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EX-32.02 - EXHIBIT 32.02 - SILICON IMAGE INCexhibit_32-02.htm
EX-31.02 - EXHIBIT 31.02 - SILICON IMAGE INCexhibit_31-02.htm
EX-32.01 - EXHIBIT 32.01 - SILICON IMAGE INCexhibit_32-01.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For quarterly period ended: September 30, 2011
 
OR
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                            to                           
 
Commission File Number: 000-26887
 
 
Silicon Image, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
77-0396307
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer I.D. Number)
 
   
 
1140 East Arques Avenue, Sunnyvale, California 94085
 (Address of principal executive office)(Zip Code)
 
(408) 616-4000
(Registrant’s telephone number, including area code)
 
N/A
 (Former name, former address and former fiscal year,
if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer    o
Accelerated filer   x
   
Non-accelerated filer   o
Smaller reporting company   o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
CLASS
 
OUTSTANDING AT September 30, 2011
Common Stock, $0.001 par value
 
82,005,362
 

 
1
 


 

SILICON IMAGE, INC.
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2011

Table of Contents

   
 Part I FINANCIAL INFORMATION
 
  3
  3
  4
  5
  6
  20
  26
  27
     Part II OTHER INFORMATION
  27
  27
       Item 1A Risk Factors
  27
  40
  40
       Item 4 Reserved
  40
  40
       Item 6 Exhibits
  41
     Signature
  42
 
 
 
2
 



Part I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS (Unaudited)

SILICON IMAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

   
September 30, 2011
   
December 31, 2010
 
ASSETS
           
Current Assets:
           
Cash and cash equivalents
  $ 43,802     $ 29,942  
Short-term investments
    111,396       160,538  
Accounts receivable, net of allowances for doubtful accounts of  $1,516 at September 30, 2011 and $1,620 at December 31, 2010
    34,003       22,598  
Inventories
    14,254       10,212  
Prepaid expenses and other current assets
    5,439       6,515  
Deferred income taxes
    968       1,008  
Total current assets
    209,862       230,813  
Property and equipment, net
    12,217       11,404  
Deferred income taxes, non-current
    4,799       4,795  
Intangible assets, net (Notes 14 and 15)
    12,411       -  
Goodwill (Notes 14 and 15)
    18,646       -  
Other assets
    17,702       3,607  
Total assets
  $ 275,637     $ 250,619  
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current Liabilities:
               
Accounts payable
  $ 13,236     $ 10,615  
Accrued and other current liabilities
    20,740       17,771  
Deferred margin on sales to distributors
    11,751       13,484  
Deferred license revenue
    2,969       4,197  
Total current liabilities
    48,696       46,067  
Other long-term liabilities
    14,850       13,356  
Total liabilities
    63,546       59,423  
Commitments and contingencies (Note 9)
               
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: 82,005,362 at September 30, 2011 and 78,191,027 at December 31, 2010
    98       95  
Additional paid-in capital
    502,552       476,915  
Treasury stock, 17,606,926 shares at September 30, 2011 and 17,076,173 shares at December 31, 2010
    (111,008 )     (107,745 )
Accumulated deficit
    (179,383 )     (177,957 )
Accumulated other comprehensive loss
    (168 )     (112 )
Total stockholders’ equity
    212,091       191,196  
Total liabilities and stockholders’ equity
  $ 275,637     $ 250,619  
 

See accompanying Notes to Condensed Consolidated Financial Statements.
 

 
3
 



SILICON IMAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)


   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenue:
                       
Product
  $ 49,129     $ 46,117     $ 129,205     $ 110,774  
Licensing
    10,595       14,387       33,071       28,589  
Total revenue
    59,724       60,504       162,276       139,363  
Cost of revenue and operating expenses:
                               
Cost of product revenue (1)
    25,072       22,587       67,211       56,898  
Cost of licensing revenue
    144       67       644       103  
Research and development (2)
    18,063       13,583       48,887       40,379  
Selling, general and administrative (3)
    14,521       11,691       41,412       34,862  
Amortization of intangible assets
    496       37       1,089       112  
Restructuring expense (Note 5)
    360       99       1,457       952  
Total cost of revenue and operating expenses
    58,656       48,064       160,700       133,306  
Income from operations
    1,068       12,440       1,576       6,057  
Interest income and other, net
    523       556       1,534       1,790  
Income before provision for income taxes
    1,591       12,996       3,110       7,847  
Income tax expense
    911       3,531       4,536       3,849  
Net income (loss)
  $ 680     $ 9,465     $ (1,426 )   $ 3,998  
                                 
Net income (loss) per share – basic and diluted
  $ 0.01     $ 0.12     $ (0.02 )   $ 0.05  
Weighted average shares – basic
    81,372       77,210       80,116       76,649  
Weighted average shares – diluted
    83,432       78,124       80,116       77,665  
                                 
(1) Includes stock-based compensation expense
  $ 272     $ 127     $ 586     $ 456  
(2) Includes stock-based compensation expense
  $ 1,636     $ 687     $ 2,997     $ 2,057  
(3) Includes stock-based compensation expense
  $ 1,720     $ 936     $ 3,941     $ 3,382  
 
 
See accompanying Notes to Condensed Consolidated Financial Statements.


 
4
 



SILICON IMAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


   
Nine Months Ended September 30,
 
   
2011
   
2010
 
Cash flows from operating activities:
           
Net  income (loss)
  $ (1,426 )   $ 3,998  
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:
               
Stock-based compensation expense
    7,524       5,895  
Depreciation
    4,810       5,872  
Amortization of investment premium
    2,111       2,170  
Tax benefits from employee stock-based transactions
    1,702       -  
Excess tax benefits from employee stock-based transactions
    (1,702 )     -  
Amortization of intangible assets
    1,089       112  
Realized gain on sale of short-term investments
    (175 )     (130 )
Asset impairment due to restructuring
    -       184  
Others
    268       50  
Changes in assets and liabilities:
               
Accounts receivable
    (11,020 )     (2,506 )
Inventories
    (2,491 )     (3,849 )
Prepaid expenses and other assets
    327       22,747  
Accounts payable
    669       7,492  
Accrued and other liabilities
    69       (12,908 )
Deferred license revenue
    (2,060 )     2,997  
Deferred margin on sales to distributors
    (1,733 )     7,359  
Cash provided by (used in) operating activities
    (2,038 )     39,483  
Cash flows from investing activities:
               
Proceeds from maturities and sales of short-term investments
    131,810       95,784  
Purchases of short-term investments
    (84,700 )     (128,003 )
Cash used in business acquisitions, net of cash acquired
    (15,910 )     -  
Purchases of property and equipment
    (5,787 )     (3,570 )
Investment in a privately-held company
    (7,514 )     -  
Other investing activities
    (5,840 )     (749 )
Cash  provided by (used in) investing activities
    12,059       (36,538 )
Cash flows from financing activities:
               
Proceeds from issuances of common stock, net
    5,982       2,932  
Excess tax benefits from employee stock-based transactions
    1,702       -  
Repurchases of restricted stock units for income tax withholding
    (3,263 )     (1,169 )
Payment of a line of credit assumed in business acquisition
    (523 )     -  
Payments for vendor financed purchases of software and intangibles
    -       (1,250 )
Cash provided by financing activities
    3,898       513  
Effect of exchange rate changes on cash and cash equivalents
    (59 )     421  
Net increase in cash and cash equivalents
    13,860       3,879  
Cash and cash equivalents — beginning of period
    29,942       29,756  
Cash and cash equivalents — end of period
  $ 43,802     $ 33,635  
Supplemental cash flow information:
               
Common stock issued in connection with business acquisition (1.3 million shares issued)
  $ 10,429     $ -  
Restricted stock units vested
  $ 9,514     $ 3,246  
Net refund (cash payment) for income taxes
  $ (4,068 )   $ 18,725  
Property and equipment purchased but not paid for
  $ 419     $ 502  
 
See accompanying Notes to Condensed Consolidated Financial Statements.

 
5
 



SILICON IMAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2011
(UNAUDITED)


1.  BASIS OF PRESENTATION
 
    In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Silicon Image, Inc. (the “Company”, “Silicon Image”, “we” or “our”) included herein have been prepared on a basis consistent with our December 31, 2010 audited financial statements and include all adjustments, consisting of normal recurring adjustments, necessary to fairly state the condensed consolidated balance sheets of Silicon Image and our subsidiaries as of  September 30, 2011 and December 31, 2010 and the related condensed consolidated statements of operations for the three and nine months ended September 30, 2011 and 2010 and the related condensed consolidated statements of cash flows for the nine months ended September 30, 2011 and 2010. All significant intercompany accounts and transactions have been eliminated. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. Financial results for the three and nine months ended September 30, 2011 are not necessarily indicative of future financial results.


2.  RECENT ACCOUNTING PRONOUNCEMENTS
 
    In September 2011, Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (ASU) No. 2011-08, Testing Goodwill for Impairment (Accounting Standards Codification (ASC) Topic 350). Under the amendments in this ASU, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any. Under the amendments in this ASU, an entity has also the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. The amendments are effective for annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted.
 
