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Silicon Image, Inc. (NASDAQ:SIMG)

Q2 2006 Earnings Conference Call

July 26 2006, 6:00 p.m. EST

Executives

Robert Freeman - Chief Financial Officer

Steve Tirado - President and Chief Executive Officer

Analysts

Alex Kim - Thomas Weisel Partners

Presentation

Operator

Good day everyone, and welcome to Silicon Image’s Q2 2006 Financial Results Conference Call. Please note that today’s call and question and answer session are being recorded. [Operator Instructions]. At this time, I would like to turn the call over to Mr. Robert Freeman, Chief Financial Officer for opening remarks. Mr. Freeman, please go ahead.

Robert Freeman - Chief Financial Officer

Thank you. Good afternoon everyone, and welcome to Silicon Image’s Second Quarter 2006 Financial Results Conference Call. Joining me today is Steve Tirado, our President and Chief Executive Officer. Our agenda for today is as follows, Steve will start with remarks about Silicon Image and trends in our markets, and I will follow up with our second quarter financial results and future guidance. We will conclude the teleconference with your questions.

For purposes of this call, we intend to present the company's financial performance on a non-GAAP basis, as defined by the SEC and Reg. G. The need for providing non-GAAP information is primarily due to the lack of comparability between periods presented with respect to stock-based compensation as a result of the adoption of 123-R. In addition, we believe that the amortization of intangibles and the non-cash portion of the income tax provision recorded to additional paid-in capital are unrelated to our ongoing business operations.

We have chosen to provide this supplemental information to investors, analysts and other interested parties since management uses this information to evaluate operations, to manage and monitor performance and to determine bonus compensation. A reconciliation of the comparable GAAP financial measures are included in our press release and along with an audio replay of this conference call today, will be available on Silicon Image's Investor Relations website at www.siliconimage.com.

By now you have all seen our press release and the associated 8-K filing this afternoon. I’d like to remind everyone that during this call, including our question-and-answer session, we will make forward-looking comments within the meaning of Section 27(a) of the Securities Act of 1933 as amended, and Section 21(e) of the Securities and Exchange Act of 1934 as amended, regarding our future performance based on our current expectations. These include remarks concerning our expected operating results, product introductions, product production ramps, announcements relative to standards and technology adoption rates. We may also make comments regarding events that could potentially impact the future of the company.

Forward-looking statements in this call are generally defined by words such as “beliefs,” “anticipate,” “expect,” “intend,” “may,” “will,” and other similar expressions. Many factors taken individually or in combination could materially affect future business outcomes. Actual company results may differ materially from what are described in these forward-looking comments.

I encourage you to familiarize yourself with our most recent 10-K for the period ending December 31, 2005. This report describes relevant risk factors that could affect future financial results. Additionally, during the call this afternoon, we may highlight other factors that could impact any projections or other forward-looking statements. We do not intend to update information contained in this teleconference.

Now I will turn the call over to our CEO, Steve Tirado.

Steve Tirado - President and Chief Executive Officer

Thank you Bob, and good afternoon everyone. I'm pleased to be with you today to report on an outstanding quarter for Silicon Image. Let me start by reviewing the non-key accomplishments in the quarter, and then summarizing some key market trends.

Number one, Silicon Image continues to demonstrate solid top line revenue growth, well-managed expenses and improvements in overall company profitability. Our year-to-date revenue grew 36.4% over the same period last year and our year-to-date net income on a non-GAAP basis grew 53.6% showing significant operating leverage in the business. For the current quarter, our top line revenue grew to $70.6 million, a 19.4% sequential increase over Q1 of 2006 and non-GAAP net income increased to $16.3 million, a 44.8% sequential increase over Q1 of 2006.

Number two, non-GAAP gross margins improved from 58.2% in Q1 from 58.6% in Q2 of 2006, largely helped by stronger IP licensing and royalty revenues. Number three, our products’ book-to-bill exceeded 1.3 and we ended the quarter with record backlog and excellent visibility into Q3 and part of Q4 enabling us to raise our projected growth for total revenue in 2006 to the 30% to 35% range over 2005 from a 25% to 30% range.

Number four, we formally announced the HDMI 1.3 specification with support for deep color, higher bandwidth, new HD audio format, mixing, a new mini-connector to enable mobile devices and much more. Number five, Sony’s PlayStation 3 was announced with support for deep color, a key feature of the HDMI 1.3 specification.

