected
      life in years
              
              
              4.7
              
              
              
              4.8
              
              
              
              4.9Expected
      volatility
              
              
              64.4
              %
              
              
              64.5
              %
              
              
              72.1
              %Risk-free
      interest rate
              
              
              2.3
              %
              
              
              2.8
              %
              
              
              4.5
              %Expected
      dividends
              
              none
              
              
              none
              
              
              noneWeighted
      average grant date fair value
              
              $
              1.38
              
              
              $
              2.81
              
              
              $
              5.36Employee
      Stock Purchase Plan:Expected
      life in years
              
              
              0.5
              
              
              
              0.5
              
              
              
              0.5Expected
      volatility
              
              
              85.6
              %
              
              
              65.8
              %
              
              
              51.2
              %Risk-free
      interest rate
              
              
              0.8
              %
              
              
              3.0
              %
              
              
              5.1
              %Expected
      dividends
              
              none
              
              
              none
              
              
              noneWeighted
      average grant date fair value
              
              $
              1.03
              
              
              $
              1.77
              
              
              $
              2.06
  Stock-based
compensation expense





The
following table shows total stock-based compensation expense included in the
Consolidated Statements of Operations for the years ended December 31,
2009, 2008 and 2007 (in thousands):





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Cost
      of sales
            
            $
            986
            
            
            $
            1,445
            
            
            $
            1,597Research
      and development
            
            
            6,252
            
            
            
            7,134
            
            
            
            8,411Selling,
      general and administrative
            
            
            10,863
            
            
            
            10,893
            
            
            
            9,442Restructuring
      expense
            
            
            -
            
            
            
            14
            
            
            
            -Stock-based
      compensation before tax effects
            
            
            18,101
            
            
            
            19,486
            
            
            
            19,450Income
      tax effects
            
            
            -
            
            
            
            (5,668
            )
            
            
            (5,758
            )Stock-based
      compensation after tax effects
            
            $
            18,101
            
            
            $
            13,818
            
            
            $
            13,692





As
required by FASB ASC 718-10-35, Subsequent Measurement of Stock
Compensation, previously discussed in SFAS 123(R), management made an
estimate of expected forfeitures and is recognizing stock-based compensation
expense only for those equity awards expected to vest.





-
89 -


At
December 31, 2009, 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 $5.9 million, after estimated forfeitures.
This cost will generally be recognized on a straight-line basis over an
estimated weighted-average period of approximately 1.9 years and will be
adjusted if necessary, in subsequent periods, if actual forfeitures differ from
those estimates.





As of
December 31, 2009, the Company had $4.3 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 1.9 years.





At
December 31, 2009, the total stock-based compensation expense related to
options to purchase common shares under the ESPP but not yet recognized was
approximately $0.1 million. This expense will be recognized on a straight-line
basis over a weighted-average period of approximately
0.2 year.





For the
years ended December 31, 2009, 2008 and 2007, we recorded $0.1
million,  $0.5 million and $2.5 million of excess tax
benefits from equity-based compensation plans, respectively, as a financing cash
inflow.




Stock-based
Compensation Adjustments





During
2009, the Company identified errors in the calculation of stock-based
compensation expense for fiscal years 2008, 2007 and 2006.  The errors
were identified after the Company’s third-party software provider notified its
clients, including the Company, that it made a change to how its software
program calculates stock-based compensation expense. Specifically, the prior
version of this software calculated stock-based compensation expense by
incorrectly applying a weighted average forfeiture rate to the vested portion of
stock option awards until the grant’s final vest date, rather than calculating
stock-based compensation expense based upon the actual vested portion of the
grant date fair value, resulting in an understatement of stock-based
compensation expense in certain periods prior to the grant’s final vest date.
Thus, this error relates to the timing of stock-based compensation expense
recognition.





The
Company determined that the cumulative error from the understatement of
stock-based compensation expense on fiscal years 2008, 2007 and 2006, if
retroactively corrected, would have been to decrease net income by
$0.1 million, $1.6 million and $1.0 million, respectively, for those years. Management
has determined that the impact of this error was not material to the previously
issued annual consolidated financial statements using the guidance of SEC Staff
Accounting Bulletin (SAB) No. 99 and SAB 108. Accordingly, the consolidated
financial statements for the year ended December 31, 2009 include the cumulative
adjustment to increase stock-based compensation expense by $2.7 million net
of tax effects, (or $0.04 per share) to correct these errors. The Company
does not believe the correction of these errors is material to the consolidated
financial statements for the year ended December 31, 2009.