    In June 2011, FASB issued ASU No. 2011-05, Comprehensive Income (ASC Topic 220). This ASU provides the guidance on the presentation of comprehensive income, which eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The guidance allows two presentation alternatives: (1) present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income; or (2) in two separate, but consecutive, statements of net income and other comprehensive income. This guidance is effective as of the beginning of a fiscal year that begins after December 15, 2011. Early adoption is permitted, but full retrospective application is required under both presentation alternatives. This Company is currently evaluating which presentation alternative it will utilize.
 
    In May 2011, FASB issued ASU No. 2011-04, Fair Value Measurements (ASC Topic 820). This ASU provides additional guidance on fair value disclosures. This guidance contains certain updates to the measurement guidance as well as enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for “Level 3” measurements including enhanced disclosure for: (1) the valuation processes used by the reporting entity; and (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any. This guidance is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. Other than requiring additional disclosures on the Company’s “Level 3” disclosures, the adoption of this new guidance will not have a material impact on the Company’s consolidated results of operations and financial position.
 
    In December 2010, FASB issued ASU No. 2010-29, Business Combinations (ASC Topic 805). The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period. The amendments also improve the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination(s). The provisions under this ASU became effective for the Company beginning in fiscal year 2011. See Note 14 for the business acquisition related disclosures following this ASU guidance.
 
    In January 2010, FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (ASC Topic 820) — Improving Disclosures About Fair Value Measurements. The ASU requires new disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements. It also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. The provisions under this ASU became effective for the Company beginning in fiscal year 2011.  Other than requiring additional disclosures, the adoption of this new guidance did not have a material impact on the Company’s consolidated results of operations and financial position.

 
6
 


Table of Contents   
 
 
Adoption of FASB issued ASU No. 2009-13, Revenue Recognition (ASC Topic 605) - Multiple-Deliverable Revenue Arrangements
 
    In October 2009, FASB issued ASU No. 2009-13, Revenue Recognition (ASC Topic 605)- Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force.  This guidance modifies the fair value requirements of ASC subtopic 605-25, Revenue Recognition-Multiple Element Arrangements by allowing the use of the “best estimate of selling price” in addition to vendor-specific objective evidence (VSOE) and verifiable objective evidence (VOE) (now referred to as TPE standing for third-party evidence) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted. This update requires expanded qualitative and quantitative disclosures and became effective for the Company’s first quarter of fiscal year 2011. The Company adopted the provisions under this update beginning in fiscal year 2011. As a result of the adoption of ASU 2009-13, revenue for the three and nine months ended September 30, 2011 was approximately $68,000 and  $481,000, respectively, higher than the revenue that would have been recorded under the previous accounting rules.
 
    As a result of the adoption of ASU 2009-13, the Company adopted the following accounting policy on licensing revenue recognition:
 
    The Company derives revenue from the license of its 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 IP licensing agreements generally include multiple elements, which may include one or more off-the-shelf and/or customized IP licenses bundled with support services covering a fixed period of time, usually one year. For such multiple element IP licensing arrangements, the Company follows the guidance in FASB ASU No. 2009-13, Revenue Recognition (ASC Topic 605) - Multiple-Deliverable Revenue Arrangements, to determine whether there is more than one unit of accounting.
 
    For multiple-element arrangements the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (VSOE), (ii) third-party evidence of selling price (TPE), and (iii) best estimate of the selling price (ESP). VSOE generally exists only when the Company sells the deliverable separately and is the price actually charged by the Company for that deliverable. ESPs reflect the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis. For the elements of IP licensing agreements the Company concluded that VSOE exists only for its support services based on periodic stand-alone renewals. For all other elements in IP licensing agreements, the Company concluded that no VSOE or TPE exists because these elements are almost never sold on a stand-alone basis by the Company or its competitors.
 
    The Company’s process for determining its ESP for deliverables without VSOE or TPE considers multiple factors that may vary depending upon the unique facts and circumstances related to each deliverable. The key factors considered by the Company in developing the ESPs include prices charged by the Company for similar offerings, if any, the Company’s historical pricing practices, the nature and complexity of different technologies being licensed.
 
    Amounts allocated to the delivered off-the-shelf IP licenses are recognized at the time of sale provided the other conditions for revenue recognition have been met. Amounts allocated to the customized IP licenses are recognized by percentage of completion or completed contract method depending on the nature of the customization project. Amounts allocated to the support services are deferred and recognized on a straight-line basis over the support period, usually one year.


3.  SIGNIFICANT ACCOUNTING POLICIES
 
    The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from these estimates. Areas where significant judgment and estimates are applied include revenue recognition, stock based compensation, cash equivalents and short-term investments,  inventory valuation, realization of long lived assets, including goodwill and intangibles, income taxes, deferred tax assets, restructuring liabilities and legal matters.
 
    The condensed consolidated financial statements include the accounts of Silicon Image, Inc. and its subsidiaries after elimination of all intercompany balances and transactions.
 
    Except for the new accounting policy on licensing revenue as set out above, no other changes have been made to the significant policies that the Company disclosed in the “Significant Accounting Policies” in its Annual Report on Form 10-K for the year ended December 31, 2010.

 
 
7
 


Table of Contents   
 
 
 
4.  STOCK-BASED COMPENSATION
 
    The Company has a share-based compensation program that provides its Board of Directors with broad discretion in creating equity incentives for employees, officers and non-employee board members. This program includes incentive and non-statutory stock option grants and restricted stock units (RSUs) for employees, and an automatic grant program for non-employee board members pursuant to which such individuals will receive grants at designated intervals over their period of board service. These awards are granted under the stockholder approved 2008 Equity Incentive Plan. Grants under the discretionary grant program generally vest as follows: 25% of the shares vest on the first anniversary of the vesting commencement date and the remaining 75% vest proportionately each month over the next 36 months of continued service. Stock option grants to non-employee members of our board vest monthly, over periods not to exceed four years. Some options provide for accelerated vesting if certain identified milestones are achieved, upon a termination of employment or upon a change in control of the Company. RSU grants generally vest over a one to four-year period and certain of the RSU grants also have performance based vesting criteria. Additionally, our Employee Stock Purchase Plan (ESPP) that allows employees to purchase shares of common stock at the lower of 85% of the fair market value on the commencement date of the six-month offering period or on the last day of the six-month offering period. 

Valuation and Expense Information Under Stock-based Compensation
 
    Share-based compensation expense recognized under FASB ASC No. 718-10-30, Initial Measurement of Stock Compensation, consists primarily of expenses for the share-based awards discussed above.
 
    The fair value of each option grant is estimated on the date of grant using the Black-Scholes- Merton option valuation model and the straight-line attribution approach with the following assumptions:


   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Employee stock option plans:
                       
Expected life in years
    4.0       4.2       4.0       4.2  
Expected volatility
    70.9 %     66.0 %     69.8 %     64.2 %
Risk-free interest rate
    0.7 %     1.1 %     1.4 %     1.9 %
Expected dividends
 
none
   
none
   
none
   
none
 
Weighted average fair value
  $ 3.27     $ 1.72     $ 3.58     $ 1.59  
                                 
Employee Stock Purchase Plan:
                               
Expected life in years
    0.5       0.5       0.5       0.5  
Expected volatility
    71.4 %     72.6 %     71.3 %     60.2 %
Risk-free interest rate
    0.1 %     0.2 %     0.1 %     0.2 %
Expected dividends
 
none
   
none
   
none
   
none
 
Weighted average fair value
  $ 1.88     $ 1.33     $ 2.28     $ 0.96  

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 Life — The expected life of the options represents the estimated period of time until exercised and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules, and expectations of future employee behavior. The expected term for the ESPP is based on the term of the purchase period.

Expected Volatility — The volatility rate is based on the Company’s historical common stock volatility derived from historical stock price data for historical periods commensurate with the options’ expected life.

Risk-Free Interest Rate —The risk-free interest rate is based on the implied yield currently available on United States Treasury zero-coupon issues with a term equal to the expected life at the date of grant of the options.

Expected Dividend — The expected dividend is based on our history and expected dividend payouts. The expected dividend yield is zero as the Company has historically paid no dividends and does not anticipate dividends to be paid in the future.
 
    As required by FASB ASC 718-10-35, Subsequent Measurement of Stock Compensation, management made an estimate of expected forfeitures and is recognizing stock-based compensation expense only for those equity awards expected to vest.
 
    For the three months ended September 30, 2011 and 2010, 297,302 and 637,491 shares of common stock were purchased under the ESPP program, respectively. For the nine months ended September 30, 2011 and 2010, 811,413 and 1,233,976 shares were purchased under the ESPP program, respectively. At September 30, 2011, the Company had $547,000 of total unrecognized compensation expense, net of estimated forfeitures under the ESPP program. The unamortized compensation expense will be amortized on a straight-line basis over a period of approximately 4.5 months.
 