Number six, we shipped our first HDMI 1.3 products for revenue during the quarter. Number seven, we announced our first major volume design win for the SteelVine storage solution with ASUSTEK targeting home media applications. Number eight, HDMI adoption increased to 435 companies by the end of Q2, up from 383 companies at the end of Q1. Number nine, we held our first Investor Analyst Day conference with 22 investors and analysts as well as 119 listeners via a live webcast. I would like to thank those who attended and look forward to holding a similar event next year.

Before discussing some key trends within our market segments, I want to also mention that we made a very significant announcement during Q3 regarding the formation of the China Digital Interface Industry Alliance or CDIA. CDIA was formed to promote the use of HDMI in China’s local market with the support of the China Video Industry Association and the Director of The Department of Broadcasting and Television Ministry of Information Industry, we believe HDMI will see broader and more accelerated adoption.

In concert with this announcement, we announced an annual fee reduction to the common HDMI adopter from $15,000 to $10,000. We view the market expansion opportunity as worth the confession made on the annual fee. The fee reduction will begin in November of 2006, it has been factored into our annual guidance for 2006. As part of this announcement, we have also signed an agreement that helps CDIA in the development of new features for future versions of HDMI as well as complimentary technologies for the local and potentially international market.

Simplay Labs will become the Silicon Image vehicle for technology development with CDIA, and very importantly the organization responsible for developing and supporting the test standards necessary to ensure plug-in play interoperability across devices. It is our belief that the Simplay HD branding program will become the consumer’s way of identifying fully interoperable devices. As the connection between devices gains in intelligence, the requirements for testing gain in importance.

I will now share some business and market trend observations for the quarter as well as some commentary on overall strategy leading into 2007. Starting with consumer electronics, we had a very strong quarter and so our key customers ordered earlier in the annual buying cycle as Q3 was normally our strongest quarter. This year we expect steady growth all the way through to the end of the year and have enough backlog visibility to project that growth. We definitely saw our stronger ship dual-input HDMI parts that support 1080p and also had very strong growth over the last year on the transmitter side of the business, mainly due to DVD set top box and A/V receiver products supporting high definition content. Our HDMI 1.3 products have already had some important design wins for 2007, an overall customer interest accelerated with the announcement of Sony PlayStation 3 support for Deep Color.

Our strategy of aggressively implementing the latest advancements in HDMI has enabled us to retain significant market share with the top-tier OEM. It has also positioned us well to growth into next year. Our strategy of focusing on the storage, distribution, and presentation of high definition content in the home and mobile environment is expected to provide a multi-year opportunity for growth in products sales as consumers continue to seek entertainment content across all the devices. We continue to believe that the mobile device world will utilize HDMI as the secured digital interface of choice for displaying content on modern LCD, Plasma and Rear-Projection television. This market conservatively represents over 300 million units of opportunity over the next two to three years. Finally, we expect our Deep Color video processor available in early 2007, will be attractive to top tier OEMs looking for differentiation in cost reduction for the late 2007 and early 2008 design. I will now turn to the PC business.

Our PC business was down 23.3% over Q1 2006 along with many other suppliers in the PC market. However, we are expecting a strong recovery next quarter and have the backlog visibility to support it. HDMI adoption in the PC market continues to garner new design wins that will yield volume in 2007. The storage business; our storage business was up 16.9% over Q1 2006 and benefited from increased serial ATA controller sales. We expect a Asustek volumes will kick in during Q4 and that the SteelVine design win represents an important milestone in our efforts to generate volume for home media storage applications.

On the margin front, I want to comment that I have consistently said that not-GAAP product margins are generally in the 50% to 55% range and that licensing adds another 5% or 6%. This quarter was no different. While non-GAAP product margins were down slightly from last quarter 53% from 53.8% in Q1 of ‘06 and 53.5% in the Q4 of ’05, this still represents a normal range for our products. The market has grown quickly and so has our volume. We will continue to drive cost reduction while we grow our volume and believe we can sustain the 50% to 55% percent product margin range going forward by adding new products and higher ASPs and integrating more features into our Silicon.

In summary, despite the weakness in PC the quarter overall produced excellent results and the order backlog gives us good confidence on growth throughout the end of ‘06. I want to thank our employees for their hard work and contribution towards the success of this quarter.

I will now turn the call over to Bob for a detailed review of our financial results including our guidance for Q3 and the reminder of the year.

Robert Freeman

Thank you, Steve. Overall, I am too pleased with the results of Q2. We recognized record revenues from both the product and an IT licensing standpoint. We noticed strong growth in our CE market and increasing performance in our storage market.