-
90 -


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 OutstandingWeighted
            
            WeightedNon-Stockholder
            
            
            
            
            
            Average
            
            AverageStockholder
            
            
            Approved
            
            
            
            
            
            Exercise
            
            Remaining
            AggregateApproved
            
            
            Plans
      From
            
            
            Non-
            
            
            
            
            
            Price
      per
            
            Contractual
            IntrinsicPlan
            
            
            Acquisitions
            
            
            Plan*
            
            
            Total
            
            
            Share
            
            Terms
      in Years
            ValueAt
      January 1, 2007
            
            
            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
            
            
            $
            8.65Granted
            
            
            186
            
            
            
            -
            
            
            
            -
            
            
            
            186
            
            
            
            2.55Canceled
            
            
            (3,916
            )
            
            
            (180
            )
            
            
            -
            
            
            
            (4,096
            )
            
            
            9.21Exercised
            
            
            (56
            )
            
            
            (109
            )
            
            
            (130
            )
            
            
            (295
            )
            
            
            1.36At
      December 31, 2009
            
            
            8,325
            
            
            
            1,119
            
            
            
            200
            
            
            
            9,644
            
            
            $
            8.51
            
            5.30
            $433Vested
      and expected to vest at December 31, 2009
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            9,059
            
            
            $
            8.61
            
            5.16
            $432Exercisable
      at December 31, 2009
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            8,059
            
            
            $
            8.88
            
            4.91
            $429





*    primarily
used as inducements for new officers





The
aggregate intrinsic value of options exercised under the Company’s stock option
plans during the years ended December 31, 2009, 2008 and 2007 was $0.3 million,
$1.5 million and $10.0 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.





-
91 -


Information with respect to
options outstanding at December 31, 2009 is as follows:




Options
      Outstanding
            
            
            Options
      ExercisableWeighted
            
            
            Weighted
            
            
            
            
            
            WeightedAverage
            
            
            Average
            
            
            
            
            
            AverageNumber
      of
            
            
            Exercise
            
            
            Remaining
            
            
            Number
      of
            
            
            ExerciseRanges of Exercise Prices
            
            
            Shares
            
            
            Price
            
            
            Contractual
      Life
            
            
            Shares
            
            
            Price(In
      thousands)
            
            
            
            
            
            (In
      Years)
            
            
            (In
      thousands)$
            1.14
      - $ 4.44
            
            
            
            1,149
            
            
            $
            2.82
            
            
            
            2.87
            
            
            
            955
            
            
            $
            2.87$
            4.45
      - $ 5.30
            
            
            
            971
            
            
            
            4.61
            
            
            
            7.76
            
            
            
            492
            
            
            
            4.65$
            5.33
      - $ 6.23
            
            
            
            1,059
            
            
            
            5.98
            
            
            
            4.98
            
            
            
            841
            
            
            
            6.01$
            6.26
      - $ 7.94
            
            
            
            1,309
            
            
            
            7.28
            
            
            
            5.03
            
            
            
            1,147
            
            
            
            7.31$
            8.03
      - $ 9.15
            
            
            
            430
            
            
            
            8.56
            
            
            
            4.18
            
            
            
            407
            
            
            
            8.55$
            9.16
      - $ 9.27
            
            
            
            1,180
            
            
            
            9.27
            
            
            
            6.93
            
            
            
            851
            
            
            
            9.27$
            9.32
      - $ 10.62
            
            
            
            973
            
            
            
            9.85
            
            
            
            4.90
            
            
            
            958
            
            
            
            9.85$
            10.65
      - $ 12.05
            
            
            
            964
            
            
            
            11.33
            
            
            
            5.24
            
            
            
            905
            
            
            
            11.34$
            12.21
      - $ 15.48
            
            
            
            1,164
            
            
            
            13.62
            
            
            
            5.44
            
            
            
            1,058
            
            
            
            13.67$
            15.51
      - $ 17.01
            
            
            
            445
            
            
            
            16.91
            
            
            
            4.89
            
            
            
            445
            
            
            
            16.919,644
            
            
            $
            8.51
            
            
            
            5.29
            
            
            
            8,059
            
            
            $
            8.88








-
92 -


Restricted
Stock Units





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





RSUs are
converted into shares of the Company’s common stock upon vesting on a
one-for-one basis. The cost of the RSUs is determined using the fair value of
the Company’s common stock on the date of the grant. Compensation is recognized
on a straight-line basis over the requisite service period of each grant
adjusted for estimated forfeitures. 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, 2009 was as follows: (in
thousands):