 
8
 


Table of Contents   
 
 
Stock Options Activity
 
    The following is a summary of activity under the Company’s stock option plans during the nine months ended September 30, 2011, excluding RSUs (in thousands, except weighted average exercise price):
 
         
Weighted
   
Weighted
       
         
Average
   
Average
       
         
Exercise
   
Remaining
   
Aggregate
 
   
Number of
   
Price per
   
Contractual
   
Intrinsic
 
   
Shares
   
Share
   
Terms in Years
   
Value
 
At January 1, 2011
    4,965     $ 5.54              
Granted
    1,979       6.77              
Forfeitures and cancellations
    (302 )     6.67              
Exercised
    (693 )     4.20              
At September 30, 2011
    5,949     $ 6.05       5.51     $ 6,291  
Vested and expected to vest at September 30, 2011
    5,121     $ 6.18       5.31     $ 5,303  
Exercisable at September 30, 2011
    2,538     $ 7.26       3.86     $ 2,022  
 
    The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that option holders would have received had all option holders exercised their options on September 30, 2011. The aggregate intrinsic value is the difference between the Company's closing stock price on the last trading day of the third quarter of fiscal 2011 and the exercise price, multiplied by the number of outstanding or exercisable in-the-money options. The aggregate intrinsic value excludes the effect of stock options that have a zero intrinsic value. The total pre-tax intrinsic value of options exercised, representing the difference between the fair market value of the Company’s common stock on the date of the exercise and the exercise price of each option, for the three and nine months ended September 30, 2011 was $234,000 and $2.9 million, respectively, and was $395,000 and $405,000 for the three and nine months ended September 30, 2010, respectively.  The total grant date fair value of the options which vested was $255,000 and $1.1 million during the three and nine months ended September 30, 2011, respectively, and $1.0 million and $4.0 million during the three and nine months ended September 30, 2010, respectively.
 
    At September 30, 2011, the total unrecognized pre-tax stock-based compensation expense related to stock options, which the Company expects to recognize over the remaining weighted-average vesting period of 2.91 years, was $5.4 million, net of estimated forfeitures.
 
 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 executive officers 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 activity with respect to the Company’s RSUs during the nine months ended September 30, 2011 is as follows: (in thousands):
 
   
Number of Units
   
Weighted- Average Grant Date Fair Value Per Share
 
Outstanding at January 1, 2011
    2,719     $ 3.49  
Granted
    2,078       6.89  
Vested
    (1,540 )     3.60  
Forfeitures and cancellations
    (287 )     5.69  
Outstanding at September 30, 2011
    2,970     $ 5.60  
 
    The total grant date fair value of the RSUs that vested during the three and nine months ended September 30, 2011 was $3.8 million and $5.5 million, respectively, and $47,000 and $4.5 million for the three and nine months ended September 30, 2010, respectively. Of the 2,970,000 RSUs outstanding as of September 30, 2011, approximately 2,293,000 units are expected to vest after considering the applicable forfeiture rate.
 
    At September 30, 2011, the total unrecognized pre-tax stock-based compensation expense related to non-vested RSUs, which the Company expects to recognize over the remaining weighted-average vesting period of 2.33 years, was $8.8 million, net of estimated forfeitures.
 
    During the three months ended September 30, 2011 and 2010, the Company repurchased 354,293 and 2,979 shares of stock, respectively, for an aggregate value of $1.8 million and $11,000, respectively, from the employees upon the vesting of their RSUs that were granted under the Company’s 2008 Equity Incentive Plan to satisfy the employees’ minimum statutory tax withholding requirement. During the nine months ended September 30, 2011 and 2010, the Company repurchased 530,753 and 441,546 shares of stock, respectively, for an aggregate value of $3.3 million and $1.2 million, respectively.   The Company will continue to repurchase shares of stock from employees as their RSUs vest to satisfy the employees’ minimum statutory tax withholding requirement.

Stock-based Compensation Expense
 
    The table below shows total stock-based compensation expense included in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 (in thousands):
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Cost of sales
  $ 272     $ 127     $ 586     $ 456  
Research and development
    1,636       687       2,997       2,057  
Selling, general and administrative
    1,720       936       3,941       3,382  
      Total stock-based compensation expense   $ 3,628     $ 1,750     $ 7,524     $ 5,895  
 
    No income tax effect is shown due to the full valuation allowance.

 
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5.  RESTRUCTURING CHARGES AND EXIT COSTS
 
    For the three and nine months ended September 30, 2011, the Company recorded restructuring expense of approximately $0.4 million and $1.5 million, respectively, which primarily consisted of severance and benefits of terminated employees and cost relating to operating lease commitments on exited facilities relating to SiBEAM acquisition.
 
    For the three and nine months ended September 30, 2010, the Company recorded restructuring expense of approximately $0.1 million and $1.0 million, respectively, which was primarily related to operating lease commitments on exited facilities, impairment of certain fixed assets, and legal and other restructuring related costs which were recognized as incurred.
 
    The table below summarizes the Company’s restructuring activities for the nine months ended September 30, 2011 (in thousands):
 
   
Employee Severance and Benefits
   
Operating Lease and Other Agreements Cancellation
   
Total
 
Accrued restructuring balance as of January 1, 2011
  $ -     $ 1,849     $ 1,849  
Additional accruals/adjustments
    925       532       1,457  
Cash payments
    (838 )     (2,107 )     (2,945 )
Foreign currency changes
    -       34       34  
Accrued restructuring balance as of September 30, 2011
  $ 87     $ 308     $ 395  

 
6.  COMPREHENSIVE INCOME (LOSS)
 
    The components of comprehensive income (loss), net of related taxes, were as follows (in thousands):


   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Net income (loss)
  $ 680     $ 9,465     $ (1,426 )   $ 3,998  
Changes in unrealized value of investments
    (137 )     169       (96 )     (113 )
Gain (loss) from foreign currency hedges
    (203 )     474       (119 )     64  
Foreign currency changes
    5       62       160       517  
Total comprehensive income (loss)
  $ 345     $ 10,170     $ (1,481 )   $ 4,466  
 

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


   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Numerator:
                       
Net income (loss)
  $ 680     $ 9,465     $ (1,426 )   $ 3,998  
Denominator:
                               
Weighted average outstanding shares used to compute basic net income (loss) per hare
    81,372       77,210       80,116       76,649  
Effect of dilutive securities
    2,060       914       -       1,016  
Weighted-average diluted outstanding shares used to compute diluted net income (loss) per share
    83,432       78,124       80,116       77,665  
                                 
Net income (loss) per share:  – basic and diluted
  $ 0.01     $ 0.12     $ (0.02 )   $ 0.05  
 
    For the three months ended September 30, 2011, approximately 5.2 million weighted common stock equivalents were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.  As a result of the net loss for the nine months ended September 30, 2011, approximately 5.5 million weighted common stock equivalents were excluded in the computation of diluted net loss per share because their effect would have been anti-dilutive.
 
    For the three and nine months ended September 30, 2010, approximately 8.1 million and 9.6 million weighted common stock equivalents, respectively, were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive.
 
 
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8.  BALANCE SHEET COMPONENTS

The table below shows the components of the Company’s inventories, prepaid expense and other current assets, property and equipment, other assets, accrued and other current liabilities and other long-term liabilities.


   
September 30, 2011
   
December 31, 2010
 
   
(In thousands)
 
Inventories:
           
Raw materials
  $ 7,094     $ 3,558  
Work in process
    2,623       1,753  
Finished goods
    4,537       4,901  
    $ 14,254     $ 10,212  
                 
                 
Prepaid expense and other current assets:
               
Prepaid expenses and software maintenance
  $ 2,159     $ 3,418  
Interest receivable
    997       1,292  
Others
    2,283       1,805  
    $ 5,439     $ 6,515  
                 
Property and equipment:
               
Equipment
  $ 31,760     $ 30,523  
Computers and software
    20,925       21,387  
Furniture and fixtures
    2,748       2,470  
      55,433       54,380  
Less: accumulated depreciation
    (43,216 )     (42,976 )
Total property and equipment, net
  $ 12,217     $ 11,404  
                 
Other assets:
               
Advances for intellectual properties (see Note 12)
  $ 8,500     $ -  
Investment in a privately-held company (see Note 16)
    7,514       -  
Secured note with a third party company (see Note 12)
    340       3,000  
Others
    1,348       607  
    $ 17,702     $ 3,607  
                 
Accrued and other current liabilities:
               
Accrued payroll and related expenses
  $ 6,521     $ 6,691  
Accrued royalties
    6,319       4,240  
Accrued product rebate
    2,817       100  
Accrued restructuring (see Note 5)
    395       1,849  
Others
    4,688       4,891  
    $ 20,740     $ 17,771  
                 
Other long-term liabilities:
               