Total revenues for the quarter were up 39.2% over the prior year and 19.4% sequentially driven by increased demand for product and higher royalty. Our Q2 product revenues were $61.7 million, up 30.3% and 15.7% from the prior year quarter and the previous quarter, respectively. Compared to the same quarters last year higher product revenues were the result of a 46.7% increase in unit shift offset with 11.1% reduction in ASP. Sequentially, the company has favorable variances in both units and pricing. Distributor revenues represent 62% of total product revenues and grew by over 49.9% year-over-year and 9.7% sequentially.

Direct revenues represent 38% percent of product revenues an increased 7.4% and 27.1% over the prior year quarter and sequentially, respectively. IT licensing revenues, which include licensing, development, royalties and testing revenues, were $8.9 million for the quarter representing approximately 12.6% of revenues up from 9.9 percent in the previous quarter. Licensing fees increased as a result of the recognition of previously deferred revenues and increasing royalty. Royalties from Genesis are currently differed and not included in these results.

Our revenues both product and IT licensing, were distributed over our three markets as follows; consumer electronics or CE represented 68.3% of total revenue. PC represented 14,5%, and storage represented 17.2%. Total revenues in the CE market increased 79.9% from the year ago quarter and 36.2% sequentially. The CE market showed year over year growth at 46.8% in receivers and 191.2% in transmitters. Total revenues in the PC market declined 20.7% from the prior year quarter and 23.3% sequentially. The decline was the result of the overall slowness in the PC sales this quarter. Our revenues in the storage market began to show some strength increasing 10% from the second quarter of 2005 and 16.9% sequentially.

From a gross margin standpoint, our gross margins on a GAAP basis were 57.8% in the quarter, which is slightly lower than the prior quarter of 58.6% due to stock compensation expense and up slightly the from the first quarter of 2006 of 57.1%. More specifically, product gross margins were down approximately 3.5% from the prior year quarter and down slightly sequentially. This decrease is a result of normal ASP pressure offset in part by a mix of higher margin products and the increased volumes resulting in favorable economies and scales.

At the same time as a result of increased product revenues these periods an increased licensing revenue gross profit increases 37.2% year-over-year and 20.9% sequentially. We continue to focus on our on going cost reduction program at the priorities for this company allowing the company to maintain competitive product close margins. We believe increasing the volume will generate continuing growth and gross profit. It should be noted that our cost of revenues that was include cost associated with our IT development range. On a non GAAP basis gross margins were 58.6% reflecting the exclusion of stock based compensation expense under 123R and are slightly lower when compare to the same period a year and slightly higher sequentially.

GAAP operating in expenses for the second quarter, total 31.8 million and 45.1% o total revenue. GAAP operating expenses approximated 41.5% for the second quarter of 2005 and 53% revenue for the first quarter of 2006. Non GAAP operating in expenses for the second quarter total $25.7 million representing 36.5%o total revenues as compare to the prior year quarter of 19.5 million or 38.5% total revenues and 24.4 million of 41.2% of revenues in Q1 of 2006. Operating expenses include expense recoveries of approximately a million dollars in both 2006 and 2005. Higher sale commissions this quarter due to increased sales and higher incentive compensation accruals as a result of exceeding company performance targets.

Operating expenses are expected to continue to increase in absolute dollars, but should decline as a percentage of revenue. Our net income on a GAAP basis for Q2 2006 was $5.8 million or $0.07 cents per deluded share, representing a decrease of 44.6% when compared to our second quarter of 2005 of net income of $10.5 million or $0.12 cents per diluted share and an increase of 146.5 sequentially from $2.4 million or $0.03 per diluted share.

On a non-GAAP basis, net income for Q2 totaled 16.3 million or $0.19 per diluted share representing an increased of 53.6% from the $10.6 million or $0.13 per diluted share for the same period last year and a sequential increased of 44.8% from $11.3 million or $0.13 per diluted share in the last quarter. For six months revenues grew to 129.7 million up 36.4% over 2005. Net income on a GAAP basis was 8.2 million or $0.10 per diluted share. Net income for the year on a non-GAAP basis was $27.6 million compared to $18.3 million for same period last year, an increased of 50.6%. Year-to-date non-GAAP operating margins were 19.7%.

From a balance sheet perspective, our cash in short term investments grew to over a $189 million up 12.9% from a $167.5 million at the end of the prior quarter and up 24.7% at the end of the year. The increase is primarily due to consistent levels of collection of receivables on a growing revenue base, and the payment of $7 million related to the Genesis settlement. I’ll speak to this a little more, later in the call.