Number
      of Units
            
            
            Aggregate
      Intrinsic ValueOutstanding
      at January 1, 2008
            
            
            -
            
            
            $
            -Granted
            
            
            3,805Vested
            
            
            -Forfeitures
      and cancellations
            
            
            (93
            )Outstanding
      at December 31, 2008
            
            
            3,712
            
            
            $
            15,591Granted
            
            
            1,879Vested
            
            
            (261
            )Forfeitures
      and cancellations
            
            
            (2,611
            )Outstanding
      at December 31, 2009
            
            
            2,719
            
            
            $
            6,798Ending
      vested and expected to vest at December 31, 2009
            
            
            1,914
            
            
            $
            4,785





For the year
ended December 31, 2009, the Company repurchased 93,882 shares of stock for an
aggregate value of $0.3 million from the employees upon the vesting of the RSUs
that were granted under the Company’s equity incentive plan to satisfy the
employees’ minimum statutory tax withholding requirement.





There were no
RSUs that vested in fiscal year 2008.  The Company will continue to
repurchase shares of stock from employees as their RSUs vest to satisfy the
employees’ minimum statutory tax withholding requirement.





- 93 -
 The table
summarizes the securities available for future issuance with respect to the
Company’s 2008 Equity Incentive Plan (in thousands):





2008
      PlanAvailable
      at January 1, 2008
            
            
            -Authorized
            
            
            4,000Granted
            
            
            (472
            )Canceled
            
            
            12Available
      at December 31, 2008
            
            
            3,540Authorized
            
            
            -Granted
            
            
            (3,004
            )Canceled
            
            
            600Available
      at December 31, 2009
            
            
            1,136




The table below summarizes the
securities which were previously available for future issuances under the
Company’s Equity Incentive Plans, including options granted outside of the Plans
(in thousands):




Non-Stockholder
      Approved Plans from Acquisitions1999
      Plan
            
            
            CMD
      Plan
            
            
            SCL
      Plan
            
            
            TWN
      Plan
            
            
            TotalAvailable
      at January 1, 2007
            
            
            5,114
            
            
            
            96
            
            
            
            48
            
            
            
            81
            
            
            
            5,339Authorized
            
            
            4,324
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4,324Granted
            
            
            (3,723
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (3,723
            )Canceled
            
            
            3,528
            
            
            
            17
            
            
            
            50
            
            
            
            26
            
            
            
            3,621Available
      at December 31, 2007
            
            
            9,243
            
            
            
            113
            
            
            
            98
            
            
            
            107
            
            
            
            9,561Authorized
            
            
            4,216
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4,216Granted
            
            
            (4,764
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,764
            )Canceled
            
            
            1,094
            
            
            
            48
            
            
            
            11
            
            
            
            9
            
            
            
            1,162Available
      at December 31, 2008
            
            
            9,789
            
            
            
            161
            
            
            
            109
            
            
            
            116
            
            
            
            10,175Authorized
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Granted
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Canceled
            
            
            6,090
            
            
            
            158
            
            
            
            23
            
            
            
            -
            
            
            
            6,271Balance
      at December 31, 2009
            
            
            15,879
            
            
            
            319
            
            
            
            132
            
            
            
            116
            
            
            
            16,446Available
      at December 31, 2009
            
            
            -*
            
            
            
            -**
            
            
            
            -**
            
            
            
            -**
            
            
            
            -





* The
1999 Plan expired in October 2009, hence, no securities under this plan are
available for future issuance.





** During
May 2008, in connection with the Stockholders' approval of the 2008 Equity
Incentive Plan, we committed to the stockholders that we will not issue any
securities from these plans, hence, no securities are available for future
issuance under these plans.




-
94 -


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 2009, 2008 and 2007, 887,045, 808,308 and
504,337 shares of common stock, respectively, were sold under the Purchase
Plan at average prices of $2.71, $3.77 and $7.04, per share, respectively. A
total of approximately 1.9 million shares were reserved for future issuance
at December 31, 2009. 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.





Option
Grants to Non-employees





Non
employees are primarily independent contractors. During 2009, 2008 and 2007, we
did not grant any options to non-employees. There was no stock-based
compensation expense related to non-employee option grants in 2009 and
2008.  The total stock-based compensation benefit recognized for the
years ended December 31, 2007 was $407,000. The non-employee options are
recorded at fair value and adjusted to market over the performance
period.