Non-current liability for uncertain tax positions
  $ 12,436     $ 11,858  
Non-current deferred license revenue
    1,142       1,498  
Others
    1,272       -  
    $ 14,850     $ 13,356  
 
 
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9.  COMMITMENTS AND CONTINGENCIES

Legal Proceedings
 
    On December 7, 2001, the Company and certain of its officers and directors were named as defendants, along with the underwriters of the Company’s initial public offering, in a securities class action lawsuit. The lawsuit alleges that the defendants participated in a scheme to inflate the price of the Company’s stock in its initial public offering and in the aftermarket through a series of misstatements and omissions associated with the offering. The lawsuit is one of several hundred similar cases pending in the Southern District of New York that have been consolidated by the court. In February 2003, the District Court issued an order denying a motion to dismiss by all defendants on common issues of law. In July 2003, the Company, along with over 300 other issuers named as defendants, agreed to a settlement of this litigation with plaintiffs. While the parties’ request for court approval of the settlement was pending, in December 2006 the United States Court of Appeals for the Second Circuit reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Second Circuit denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the Court terminated the proposed settlement as stipulated among the parties. Plaintiffs filed an amended complaint on August 14, 2007. On September 27, 2007, plaintiffs filed a motion for class certification in the six focus cases, which was withdrawn on October 10, 2008. On November 13, 2007 defendants in the six focus cases filed a motion to dismiss the complaint for failure to state a claim, which the district court denied in March 2008. Plaintiffs, the issuer defendants (including the Company), the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations. The parties have reached a settlement agreement, which was submitted to the District Court for preliminary approval on April 2, 2009. As part of this settlement, the Company’s insurance carrier has agreed to assume the Company’s entire payment obligation under the terms of the settlement. On June 10, 2009, the District Court granted preliminary approval of the proposed settlement agreement. 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. All but two of the objectors withdrew their appeals, and Plaintiff moved to dismiss the remaining appeals, one for violation of the Second Circuit’s rules and one for lack of standing.  On May 17, 2011, the Second Circuit granted the motion to dismiss one objector’s appeal for violations of the Court’s rules and remanded the other appeal to the District Court to determine whether objector Hayes was a class member.  On August 25, 2011, the District Court issued its decision determining that Hayes was not a class member.  On September 30, 2011, objector Hayes filed a notice of appeal from the District Court’s decision.  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. In light of the uncertainty of the appellate process, and any subsequent proceedings in the trial court in the event the settlement is reversed on appeal, the Company is unable to determine the likelihood of an unfavorable outcome against them and is unable to reasonably estimate a range of loss, if any.   
 
    On July 31, 2007, the Company received a demand on behalf of alleged stockholder 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 stockholders as identified in the Company’s 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 22, 2009, an order was issued granting the parties’ joint motion to consolidate the 54 appeals and 30 cross-appeals. Oral argument in the Ninth Circuit was heard on October 5, 2010, and the Court issued its written opinion on December 2, 2010.  The Ninth Circuit affirmed the District Court’s decision that the demand letters that plaintiff submitted to the thirty moving issuers were inadequate and directed the District Court to dismiss those actions with prejudice.  The Ninth Circuit further directed the District Court to consider in the first instance whether the demand letters submitted to the other 24 issuers (including the Company) were sufficiently similar as also to require dismissal with prejudice.  The Ninth Circuit reversed the District Court’s decision in favor of the underwriter defendants on statute of limitations grounds.  On December 16, 2010, plaintiff and the underwriter defendants separately petitioned for a rehearing and a rehearing en banc, which petitions were denied on January 18, 2011.   On January 25 and 26, 2011, the Ninth Circuit granted the motions of the underwriter defendants and of the plaintiff to stay the issuance of the court’s mandate pending those parties’ respective petitions for review by the United States Supreme Court.  On April 5 and April 15, 2011, respectively, plaintiff and the underwriter defendants filed their petitions for review in the Supreme Court.  On June 27, 2011, the Supreme Court granted the petition of the underwriter defendants and denied the petition of the plaintiff.  Oral argument in the Supreme Court has been scheduled for November 28, 2011.    Due to the complexities and uncertainty surrounding the proceedings in the Supreme Court, the Company is unable to determine either the likelihood of an outcome in favor of the plaintiff, or whether any ultimate recovery of short-swing profits might result in a net recovery in our favor in light of the expenses of any future proceedings.
 
    In addition, the Company has been named as a defendant 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 such matters vigorously and although adverse decisions or settlements may occur in one or more of such cases, the final resolution of these matters, individually or in the aggregate, is not expected to have a material adverse effect on the Company’s results of operations, financial position or cash flows.
 
 
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Guarantees
 
    Certain of the Company’s licensing agreements indemnify its customers for any expenses or liabilities resulting from claimed infringements of third party patents, trademarks or copyrights by its products. Certain of these indemnification provisions are perpetual from execution of the agreement and, in some instances; the maximum amount of potential future indemnification is not limited. To date, the Company has not paid any such claims or been required to defend any lawsuits with respect to any such claim.
 
Contractual Obligations and Off-Balance Sheet Arrangements

Operating Leases
 
    On January 6, 2011, the Company entered into a seven-year lease agreement (the “Lease”) with Christensen Holdings, L.P., a California limited partnership. Pursuant to the Lease,  the Company leases an office building in Sunnyvale, California consisting of approximately 128,154 square feet, together with the non-exclusive right to use parking facilities and other amenities. The monthly base rent payment for the first year of the Lease is $108,931, with annual increases of 4% in the second, third and fourth years of the Lease and with an annual increases of 9%, 8% and 7% in the fifth, sixth and seventh years of the Lease, respectively. This facility is the Company’s corporate headquarters, which the Company began occupying in July 2011.  
 
    The Company also leases an operating facility in Irvine, California, pursuant to a non-cancelable operating lease agreement with a term that extends through November 2012.
 
    As a result of the Company’s acquisition of SiBEAM, Inc., the Company assumed a non-cancelable operating lease agreement for an operating facility located in Sunnyvale, California. The term of the lease agreement extends through September 2012.
 
    The Company also leases office spaces in China, Japan, Korea, and Taiwan.
   
    The Company’s future operating lease commitments at September 30, 2011 were as follows (in thousands):


Year ending December 31,
 
Operating Lease Obligations
2011 (remaining 3 months)
  $ 321
2012
    2,124
2013
    1,513
2014
    1,442
2015
    1,535
Thereafter
    4,368
Total
  $ 11,303
 
Other Contractual Obligations
 
    Certain of the Company’s licensing agreements indemnify its customers for any expenses or liabilities resulting from claimed infringements of third party patents, trademarks or copyrights by its products. Certain of these indemnification provisions are perpetual from execution of the agreement and, in some instances; the maximum amount of potential future indemnification is not limited. To date, the Company has not paid any such claims or been required to defend any lawsuits with respect to any claim.

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

Revenue

            The Company attributes revenue to geographic regions based on the “bill to address” location as specified in the customers’ agreements. The following table presents the revenue by geographic region based on bill to location (in thousands):
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
United States
  $ 23,921     $ 8,040     $ 48,954     $ 29,444  
Taiwan
    15,227       13,963       45,908       29,176  
Japan
    9,928       18,028       34,968       41,130  
China
    4,049       3,771       12,611       10,245  
Europe
    3,592       3,526       10,463       12,068  
Korea
    2,375       12,534       7,806       15,471  
Others
    632       642       1,566       1,829  
Total revenue
  $ 59,724     $ 60,504     $ 162,276     $ 139,363  

Reclassifications
 
    Beginning with the three months ended March 31, 2011, the Company has reclassified its product revenue under the following three market categories: 1) Consumer Electronics (CE); 2) Mobile; and 3) Personal Computers (PC). Previously, the Company reported its product revenue under the following three market categories: 1) CE, 2) PC and 3) Storage. As a result of this change, the Company’s CE product category now consists of the DTV and Home Theater markets.  The Company’s mobile category now incorporates all mobile-related activities, including both HDMI and MHL.  PC consists of all PC and Storage related activities.
 
    As a result of the change in the reported market categories, the revenue reported for the three and nine months ended September 30, 2010 under the previous primary market categorization was reclassified to conform to the revenue presentation for the three and nine months ended September 30, 2011. This reclassification did not impact the Company's previously reported net revenues, operating income, net income, or earnings per share.
 
    The Company’s revenue by its primary markets was as follows (in thousands):
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Consumer Electronics
  $ 22,381     $ 36,351     $ 68,072     $ 88,330  
Mobile
    21,516       3,370       44,647       5,940  
Personal Computers
    5,232       6,396       16,486       16,504  
Total product revenue
    49,129       46,117       129,205       110,774  
Licensing
    10,595       14,387       33,071       28,589  
Total revenue
  $ 59,724     $ 60,504     $ 162,276     $ 139,363  
 
    For the three months ended September 30, 2011, three customers each represented 30.8%, 13.3% and 10.2% of the Company’s revenue. For the nine months ended September 30, 2011, three customers each represented 22.0%, 14.8% and 10.9% of the Company’s revenue.  At September 30, 2011, two customers each represented 32.2% and 11.4% of net accounts receivable.
 