At June 30, 2006, the company’s cash per diluted share was $2.21 per share up from $1.96 at the end of the prior quarter. And in fixed income per diluted share for Q2 was $0.02 a share as compared to last $0.01 per share last year and approximately 2% sequentially. Accounts receivable grew slightly as a result of shipment to distributors and the company DSO was 49 days down from 67 days from the prior quarter and up from 44 days at the end of the year. The DS0 has increased as a result of increased deferrals of margins on sale to distributors. Inventories were up slightly while inventory turns increased to 6.3 times from 5.6 times at the end of the prior quarter and slighter faster than 6 times at the end of last year.

We continue to believe that our inventory balances are within acceptable levels, while ensuring our ability to meet expected increased customer demands during various capacity constraints.

Capital spending increased to $4.1 million for the quarter, up from $1.4 million in the prior quarter. The increase is a result of the company’ acquiring certain test equipment as it implemented certain manufacturing cost reduction programs as well as IT and IS infrastructure to address the company’s growth trends. We believe our capital spending will turn back down in future quarters to levels previously recorded. Other financial matters of note include the finalization of the accounting treatment of the funds previously received under the Genesis Memorandum of Understanding.

We now have received a total of approximately $11.2 million from Genesis under the MUO. Recognition of the settlement in the state of an operation is deferred and in the conclusion of the definitive agreement. While we have taken possession of the funds as a result of this settlement, our financial statements continue to reflect the result as a liability pending negotiations of a new definitive agreement addressing past and future royalties.

I will now turn to our outlook for Q3 and the remainder of the year. Let me remind you that the forward-looking comments I previously mentioned, are subject to risks and uncertainties as described at the beginning of this call and then our periodic SEC filings and we do not intend to update these comments or forecasts prior to our next quarterly conference call.

I will now discus our financial guidance. As noted in today’s press release, we expect to see revenues increase in the Q3 by 10% with increasing visibility and a healthy backlog of the quarters reaching into the Q4. We now expect to see annual revenues increase 30% to 35% we expect the cost initiatives we have put in place to take effect at the end of 2006. Until then we expect to see gross margins in the 56% to 58% range and at the same time the gross profit increase as a result of higher revenue. We expect to maintain our non-GAAP expenses as the percentage of sales inline with our performance this quarter. Our guidance at this time does not reflect any changes to the operating results, as a result of the Genesis settlement.

This concludes the formal course of our presentation. We would now like to open up the call for your questions.

Question-and-Answer Session

Operator

Thank you. The question and answer session will be conducted electronically. [Operation Instructions].

Our first question comes from Jason Pflaum with Thomas Weisel Partners.

Alex Kim - Thomas Weisel Partners

Good afternoon, this is actually Alex Kim calling in for Jason. First I guess, I’d like to start off with a question regarding licensing and royalty revenue. It seems that there was a nice bond from Q1 there, what are your expectations going forward as far as growth, looking into the second half and beyond?

Robert Freeman

Well what we’ve seen over the last couple of quarters is increasing royalties both from HDMI and prior development licensing arrangements that we’ve done that now are starting to ship products. And in addition we think that you know, on the other side the development contracts that are either currently under way or in place but deferred we will see a function of our percentage completion accounting that we were applying to the development projects. We have a big way to address your question it’s probably going to be about the same as this quarter roughly.

Okay, perfect, as far as 1.3 you said you started shipping revenues this quarter, any sense of expectations or is a percent of revenue exiting this current accounting year and -- or rather how can we think about the ramp up revenue expectations from 1.3?

Steve Tirado

You know, that’s a great question but you know, what’s going to happen, I will be able to report more on design win activity than actual revenue impact, we are getting revenue impact obviously as I said starting in ‘Q2. I expect this to be much more significant in ’07 but we do have some early adopters you know, for -- so I don’t have any good data for you right now but, I think next quarter maybe we can give you come color on that.

And just a final question on gross margins, I know that gross margins tick down on non pro forma here I think I have heard correctly that expectation were 56% to 58% going forward but any sense of do you expect gross margins to mark a bottom in Q3 or is it going to be roughly in line mind going forward to 56% to 58%?

Robert Freeman

Well, some of the cost initiatives that we spoke about before were essentially were trying to take back the manufacturing of some of the products that we have contracted out to people. Probably, we wont show much improvement before the end of the year.