-
95 -
 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.  FASB ASC No. 280-10-50, “Disclosures on Segment
Reporting,” previously discussed in SFAS No. 131, “Disclosures about Segments of an
Enterprise and Related Information,” 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. FASB ASC No. 280-10-50 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, 2009, 2008 and 2007 and it operates in only one
reportable operating segment, semiconductor and IP solutions for high-definition
content.




Revenue





Revenue
by geographic area based on bill to location was as follows (in
thousands):





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Japan
            
            $
            40,842
            
            
            $
            65,824
            
            
            $
            113,107Taiwan
            
            
            38,036
            
            
            
            54,434
            
            
            
            53,608United
      States
            
            
            31,008
            
            
            
            45,479
            
            
            
            64,610Europe
            
            
            18,189
            
            
            
            32,960
            
            
            
            25,965Hong
      Kong
            
            
            9,008
            
            
            
            32,000
            
            
            
            20,809Korea
            
            
            4,788
            
            
            
            11,858
            
            
            
            17,607Other
            
            
            8,718
            
            
            
            31,860
            
            
            
            24,797$
            150,589
            
            
            $
            274,415
            
            
            $
            320,503




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





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Consumer
      Electronics
            
            $
            102,391
            
            
            $
            167,599
            
            
            $
            212,910Personal
      Computers
            
            
            8,905
            
            
            
            40,141
            
            
            
            34,283Storage
      products
            
            
            11,372
            
            
            
            25,461
            
            
            
            25,181Licensing
            
            
            27,921
            
            
            
            41,214
            
            
            
            48,129$
            150,589
            
            
            $
            274,415
            
            
            $
            320,503




-
96 -





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





Year
      Ended December 31,2009
            
            
            2008
            
            
            2007Consumer
      Electronics
            
            $
            129,178
            
            
            $
            199,591
            
            
            $
            247,205Personal
      Computers
            
            
            8,957
            
            
            
            44,311
            
            
            
            40,767Storage
      products
            
            
            12,454
            
            
            
            30,513
            
            
            
            32,531$
            150,589
            
            
            $
            274,415
            
            
            $
            320,503





In
2009, two customers generated 11.9% and 10.3% of the Company’s total revenue,
and at December 31, 2009, one customer represented 14.5% of gross accounts
receivable.  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. The Company’s top five customers, including
distributors, generated 44.2%, 55.1% and 57.7% of the Company’s revenue in 2009,
2008 and 2007, respectively.








Property
and Equipment





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





-
97 -
 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, which was withdrawn on October
10, 2008. On November 13, 2007 defendants in the six focus cases filed a motion
to dismiss the complaint for failure to state a claim, which the district court
denied in March 2008.  Plaintiffs, the issuer defendants (including
the Company), the underwriter defendants, and the insurance carriers for the
defendants, have engaged in mediation and settlement
negotiations.  The parties have reached a settlement agreement, which
was submitted to the District Court for preliminary approval on April 2,
2009.  As part of this settlement, the Company’s insurance carrier has
agreed to assume the Company’s entire payment obligation under the terms of the
settlement.  On June 10, 2009, the District Court granted preliminary
approval of the proposed settlement agreement.  After a September 10,
2009 hearing, the District Court gave final approval to the settlement on
October 5, 2009. Several objectors to the settlement have filed notices of
appeal to the United States Court of Appeal for the Second Circuit from the
District Court’s order granting final approval of the
settlement.  Although the District Court has granted final approval of
the settlement agreement, there can be no guarantee that it will not be reversed
on appeal.  The Company believes that it has meritorious defenses to
these claims.  If the settlement is not implemented and the litigation
continues against the Company, the Company would continue to defend against this
action vigorously.





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





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





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





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




- 98 -


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. There were no stock repurchases during the year ended December
31, 2009 related to the above mentioned stock repurchase programs.








NOTE 9 — BUSINESS
ACQUISITION





The
following acquisition was accounted for under FASB ASC No. 805, “Business Combinations,”
previously discussed in SFAS No. 141, “Business Combinations.”
Accordingly, the results of operations are included in the accompanying
consolidated statements of operations 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, 2009, 2008 and 2007.





-
99 -
 Net tangible
assets acquired, as adjusted, is as follows: (in thousands)




January
      3, 2007Cash
            
            $
            2,015Accounts
      receivable, net of allowance 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
            
            
            136016,176Direct
      acquisition costs
            
            
            (410
            )Purchase
      price
            
            $
            15,766





The
Company did not have any business acquisitions in 2009 and 2008.