    For the three months ended September 30, 2010, four customers each represented 19.8%, 12.9%, 11.8% and 10.6% of the Company’s revenue. For the nine months ended September 30, 2010, three customers each represented 18.6%, 11.5% and 11.2% of the Company’s revenue.  At September 30, 2010, two customers each represented 20.4% and 11.1% of net accounts receivable.
   
Property and Equipment
 
    The table below presents the net book value of the property and equipment by their physical location (in thousands):
 
   
September 30, 2011
   
December 31, 2010
 
United States
  $ 6,968     $ 5,634  
China
    2,754       2,877  
Taiwan
    1,895       2,030  
Others
    600       863  
Net book value
  $ 12,217     $ 11,404  
 
 
 
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11.  PROVISION FOR INCOME TAXES
 
    The Company recorded an income tax expense of $0.9 million and $4.5 million for the three and nine months ended September 30, 2011, respectively.  The effective tax rates for the three and nine months ended September 30, 2011 were 57.3% and 145.9%, respectively, and were based on the Company’s projected taxable income for 2011, plus certain discrete items recorded during the quarter. The difference between the provision for income taxes and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to foreign taxes (including foreign withholding taxes), a provision for charges in lieu of income taxes related to employee stock plans where the windfall benefit is charged to tax expense with the benefit to additional paid-in capital and state taxes.
 
    The Company continued to maintain a valuation allowance as a result of uncertainties related to the realization of its net deferred tax assets at September 30, 2011.  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. 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.
 
    The Company recorded an income tax expense of $3.5 million and $3.8 million for the three and nine months ended September 30, 2010, respectively. The effective tax rates for the three and nine months ended September 30, 2010 were 27.2% and 49.0%, respectively, and were based on the Company’s projected taxable income for 2010, adjusted for the impact of certain discrete items for which the tax effect is recorded during the respective quarter that the event occurs. 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 change in valuation allowance, foreign taxes (including foreign withholding taxes) and state taxes.
 
    The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the provision for income taxes. The Company had interest and penalties of $53,000 and $156,000 for the three and nine months ended September 30, 2011, respectively, and approximately $113,000 and $287,000 for the three and nine months ended September 30, 2010, respectively.  The Company conducts business globally and, as a result, the Company and its subsidiaries file income tax returns in various jurisdictions throughout the world including with the U.S. federal and various U.S. state jurisdictions as well as with various foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world.
 
 
12.  FAIR VALUE MEASUREMENTS

Measurement of Fair Value
 
    Fair value is defined as the price that would be received from selling an asset or the price paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability.
 
Fair Value Hierarchy
 
    A fair value hierarchy is based on whether the market participant assumptions used in determining fair value are obtained from independent sources (observable inputs) or reflects the Company’s own assumptions of market participant valuation (unobservable inputs). A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of inputs that may be used to measure fair value are:
 
Level 1 — Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;
 
Level 2 — Quoted prices for identical assets and liabilities in markets that are inactive; quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly; or
 
Level 3 — Prices or valuations that require inputs that are both unobservable and significant to the fair value measurement.
     
    The Company’s 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.
 
     Level 1 assets consist generally of U.S. government and agency securities. These instruments are generally classified within Level 1 of the fair value hierarchy because they are valued based on quoted market prices in active markets.
 
    The Company classifies items in Level 2 of the fair value hierarchy if the financial asset or liability is valued using observable inputs. The Company uses observable inputs including quoted prices in active markets for similar assets or liabilities. The Company’s Level 2 financial assets include corporate and municipal securities. These investments are priced using observable inputs and valuation models, which vary by asset class. The fair values of all of the Company’s investments in corporate and municipal securities are determined through the assistance of a third party pricing service. For the short-term investments in the Company’s portfolio, multiple pricing sources are generally available. The pricing service uses inputs from multiple industry standard data providers or other third party sources and various methodologies, such as weighting and models, to determine the appropriate price at the measurement date.  
 
    The Company’s Level 3 assets consist of a secured note with a third party company which is secured by certain current assets. Since there is no active market for these types of notes, the fair value is determined based on  available evidence, including general market conditions, financial condition, earnings and cash flow forecasts, recent operational performance and any other readily available market data.The carrying value of the note approximates the fair market value due to the relatively short period of time to maturity or realization.
      
 
 
    The table below sets forth the Company’s assets and liabilities as of September 30, 2011, which are measured at fair value on a recurring basis by level within the fair value hierarchy. The assets are classified based on the lowest level of input that is significant to the fair value measurement.
 
   
Fair value measurements using
   
Assets (Liabilities)
 
   
Level 1
   
Level 2
   
Level 3
   
at fair value
 
Short-term investments:
 
(In thousands)
 
United States government agencies
  $ 10,109     $ -     $ -     $ 10,109  
Municipal securities
    -       82,174       -       82,174  
Corporate securities
    -       19,113       -       19,113  
Total short-term investments at fair value
    10,109       101,287       -       111,396  
Other asssets:
                               
Secured note with a third party company
    -       -       340       340  
Liabilities:
                               
Contingent payments in connection with a business acquisition (Note 14)
    -       -       (1,375 )     (1,375 )
                                 
Total net assets measured at fair value
  $ 10,109     $ 101,287     $ (1,035 )   $ 110,361  
 
    The following table presents the changes in the Company’s Level 3 assets and liabilities, which are measured at fair value on a recurring basis, for the nine months ended September 30, 2011 (in thousands):
 
   
Fair Value Measurement Using Level 3 Inputs
 
   
Assets
   
Liabilities
 
Beginning balance at January 1, 2011
  $ 3,000     $ -  
Net issuances
    6,840       (1,481 )
Conversion of secured notes to advances for intellectual properties
    (8,500 )     -  
Conversion of a bridge loan to equity investment (Note 16)
    (1,000 )     -  
Adjustment in the fair value of contingent considerations (Note 14)
    -       106  
Ending Balance at September 30, 2011
  $ 340     $ (1,375 )
 
    Issuances during the nine months ended September 30, 2011 were related to approximately $5.8 million advances to a third party company pursuant to secured notes which were converted to advances for intellectual properties and $1.0 million bridge loan extended to a different privately-held company which was subsequently converted to an equity investment which is accounted for under the cost method.  Refer to Note 16 for further information on this equity investment.
 
    Apart from the adjustment in fair value of the contingent considerations discussed in Note 14, no gains or losses from these assets and liabilities were recognized during the three and nine months ended September 30, 2011 and 2010. During the three and nine months ended September 30, 2011, the Company held no direct investments in auction rate securities, collateralized debt obligations, structured investment vehicles or mortgage-backed securities. There were no transfers between Level 1, Level 2 and Level 3 fair value hierarchies during the three and nine months ended September 30, 2011.     
 
    The table below sets forth the Company’s short-term investments as of December 31, 2010, which were measured at fair value on a recurring basis by level within the fair value hierarchy. The assets were classified based on the lowest level of input that is significant to the fair value measurement (in thousands).

   
Fair value measurements using
   
Assets
 
   
Level 1
   
Level 2
   
at fair value
 
Short-term investments:
                 
United States government agencies
  $ 19,480     $ -     $ 19,480  
Municipal securities
    -       79,472       79,472  
Corporate securities
    -       61,586       61,586  
Total short-term investments at fair value
  $ 19,480     $ 141,058     $ 160,538  
 
    There were no transfers between Level 1, Level 2 and Level 3 fair value hierarchies during fiscal year 2010.    
 

13.  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. 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 condensed 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 net gain recognized in other comprehensive income (“OCI”) on effective cash flow hedges as of September 30, 2011 and December 31, 2010 was insignificant. The amount of gain or loss reclassified from accumulated OCI to operating expenses for the three and nine months ended September 30, 2011 and 2010, and the amount of gain or loss recognized in income on ineffective cash flow hedges for the three and nine months ended September 30, 2011 and 2010 were insignificant.
 
    As of September 30, 2011 and December 31, 2010, the outstanding foreign currency forward contracts had a total notional value of approximately $4.7 million and $2.9 million, respectively. 
 
 
 
 
14.  BUSINESS ACQUISITIONS
 

SiBEAM, Inc.
 
    On May 16, 2011, the Company completed its acquisition of SiBEAM, Inc. (“SiBEAM”) pursuant to an Agreement and Plan of Merger (the “Merger Agreement”) dated April 13, 2011.  SiBEAM is a privately-held, fabless semiconductor company headquartered in Sunnyvale, California. and is a provider of high-speed wireless communication products for uncompressed HD video in consumer electronics and personal computer applications. The acquisition of SiBEAM supports the Company’s mission to be the leader in advanced video connectivity solutions. SiBEAM’s results of operations and the estimated fair value of assets acquired and liabilities assumed were included in the Company’s unaudited consolidated financial statements beginning May 16, 2011.  The revenue and net loss of SiBEAM from the period May 16, 2011 through September 30, 2011 was approximately $1.2 million and $4.9 million, respectively. Acquisition costs, which were expensed as incurred, were approximately $920,000 for the nine months ended September 30, 2011.
 