-
100 -
 NOTE 10 — RESTRUCTURING
AND ASSET IMPAIRMENT CHARGES





Ongoing
Restructuring Activities





For the
years ended December 31, 2009 and 2008, the Company recorded restructuring
expense of approximately $22.9 million and $5.9 million, respectively, which was
primarily related to the severance cost and termination benefits associated with
the Company’s restructuring activities in those years.





Fiscal
2009 Restructuring Plan





In June
and October 2009, the Company’s management approved and announced restructuring
programs, which primarily included a reduction in force, to realign and focus
the Company’s resources on its core competencies and in order to better align
its revenues and expenses.  In 2009, because of the Company’s decision
to focus on discrete semiconductor products and related intellectual property,
the Company decided to restructure its research and development operations
resulting in the closure of its two sites in Germany.





As of
December 31, 2009, approximately $17.3 million of the costs, mostly severance
costs and other termination benefits, associated with restructuring programs
announced in June and October 2009 remained unpaid. We expect that the
severance-related charges and other costs will be substantially paid during the
first half of fiscal year 2010 and the facilities-related lease payments to be
substantially paid by November 2012.





Fiscal
2008 Restructuring Plan





As of
December 31, 2009, approximately $0.1 million of the costs associated with the
restructuring plan announced in December 2008 remained unpaid. This remaining
liability relates to the operating lease obligations for offices that the
Company ceased to use. This obligation will be substantially paid by July
2011.





The table
below presents restructuring activity for the years ended December 31, 2009
and 2008 (in thousands):




Employee
      Severance and Benefits
            
            
            Operating
      Lease Termination
            
            
            Fixed
      Assets and Other Assets Impaired
            
            
            Other
            
            
            TotalAccrued
      restructuring balance as of January 1, 2008
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Additional
      accruals/adjustments
            
            
            4,606
            
            
            
            189
            
            
            
            1,063
            
            
            
            -
            
            
            
            5,858Cash
      payments
            
            
            (1,340
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,340
            )Noncash
      charges and adjustments
            
            
            (14
            )
            
            
            11
            
            
            
            (1,063
            )
            
            
            -
            
            
            
            (1,066
            )Accrued
      restructuring balance as of December 31, 2008
            
            
            3,252
            
            
            
            200
            
            
            
            -
            
            
            
            -
            
            
            
            3,452Additional
      accruals/adjustments
            
            
            21,632
            
            
            
            225
            
            
            
            649
            
            
            
            401
            
            
            
            22,907Cash
      payments
            
            
            (6,950
            )
            
            
            (164
            )
            
            
            -
            
            
            
            
            
            
            
            (7,114
            )Noncash
      charges and adjustments
            
            
            -
            
            
            
            -
            
            
            
            (649
            )
            
            
            (401
            )
            
            
            (1,050
            )Foreign
      currency changes
            
            
            (882
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (882
            )Accrued
      restructuring balance as of December 31, 2009
            
            $
            17,052
            
            
            $
            261
            
            
            $
            -
            
            
            $
            -
            
            
            $
            17,313




-
101 -
 NOTE 11
— FAIR VALUE MEASUREMENTS





The Company
records its financial instruments that are accounted for under FASB ASC No.
320-10-25, Recognition of
Investments in Debt and Equity Securities,previously discussed in SFAS
115, Accounting for Certain
Investments in Debt and Equity Securities, and derivative contracts under
FASB ASC No. 815, Derivatives
and Hedging, previously discussed in SFAS 133,Accounting for Derivative
Instruments and Hedging Activities, at fair value. The determination of
fair value is based upon the fair value framework established by FASB ASC No.
820-10-35, Fair Value
Measurements and Disclosures – Subsequent Measurement(“ASC 820-10-35”),
previously discussed in SFAS 157, Fair Value Measurements. ASC
820-10-35 provides that a fair value measurement assumes that the transaction to
sell an asset or transfer a liability occurs in the principal market for the
asset or liability or, in the absence of a principal market, the most
advantageous market for the asset or liability. The carrying value of the
Company’s financial instruments including cash and cash equivalents and
short-term investments, approximates fair market value due to the relatively
short period of time to maturity. The fair value of investments is determined
using quoted market prices for those securities or similar financial
instruments.





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





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





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





The table
below sets forth the Company’s cash equivalents and short-term investments as of
December 31, 2009, which are measured at fair value on a recurring basis by
level within the fair value hierarchy. As required by ASC 820-10-35, these are
classified based on the lowest level of input that is significant to the fair
value measurement.




Fair
      value measurements using
            
            
            Assets(dollars
      In thousands)
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            at
      fair valueCash
      equivalents
            
            $
            7,520
            
            
            $
            -
            
            
            $
            -
            
            
            $
            7,520Short-term
      investments
            
            
            3,682
            
            
            
            117,184
            
            
            
            -
            
            
            
            120,866Total
            
            $
            11,202
            
            
            $
            117,184
            
            
            $
            -
            
            
            $
            128,386





The cash
equivalents in the above table exclude $22.2 million in cash held by the Company
or in its accounts or with investment fund managers as of December 31, 2009.
During the year ended December 31, 2009, the Company held no direct investments
in auction rate securities, collateralized debt obligations, structured
investment vehicles or mortgage-backed securities.





As of
December 31, 2009, the Company did not hold financial assets and liabilities
which were recorded at fair value in the Level 3 category.




The following
table sets forth the Company’s cash equivalents and short-term investments as of
December 31, 2008, which were measured at fair value on a recurring basis by
level within the fair value hierarchy. As required by ASC 820-10-35, these were
classified based on the lowest level of input that was significant to the fair
value measurement.





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





The cash
equivalents in the above table excluded $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.




- 102 -
 NOTE 12 —
IMPAIRMENT OF INTANGIBLE ASSETS





In February
2007, the Company entered into an agreement with Sunplus Technology Co., Ltd.
(“Sunplus”) to license certain technology (the “Sunplus IP”) from Sunplus for
$40.0 million. The purpose of this licensing agreement was to obtain advanced
technology for development of future products. The agreement provided for
the Company to pay an aggregate of $40.0 million to Sunplus. Through December
31, 2009, the Company has paid Sunplus a total of $38.7 million of the
consideration for the licensed technology and related deliverables and support.
The Company’s remaining current obligation under this agreement is $1.3 million
as of December 31, 2009.





As required
by FASB ASC No. 360-10-35, Subsequent Measurement of
Property, Plant and
Equipment, paragraphs 15-49, Impairment or Disposal of Long-Lived
Assets,previously discussed in SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets,the Company made an impairment evaluation
of its long-lived assets and determined that its investment in Sunplus IP was
impaired as of December 31, 2009. The impairment charge for intangible assets
subject to amortization, for which impairment indicators exist, 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. On October 18, 2009, the
Company determined that, in light of certain changes to its product strategy
going forward, the intellectual property licensed from Sunplus no longer aligns
with the Company’s product roadmap and therefore will not be used. The reason
for acquiring the Sunplus IP was to provide the Company with advanced technology
for the development of large scale integrated circuits, which included
comprehensive digital television system functionality. Given the Company’s
current product strategy, which is to continue to focus on discrete
semiconductor products and related intellectual property, the Sunplus IP no
longer aligns with the Company’s product roadmap. The change in the Company’s
product strategy was due to market place and related competitive
dynamics.  In connection with the decision to discontinue the use of
the Sunplus IP, the Company wrote-off the unamortized balance of the investment
in Sunplus IP of $28.3 million and recognized a pre-tax impairment charge of
$28.3 million in the consolidated statement of operations under operating
expense, “Impairment of Intangibles”.








NOTE 13
— IMPAIRMENT OF GOODWILL





The Company
periodically reviews the carrying value of intangible assets not subject to
amortization, including goodwill, to determine if any impairment exists. FASB
ASC No. 350-20-35, Subsequent
Measurement of Goodwill, whose provisions
were previously discussed in SFAS 142, Goodwill and Other Intangible
Assets, requires that goodwill 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
determines the fair value of the reporting unit using generally accepted
valuation methodology which considers market capitalization and market premiums.
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 Company
has one reportable operating segment and the goodwill impairment testing was
done at the reporting unit level. During the three months ended March 31,
2009, the Company assessed goodwill for impairment since it observed there were
indicators of impairment. The notable indicators were a sustained and
significant decline in the Company’s stock price, depressed market conditions
and declining industry trends. The Company’s stock price had been in a period of
sustained decline and the business climate had deteriorated substantially in the
preceding three months. Based on the results of the first step of the goodwill
analysis, it was determined that the Company’s net book value exceeded its
estimated fair value. As a result, the Company performed the second step of the
impairment test to determine the implied fair value of goodwill. Under step two,
the difference between the estimated fair value of the Company and the sum of
the fair value of the identified net assets results in the residual value of
goodwill. Specifically, the Company allocated the estimated fair value of the
Company as determined in the first step of the goodwill analysis to the
recognized and unrecognized net assets, including allocations to intangible
assets. Based on the analysis performed under step two, there was no remaining
implied value attributable to goodwill and accordingly, the Company wrote off
the entire goodwill balance and recognized goodwill impairment charges of
approximately $19.2 million in the consolidated statement of operations under
operating expense, “Impairment of Goodwill.”