    The fair value of the purchase price consideration consisted of the following (in thousands):
 
Cash
  $ 14,540  
Fair value of shares of stock issued
    10,429  
Total purchase  price
  $ 24,969  
 
    As part of the consideration, the Company issued 1,300,369 shares of its common stock to the former SiBEAM stockholders. The total fair value of the shares of stock issued of $10.4 million was determined based on the closing price of the Company’s stock on May 16, 2011 of $8.02 per share.
 
    The purchase consideration was allocated to the tangible and intangible assets acquired and liabilities assumed on the basis of their respective estimated fair values on the acquisition date. The Company’s allocation of the total purchase price is as follows (in thousands):

   
Estimated Fair Value
 
Assets acquired:
     
Cash
  $ 546  
Accounts receivable
    564  
Inventories
    1,353  
Other current assets
    260  
Fixed assets and other long-term assets
    336  
Intangible assets
    8,500  
Goodwill
    18,483  
Total assets acquired
    30,042  
Current liabilities assumed:
       
Accounts payable
    (546 )
Accrued liabilities
    (3,465 )
Line of credit
    (523 )
Deferred license revenue
    (417 )
Total current liabilities
    (4,951 )
Deferred income tax liability, non-current
    (122 )
Total liabilities assumed
    (5,073 )
Total purchase price
  $ 24,969  
 
The following table presents details of the intangible assets acquired  through the acquisition of SiBEAM (in thousands, except years):

   
Asset Life in Years
   
Fair Value
 
In-process research and development
 
indefinite
    $ 4,500  
Customer relationships
    5       1,000  
Trademark
    5       3,000  
Total intangible assets
          $ 8,500  
 
    The Company does not believe there is any significant residual value associated with these intangible assets. The Company amortizes the intangible assets straight-line over their estimated useful lives. The Company’s management determined the fair values of the intangible assets with the assistance of a valuation firm. The estimation of the fair value of the intangible assets required the use of valuation techniques and entailed consideration of all the relevant factors that might affect the fair value, such as present value factors, estimates of future revenues and costs.

Goodwill
 
    Goodwill represents the excess of the purchase price over the fair value of the underlying net tangible and intangible assets. The goodwill recognized in this acquisition was derived from expected benefits from future technology, cost synergies and knowledgeable and experienced workforce who joined the Company after the acquisition. Goodwill will not be amortized, but will be tested instead for impairment annually or more frequently if certain indicators of impairment are present. Goodwill is not expected to be tax deductible for income tax purposes.
 
Unaudited Pro Forma Financial Information
 
    The unaudited pro forma financial information in the table below summarizes the combined results of operations for the Company and SiBEAM as if the merger occurred at the beginning of each of the reporting periods presented. The pro forma financial information for all periods presented also includes the business combination accounting effects resulting from this acquisition including the amortization charges from acquired intangible assets and the stock-based compensation expense recognized for equity awards granted to SiBEAM employees who joined the Company after the acquisition as though the acquisition was completed at the beginning of each reporting period presented. The pro forma financial information as presented below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each reporting period presented.
 
    The unaudited pro forma financial information for the three and nine months ended September 30, 2011 represent (a) the historical results of the Company for the three and nine months ended September 30, 2011, (b) the historical results of SiBEAM for the three and nine months ended September 30, 2011, and (c) the effects of the pro forma adjustments described above.
 
    The unaudited pro forma financial information for the three and nine months ended September 30, 2010 represent (a) the historical results of the Company for the three and nine months ended September 30, 2010, (b) the historical results of SiBEAM for the three and nine months ended September 30, 2010 and (c) the effects of the pro forma adjustments described above.
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Dollars in thousands, except per share amounts)
 
Total revenues
  $ 59,724     $ 61,115     $ 163,225     $ 141,153  
Net income (loss)
  $ 680     $ 3,734     $ (9,510 )   $ (12,977 )
Basic and diluted income (loss) per share
  $ 0.01     $ 0.05     $ (0.12 )   $ (0.17 )

The pro forma adjustments did not have significant impact on the pro forma combined provision for income taxes for the three and nine months ended September 30, 2011 and 2010 due to net loss positions and/or valuation allowances on deferred income tax assets in those periods.
 
 
 

Anchor Bay Technology
 
    On February 2, 2011, the Company purchased the net assets Anchor Bay Technology (“ABT’), a San Jose, California based company involved in developing certain technology that is consistent with the Company’s long-term business strategy, for a total consideration of approximately $3.6 million in cash, subject to certain contingent milestone and earn-out payments as further described below. ABT designs and manufactures video processing semiconductor and system-level solutions. ABT offers advanced video processing chips for de-interlacing and format conversion applications, and video scaling chips for Blu-Ray players, HD set-top box, and AV receiver applications. 
 
    The total fair value of the purchase consideration for this acquisition consists of the following (in thousands):
 
   
Estimated Fair Value
 
Cash consideration
  $ 1,916  
Contingent payments:
       
First milestone
    529  
Second milestone
    525  
Earn-out payments
    427  
Settlement of pre-existing arrangement
    249  
Total Purchase Price
  $ 3,646  
 
Contingent Considerations

First milestone – The Company will pay the former stockholders of ABT $590,000 in cash upon the successful release on or before March 31, 2012 of product samples being developed by the Company which incorporate certain of ABT’s technologies.  The acquisition-date fair value of the first milestone payment was approximately $529,000.
 
Second milestone – The Company will pay the former stockholders of ABT $590,000 in cash upon the successful release on or before November 30, 2012 of production units being developed by the Company which incorporate certain of ABT’s technologies. The acquisition-date fair value of the second milestone payment was approximately $525,000.
 
Earn-out Payments – The former stockholders of ABT are entitled to (i) 50% of net licensing revenue to be derived from each initial ABT IP license entered into by the Company during the first 18 months from the acquisition date and (ii) 50% of support fees collected by the Company on ABT’s IP licenses in excess of 200% of the costs of providing the support services during the first 18 months from the acquisition date.  The acquisition-date fair value of the earn-out payments was approximately $427,000.
 
    The Company had considered the acquisition-date fair values of the milestone and earn-out payments as part of the purchase price. The Company’s management determined the fair values of the contingent payments with the assistance of a valuation firm. The estimation of the fair value of the contingent payments required the use of valuation techniques and entailed consideration of all the relevant factors that might affect the fair value, such as present value factors and the probability of the achievement of the factors on which the contingency is based.
 
    The Company re-evaluated the fair value of the earn-out payments and determined that the revised fair value was approximately $321,000, $106,000 lower than the acquisition date fair value of $427,000. The Company recognized as other income the $106,000 reduction in the fair value of the earn-out consideration during the three months ended September 30, 2011. The Company also re-evaluated the fair values of the milestone considerations discussed above as of September 30, 2011 and no significant changes to fair value of such contingent considerations were considered necessary.
 
    Prior to this acquisition, the Company entered into a IP License Agreement with ABT in 2010 for the use of certain of its intellectual property in exchange for a payment of $249,000, which was included in “Intangible and Other Assets” in the Company’s consolidated balance sheet as of December 31, 2010. The Company’s acquisition of ABT in February 2011 resulted in the acquisition of the IP licensed in this IP License Agreement and the effective settlement of that agreement. There was no gain or loss on such effective settlement.  As a result, the payment made to ABT in connection with this IP License Agreement was considered part of the acquisition-date fair value of the total consideration transferred.
  
    The allocation of the purchase consideration of this acquisition is summarized as follows (in thousands):

   
Estimated Fair Value
 
Intangible assets acquired
  $ 5,000  
Goodwill
    163  
Net liabilities assumed
    (1,517 )
Total
  $ 3,646  
 
    The Company allocated $163,000 of the purchase price to goodwill which is deductible for tax purposes. The goodwill recognized in this acquisition was derived from expected benefits from future technology, cost synergies and knowledgeable and experienced workforce who joined the Company as part of the acquisition.
 
    The accompanying consolidated financial statements for the three and nine months ended September 30, 2011 include the operations of the aforementioned acquisition, commencing on February 2, 2011, the acquisition date. No supplemental pro-forma information is presented for this acquisition due to the immaterial effect of the acquisition on the Company’s results of operations.
 
    The following table presents details of the intangible assets acquired through the acquisition of ABT (in thousands, except years):
 
   
Estimated Fair Value
   
Estimated Useful Life (In Years)
 
Intellectual property
  $ 1,600       6  
Core technology
    1,600       3  
Trade name
    600    
indefinite
 
Customer relationships
    500       2  
System technology
    400       3  
In-process research and development
    300    
indefinite
 
Total
  $ 5,000          
 
    The Company does not believe there is any significant residual value associated with these intangible assets. The Company amortizes the intangible assets straight-line over their estimated useful lives. The Company’s management determined the fair values of the intangible assets with the assistance of a valuation firm. The estimation of the fair value of the intangible assets required the use of valuation techniques and entailed consideration of all the relevant factors that might affect the fair value, such as present value factors, estimates of future revenues and costs.
 
 
 


15.  GOODWILL AND INTANGIBLE ASSETS
 
Goodwill
 
    The table below summarizes the Company's goodwill activities during the nine months ended September 30, 2011 (in thousands): 

Carrying value at January 1, 2011
  $ -  
Goodwill, SiBEAM acquisition
    18,483  
Goodwill, ABT acquisition
    163  
Carrying value at September 30, 2011
  $ 18,646  
 
    There were no impairments to goodwill during the three and nine months ended September 30, 2011.
 
Purchased Intangible Assets
 
    The following table presents the Company’s purchased intangible assets as of September 30, 2011 as a result of acquisitions completed during the three and nine months ended September 30, 2011 (in thousands):
 
   
Estimated Fair Value
   
Estimated Useful Life (In Years)
   
Accumulated Amortization
   
Net
 
Intangible assets with finite lives:
                       
Intellectual property
  $ 1,600       6     $ (178 )   $ 1,422  
Core technology
    1,600       3       (355 )     1,245  
Trademark
    3,000       5       (225 )     2,775  
System technology
    400       3       (89 )     311  
Customer relationships
    1,500       2-5       (242 )     1,258  
Total intangible assets with finite lives
    8,100               (1,089 )     7,011  
Intangible assets with indefinite lives:
                               
Trade name
    600    
indefinite
      -       600  
In-process research and development
    4,800    
indefinite
      -       4,800  
Total intangible assets with indefinite lives
    5,400               -       5,400  
Total purchased intangible assets
  $ 13,500             $ (1,089 )   $ 12,411  
 
    The Company recorded $13.5 million of purchased intangible assets as a result of the acquisitions completed during the three and nine months ended September 30, 2011. For further discussion, see Note 14.
 
    Amortization of purchased intangible assets which was presented as “Amortization of Intangible Assets” in the consolidated statements of operations for the three and nine months ended September 30, 2011 was $496,000 and $1.1 million, respectively, and $37,000 and $112,000 for the three and nine months ended September 30, 2010, respectively. There were no impairment charges with respect to the purchased intangible assets during the three and nine months ended September 30, 2011, and 2010.
 
    The intangible asset related to the in-process research and development will be amortized over the estimated useful life of the technology upon completion of its development.  After initial recognition, acquired in-process research and development assets are accounted for as indefinite-lived intangible assets until the completion of the related development. Development costs incurred after acquisition on acquired development projects are expensed as incurred. Upon completion of development, acquired in-process research and development assets are considered amortizable finite-lived assets. If the in-process research and development project is abandoned, the Company records an impairment charge in the period it is abandoned.  As of September 30, 2011, the related in-process research development projects were not yet completed.
 
    The estimated future amortization expense of purchased intangible assets with finite lives for future periods is as follows (in thousands):
 
Year ending December 31,
 
Amount
 
2011 (remaining 3 months)
  $ 496  
2012
    1,983  
2013
    1,754  
2014
    1,122  
2015
    1,067  
Thereafter
    589  
Total
  $ 7,011  
 
 
16.  INVESTMENT IN A PRIVATELY-HELD COMPANY
 
    On July 13, 2011, the Company made a $7.5 million investment in the Class B units of a privately-held company which develops and designs wireless video and audio semiconductor chips. The Company accounts for this investment under the cost method as the Company has less than 20% ownership interest and it does not have the ability to exercise significant influence over the operations of the privately-held company.  Prior to the Company's investment, it had provided a bridge loan of $1.0 million to the privately-held company in April 2011. This loan, including earned interest, was converted into equity of the privately-held company upon execution of the Class B Unit Purchase Agreement, and an additional $6.5 million in cash was paid to the privately-held company on July 13, 2011 to fund the equity investment. Concurrently with the equity investment, the Company entered into the following with the privately-held company: (a) call option agreement whereby the Company can acquire the privately-held company at a fixed price plus earn-out payments on or before April 2012 or until January 2013 subject to certain conditions; (b) sales representative agreement  whereby the privately-held company appointed the Company as sole and exclusive independent representative for the purposes of soliciting orders for and promoting  their product to the Company’s prospects as listed in the agreement; and (c) technology and IP license agreement granting the Company a license to certain technology of the privately-held company upon occurrence of certain events in the future.
 
    The Company had determined that the privately-held company is a variable interest entity but the Company is not the primary beneficiary. The key factors in this assessment were that the management team and the board of directors of the privately-held company were solely responsible for all economic aspects of the entity, including key business decisions that impact the economic performance of the privately-held company and the Company does not have the power, through its variable interest, to direct the activities that most significantly impact the economic performance of the privately-held company. The Company’s maximum exposure to loss as a result of its interest in the privately-held company is limited to its equity investment.
 
    The Company accounts for this investment under the cost method. The investment is periodically reviewed for other-than-temporary declines in fair value by considering available evidence, including general market conditions, financial condition, pricing in recent rounds of financing, if any, earnings and cash flow forecasts, recent operational performance and any other readily available market data. The carrying value of the investment is $7.5 million and was recorded within other long-term assets on the Company’s condensed consolidated balance sheet as of September 30, 2011.
 

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

Company Overview
 
    Silicon Image is a leading provider of wireless and wired HD connectivity solutions that enable the reliable distribution and presentation of high-definition content for consumer electronics, mobile, and PC markets.  We deliver our technology via semiconductor and intellectual property (IP) products that are compliant with global industry standards and also feature industry leading Silicon Image innovations such as InstaPort™.  Silicon Image’s products are deployed by the world’s leading electronics manufacturers in devices such as desktop and notebook PCs, DTVs, Blu-ray Disc™ players, audio-video receivers, as well as mobile phones, tablets and digital cameras.  Silicon Image has driven the creation of the highly successful HDMI® and DVI™ industry standards, the latest standards for mobile devices - SPMT™ (Serial Port Memory Technology) and MHL™ (Mobile High-Definition Link), and the standard for 60GHz wireless HD video – WirelessHD™ (WiHD).  Via its wholly-owned subsidiary, Simplay Labs, Silicon Image offers manufacturers comprehensive standards interoperability and compliance testing services. Founded in 1995, we are headquartered in Sunnyvale, California, with regional engineering and sales offices in China, Japan, Korea, and Taiwan.
 
    Our mission is to be the leader in advanced interoperable connectivity solutions for consumers.  Our “standards plus” business strategy is to expand the available market for our products and IP solutions through the development, introduction and promotion of market leading products which are based on industry standards but also include Silicon Image innovations that our customers value. We believe that 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.
 
    Our customers are product manufacturers in each of our target markets — consumer electronics, mobile, and personal computer. Because we leverage our technologies across different markets, certain of our products may be incorporated into our customers’ products used in multiple markets. We sell our products to original product manufacturers (OEMs) throughout the world using a direct sales force and through a network of distributors and manufacturer’s representatives. Our revenue is generated principally by sales of our semiconductor products, with other revenues derived from IP core/design licensing and royalty and adopter fees from our standards licensing activities. We maintain relationships with the eco-system of companies that make the products that drive digital content creation, distribution and consumption, including major Hollywood studios, service providers, consumer electronics companies and retailers. Through these and other relationships, we have formed a strong understanding of the requirements for 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 technologies and standards and entering new markets. We collaborated with other companies to jointly develop the DVI and HDMI standards. Our first products addressed the PC market. We then introduced products for a variety of CE market segments, including the set top box (STB), game console and DTV markets. This year, we began selling products in the mobile device market using our innovative interconnect core technology. Most recently, we completed the acquisition of SiBEAM which supports our stated mission to be the leader in advanced video connectivity solutions and SiBEAM’s 60GHz wireless technology will enable us to rapidly bring the highest quality of wirelessly transmitted HD video and audio to market.
     
    We are a Delaware corporation headquartered in Sunnyvale, California. Our Internet website address is www.siliconimage.com.
 
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 66.8% and 63.2% of our revenue for the three and nine months ended September 30, 2011, respectively, and 64.0% and 58.2% of our revenue for the three and nine months ended September 30, 2010. Additionally, the percentage of revenue generated through distributors tends to be material, since many OEMs rely upon third party manufacturers or distributors to provide purchasing and inventory management services.  Revenue generated through distributors was 46.0% and 53.1% of our total revenue for the three and nine months ended September 30, 2011, respectively, and  64.8% and 58.8% of our total revenue for the three and nine months ended September 30, 2010, respectively.  Our licensing revenue is not generated through distributors, and to the extent licensing revenue increases faster than product revenue, we would expect a decrease in the percentage of our total revenue generated through distributors.
   