-
103 -


NOTE 14
— DERIVATIVE INSTRUMENTS





The Company
accounts for derivative instruments in accordance with the provisions of FASB
ASC No. 815-20-25, Derivatives
and Hedging – Hedging Recognition, previously discussed in SFAS 133,
Accounting for Derivative
Instruments and Hedging Activities. 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’s derivatives are designated as cash flow hedges. 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 (loss) is reported immediately in other income (expense) on the
Company’s consolidated statement of operations.




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





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





The amount of
gain (loss) recognized in other comprehensive income (“OCI”) on effective cash
flow hedges as of December 31, 2009, the amount of gain (loss) reclassified from
accumulated OCI to operating expenses for the year ended December 31, 2009, and
the amount of gain (loss) recognized in income on ineffective cash flow hedges
for the year ended December 31, 2009 are insignificant.





As of
December 31, 2009, the outstanding foreign currency forward contract had a
notional value of approximately $0.5 million. As of December 31, 2009, there
were no outstanding effective cash flow hedges, hence, there was no unrealized
gain relating to effective cash flow hedges was outstanding in accumulated other
comprehensive income as of December 31, 2009.





The Company
had no outstanding derivative instruments as of December 31, 2008.








NOTE 15
— SUBSEQUENT EVENTS





The Company’s
management evaluated subsequent events through February
12, 2010, which is the date these financial statements were
issued.




-
104 -
 
 Part IV Table of Contents
 
 NOTE 16
— UNAUDITED SELECTED QUARTERLY
FINANCIAL DATA





The
following table sets forth the Company’s consolidated statements of operations
data for the eight quarters ended December 31, 2009. 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 (5)
            
            
            Jun
      30 (6)
            
            
            Sep
      30 (8)
            
            
            Dec
      31 (6) (7) (8)(In
      thousands, except per share amounts)2009Total
      revenue
            
            $
            40,512
            
            
            $
            37,336
            
            
            $
            37,156
            
            
            $
            35,585Gross
      margin (1)
            
            
            22,097
            
            
            
            19,798
            
            
            $
            20,199
            
            
            
            18,709Loss
      from operations (2)
            
            
            (30,794
            )
            
            
            (19,070
            )
            
            
            (16,651
            )
            
            
            (50,802
            )Net
      loss
            
            
            (33,329
            )
            
            
            (13,329
            )
            
            
            (15,511
            )
            
            
            (66,940
            )Net
      loss per share - basic and diluted
            
            $
            (0.45
            )
            
            $
            (0.18
            )
            
            $
            (0.21
            )
            
            $
            (0.88
            )Weighted
      average shares - basic and diluted
            
            
            74,421
            
            
            
            74,806
            
            
            
            75,053
            
            
            
            75,3552008Total
      revenue
            
            $
            67,113
            
            
            $
            70,083
            
            
            $
            77,776
            
            
            $
            59,443Gross
      margin (3)
            
            
            38,976
            
            
            
            40,976
            
            
            
            46,035
            
            
            
            34,702Income/(loss)
      from operations (4)
            
            
            (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
            
            
            
            74,940(1)
      Includes stock-based compensation expense
            
            $
            199
            
            
            $
            244
            
            
            $
            363
            
            
            $
            180(2)
      Includes stock-based compensation expense
            
            $
            3,366
            
            
            $
            3,969
            
            
            $
            7,285
            
            
            $
            2,495(3)
      Includes stock-based compensation expense
            
            $
            350
            
            
            $
            431
            
            
            $
            351
            
            
            $
            313(4)
      Includes stock-based compensation expense
            
            $
            3,673
            
            
            $
            5,827
            
            
            $
            3,757
            
            
            $
            4,784





(5)
During the three months ended March 31, 2009, the Company performed an
impairment analysis of its goodwill with a carrying value of $19.2 million.
Based on the negative external indicators and the analysis performed by the
Company, the goodwill was determined to be impaired. As a result, the Company
recognized goodwill impairment charges of approximately $19.2 million in the
consolidated statement of operations under operating expense, “Impairment of
Goodwill” during the three months ended March 31, 2009. See related discussion
in Note 13.


(6) In
June and October 2009, the Company’s management approved and announced
restructuring programs, which primarily included a reduction in force, to
realign and focus the Company’s resources on its core competencies and in order
to better align its revenues and expenses.  In the quarters ended June
30, 2009 and December 31, 2009, the Company incurred expenses related to
restructuring programs of $7.1 million and $14.7 million,
respectively.  See Note 10 of our notes to consolidated financial
statements for further details on our restructuring plans. 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 September 30, 2008 and December
31, 2008, The Company incurred expenses related to restructuring programs of
$1.9 million and $4.0 million, respectively.


(7) In
October 2009, the Company determined that, in light of certain changes to its
product strategy, the intellectual property licensed from Sunplus Technology
Co., Ltd in February 2007 (the “Sunplus IP”) no longer aligned with the
Company’s product roadmap and therefore will not be used. In connection with the
decision to discontinue the use of the Sunplus IP, the Company wrote-off the
unamortized balance of the investment in Sunplus IP of $28.3 million and
recognized a pre-tax impairment charge of $28.3 million in the consolidated
statement of operations under operating expense, “Impairment of Intangible
Assets” for the three months ended December 31, 2009.  See related
discussion in Note 12.


(8) In
the fourth quarter of 2009, the Company recorded an income tax provision of
$16.9 million. This was primarily due to (1) $34.0 million of provision related
to the valuation allowance on deferred tax assets and (2) $6.4 million of fourth
quarter stock compensation, partially offset by the (3) $5.6 million benefit
related to a worthless stock deduction for the Company’s investment in its
German subsidiary and (4) $17.5 million federal benefit related to the
pre-tax loss incurred during the fourth quarter of 2009 amounting to
approximately $50.0 million.  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: (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.




-
105 -
 
 Part
IV Table of Contents





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








To the Boardof 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, 2009 and 2008, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2009. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these 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, 2009 and 2008, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2009, 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 a new accounting principle related to fair value
measurements.
  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, 2009, 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 12, 2010 expressed an
unqualified opinion on the Company's internal control over financial
reporting.
   /s/
DELOITTE & TOUCHE LLP
  San Jose,
California
 February
12, 2010











-
106 -
 Table of
Contents


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 12, 2010
            
            By:
            /s/  Camillo
      MartinoCamillo
      MartinoChief
      Executive Officer(Principal
      Executive Officer)





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/  Camillo
      Martino
            Chief
      Executive Officer and Director
            February
      12, 2010Camillo
      Martino
            (Principal
      Executive Officer)/s/  Noland
      Granberry
            Chief
      Accounting Officer
            February
      12, 2010Noland
      Granberry
            (Principal
      Financial Officer)/s/  Harold
      Covert
            Director
            February
      12, 2010Harold
      Covert/s/  William
      George
            Director
            February
      12, 2010William
      George/s/  Peter
      Hanelt
            Director
            February
      12, 2010Peter
      Hanelt/s/  John
    Hodge
            Director
            February
      12, 2010John
      Hodge/s/  Masood
      Jabbar
            Director
            February
      12, 2010Masood
      Jabbar/s/  William
      Raduchel
            Director
            February
      12, 2010William
      Raduchel




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 Table of Contents


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)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)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 (Incorporated by reference to No. 10.45*
      of the Form 10K filed by the Registrant on February 13,
    2009).10.46*
              Amended
      and restated employment letter between Steve Tirado and the Registrant,
      dated October 22, 2008 (Incorporated by reference to No. 10.46* of the
      Form 10K filed by the Registrant on February 13, 2009).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 (Incorporated by reference to No. 10.48* of the Form 10K filed by the
      Registrant on February 13, 2009).10.49*
              Confidential Severance
      and General Release Agreement between Paul Dal Santo, the Registrant’s
      Chief Operating Officer and the Registrant dated March 31, 2009
      (Incorporated by reference to Exhibit 99.01 to the Registrant’s current
      report on Form 8-K filed on April 2, 2009).10.50*
              Silicon
      Image, Inc. Sales Compensation Plan for Vice President of Worldwide Sales
      for Fiscal Year 2009 (Incorporated by reference to Exhibit 99.01 to
      the Registrant’s current report on Form 8-K filed on March 28,
      200910.51*
              Employee
      Bonus Plan for Fiscal Year 200921.01
              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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