    A significant portion of our revenue is generated from products sold overseas. Sales to customers in Asia, including distributors, represented 53.0% and 62.6% of our revenue for the three and nine months ended September 30, 2011, respectively and 80.0% and 75.4% for the three and nine months ended September 30, 2010, respectively. One of the primary reasons for the decrease in the revenue from customers in Asia was the disaster in Japan. The 9.0 magnitude earthquake and subsequent tsunami that hit Japan in March 2011 has affected both demand in Japan and the global supply chain for CE products.  High-end DTVs with the latest features and capabilities (the market segment where we typically deliver our latest CE innovations) have been particularly affected by this trend. Our revenue from Japan for the three and nine months ended September 30, 2011 was 44.9%  and 15.0% lower than what we generated from the same periods in 2010, respectively.
 
    The reason for the geographical concentration in Asia is that most of our products are components of consumer electronics, computer and storage products, the majority of which are manufactured in Asia. The percentage of our revenue derived from any country is dependent upon where our end customers choose to manufacture their products. Accordingly, variability in our geographic revenue is not necessarily indicative of any geographic trends, but rather is the combined effect of new design wins and changes in customer manufacturing locations. Primarily all revenue to date has been denominated in U.S. dollars. 

Critical Accounting Policies
 
    The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect amounts reported in our condensed consolidated financial statements and accompanying notes. We base our estimates on historical experience and all known facts and circumstances that we believe are relevant. Actual results may differ materially from our estimates. We believe the following accounting policies to be most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain. Our critical accounting estimates include those regarding (1) revenue recognition, (2) inventories, (3) goodwill and intangible assets, (4) income taxes, (5) restructuring liabilities, (6) stock-based compensation expense, and (7) legal matters. For a discussion of the critical accounting estimates, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2010.

 
 
 
 
Results of Operations
REVENUE
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
Change
   
2011
   
2010
   
Change
 
   
(dollars in thousands)
         
(dollars in thousands)
       
Product revenue
                                   
Consumer Electronics
  $ 22,381     $ 36,351       -38.4 %   $ 68,072     $ 88,330       -22.9 %
Mobile
    21,516       3,370       538.5 %     44,647       5,940       651.6 %
Personal Computers
    5,232       6,396       -18.2 %     16,486       16,504       -0.1 %
Total product revenue
    49,129       46,117       6.5 %     129,205       110,774       16.6 %
Percentage of total revenue
    82.3 %     76.2 %             79.6 %     79.5 %        
Licensing revenue
    10,595       14,387       -26.4 %     33,071       28,589       15.7 %
Percentage of total revenue
    17.7 %     23.8 %             20.4 %     20.5 %        
Total revenue
  $ 59,724     $ 60,504       -1.3 %   $ 162,276     $ 139,363       16.4 %

Product Revenue
 
    Our product revenue for the three and nine months ended September 30, 2011 increased by approximately $3.0 million or 6.5% and $18.4 million or 16.6%, respectively, compared to the product revenue in the same periods in 2010. The increase in product revenue year over year was primarily due to the revenue growth in our Mobile market. Our Mobile revenue for the three and nine months ended September 30, 2011 increased by $18.1 million and $38.7 million, respectively, compared to the Mobile revenue generated in the same periods in 2010. The revenue growth in our Mobile market was primarily due to the successful launch of our MHL technology in the latter part of fiscal year 2010 which resulted in MHL product shipments starting in the first quarter of fiscal year 2011 and MHL product shipments have ramped up in the second and third quarters. The revenue growth in our Mobile market was partially offset by the decrease in revenue in our CE market. Revenue from our CE market for the three and nine months ended September 30, 2011 decreased by $14.0 million and $20.3 million, respectively, compared to the CE revenue generated in the same periods in 2010. The decrease in our CE revenue was primarily due to global macro-economic pressures that drove consumers to purchase lower priced CE products, and the 9.0 magnitude earthquake and subsequent tsunami that hit Japan in March 2011, which has affected both demand in Japan and the global supply chain for CE products.  High-end DTVs with the latest features and capabilities (the market segment where we typically deliver our latest CE innovations) have been particularly affected by this trend.  The earthquake in Japan had a two-fold impact.  First, it reduced demand for higher-end TVs in the domestic Japanese market. Secondly, as a result of damage to the production facilities, the brands shifted a portion of their TV production to original design manufacturers (ODMs) outside of Japan who typically supply the lower-end to mid-range DTV market. Our revenue from Japan for the three and nine months ended September 30, 2011 was 44.9%  and 15.0% lower than what we generated from the same periods in 2010, respectively.
 
Licensing Revenue
 
    Our licensing activity is complementary to our product sales and helps us to monetize our intellectual property and accelerate market adoption curves associated with our technology.  Licensing continues to represent an important part of our overall business. Licensing revenue for the three months ended September 30, 2011 decreased by $3.8 million compared to the same period in 2010 primarily due to the higher additional royalties we recorded during the three months ended September 30, 2010 compared to the additional royalties we recorded in the same period in 2011 as a result of the completion of certain licensing audit activities in 2010. Additional royalties recognized due to licensing audit activities during the three months ended September 30, 2011 were $0.7 million compared to $7.5 million of additional royalties we recorded during the three months ended September 30, 2010. Excluding the $6.8 million higher additional royalty revenue from licensing audit activities during the three months ended September 30, 2010, licensing revenue for the three months ended September 30, 2011 would have been $3.0 million higher than the licensing revenue in the same period in 2010, primarily due to higher HDMI royalties and new licensing deals closed during the three months ended September 30, 2011.
 
    Licensing revenue for the nine months ended September 30, 2011 increased by $4.5 million compared to the same period in 2010. The higher licensing revenue during the nine months ended September 30, 2011 was primarily due to higher HDMI royalties and new licensing arrangements executed during the nine months ended September 30, 2011.


 
 
 
COST OF REVENUE AND GROSS PROFIT
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
Change
   
2011
   
2010
   
Change
 
   
(dollars in thousands)
         
(dollars in thousands)
       
Cost of product revenue (1)
  $ 25,072     $ 22,587       11.0 %   $ 67,211     $ 56,898       18.1 %
Product gross profit
    24,057       23,530       2.2 %     61,994       53,876       15.1 %
Product gross profit margin
    49.0 %     51.0 %             48.0 %     48.6 %        
                                                 
(1) Includes stock-based compensation expense
  $ 272     $ 127             $ 586     $ 456          
                                                 
Cost of licensing revenue
  $ 144     $ 67       114.9 %   $ 644     $ 103       525.2 %
Licensing gross profit
  $ 10,451     $ 14,320       -27.0 %   $ 32,427     $ 28,486       13.8 %
Licensing gross profit margin
    98.6 %     99.5 %             98.1 %     99.6 %        
                                                 
Total cost of revenue
  $ 25,216     $ 22,654       11.3 %   $ 67,855     $ 57,001       19.0 %
Total gross profit
  $ 34,508     $ 37,850       -8.8 %   $ 94,421     $ 82,362       14.6 %
Total gross profit margin
    57.8 %     62.6 %             58.2 %     59.1 %        
 
    Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, and 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. Total cost of revenue for the three and nine months ended September 30, 2011 increased by $2.6 million or 11.3% and $10.9 million or 19.0%, respectively, when compared to the total cost of revenue in the same periods in 2010. The increase in the total cost of revenue was primarily due to the growth in revenue volume during the same comparative periods. 

Product Gross Margin
 
    Our product gross profit as a percentage of product revenue was 49.0% and 48.0% for the three and nine months ended September 30, 2011, respectively, and 51.0% and 48.6% for the three and nine months ended September 30, 2010, respectively. Product gross profit margin for the three months ended September 30, 2011 was 2.0 percentage points lower than the product gross profit margin in the same period in 2010 primarily due to the decrease in average selling price per unit from $1.43 during three months ended September 30, 2010 to $1.21 during the three months ended September 30, 2011, partially offset by favorable variances and better overhead absorption due to the increase in volume.. Product gross profit margin for the nine months ended September 30, 2011 of 48.0% was comparable with the gross profit margin of 48.6% in the same period in 2010.

Licensing Gross Margin
 
    Our licensing gross profit as a percentage of licensing revenue for the three and nine months ended September 30, 2011 was 98.6% and 98.1%, respectively, compared to 99.5% and 99.6% for the three and nine months ended September 30, 2010, respectively.  Licensing gross profit margin for the three and nine months ended September 30, 2011 was 0.9% and 1.5% lower, respectively, than the licensing gross profit margin for the same periods in 2010 primarily due to higher mix of IP customization projects during the three and nine months ended September 30, 2011 compared to the same periods in 2010.

 
 

OPERATING EXPENSES
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2011
   
2010
   
Change
   
2011
   
2010
   
Change
 
   
(dollars in thousands)
         
(dollars in thousands)
       
Research and development (1)
  $ 18,063     $ 13,583       33.0 %   $ 48,887     $ 40,379       21.1 %
Percentage of total revenue
    30.2 %     22.4 %             30.1 %     29.0 %