Steve Tirado

So there are three things I think they are going to impact both margins and prices one is the cost reduction work that we were doing. Two is the fact that new products were coming in at higher ASP’s and we have some what I call kind of partially integrated parts that have quite a significantly higher ASP than what we have been selling in previous years. So all those things that we are going an impact on both margins and average selling prices going in to 2007. This is something we got a lot of focused on.

Okay, perfect, thanks you guys.

Steve Tirado

You are welcome.

Operator

Our next question comes from Charlie Glavin with Needham.

Charlie Glavin - Needham & Co

Thanks, Steve if I can go into probably a lingering -- if you were concerned by some people and that’s in regards to the integration of HDMI into some of the future chips that certainly this has been raised with AMCC integrating into our fine ATI and sort of their 4x4 program. As you look at this right now Broadcom is talking about digital TV’s of which some if those will have their own HDMI or at least that’s the indication from some of the guys internally, can you give some sort of indication right now as far as where you’ve seen that and I know by going with the generation certainly in 1.3 will keep you ahead of anybody else just trying to do this simple integration but from your standpoint right now raising the guidance for the rest of the year, how do you look at this going in to ’07 - ’08?

Steve Tirado

Well, I think that there will be a trend or integration however what we were happy to see as that when 1.3 got announced and then the PlayStation was announced supporting that it really shifted that the quantity and quality of interest around making sure that they had products that would you know, play 1.3 so, I think for ‘07 we’re really well positioned. No one else had these products today we have them, we were able to enable the customers, the other thing that we are doing is we are integrating our own Deep Color video processor for early ‘07, so I think, we are -- its hard for me Charlie, to say okay, so how -- you are kind of asking a market share issue, right?. And its just tough to say, I think we put together a very compelling strategy for retaining as much market share as I think as we can. Bear in mind that the HDMI market is expected to double next year from 60 million to over a 120 million devices. So, you got a lot of things going on we think from a strategy standpoint, we are probably about as well positioned as we are going to be, this will be a competitive market. There are lot of companies going and I can tell you this though that for those companies who are looking at a video processor with an integrated HDMI, I will not be surprised if many of them will continue to go to street simply because they want a 1.3 capability.

Charlie Glavin - Needham & Co

Steve, I guess it’s the first time you actually acknowledge that double number from that third party group as opposed to using the old number and so, I will ask this question, you have -- yourself, and normally we see 75% of the design wins for the out year being done by say the October time period, maybe a different way at looking at this question or some of the competitive dynamics we’ve seen a fundamental shift by that particularly see more people going to street and some of the other convergence products, it would seem the complexity of some of these would lengthen on some of those design cycles but on the others where people are actually integrating their own but you may see some late CES type of designs or things right after CES, are you seeing this in terms of -- shorter as a more complex length --?

Mr. Steve Tirado

I think the whole market is in fact it is changing. I think still a large presentation of our visibility regarding 2007 was -- will still be there as we come out of Q3 going into Q4 but there are now a lot of new product cycles I see being introduced and I think its part of why our sales pattern is changing as well. The people are deploying at all different times, they are trying everything they can to try to get an edge against their competitors including coming out of at different times of the year with their new products so, the cycle is sort of moderating and like this year our pattern was we had a big surge this quarter, we had good solid steady growth quarter through the end of the year but normally, I had this cycle where its lowest in Q1, starts to build in Q2 and highest in terms of growth in Q3 and then it moderates in Q4 down in Q1 and back up again and next starting day, I don’t have enough data right now to tell you how its going to change, I just know that it is changing and people are introducing products outside their normal seasonal pattern.

Charlie Glavin - Needham & Co

And Steve -- given that you said that some of these cost reductions, in other words what’s going to happen at the end of the year and with that changing dynamics and the design cycle. Previously you have used price in order to motivate some of the markets particularly going into those design periods to move them from say to single port to dual port. Will you be using a similar strategy even on those higher prices to motivate people to get to 1.3 or even commit to the Deep Color earlier than you had thought?

Mr. Steve Tirado

Absolutely, I mean that will continue to use that was very effective in getting the markets to move to dual input, we will Deep Color attractive for customers so that you get a larger swing as possible because the market is just gotten so large now it makes it worth our while to do that. I’ve focused the company real hard on top line revenue growth and continue to drive the operating margins. And its not to say we don’t care about gross margins, we care deeply about gross margins, but we know that those will fluctuate within a range and we’re comfortable with that 50% to 55% range.

Charlie Glavin - Needham & Co

Got it.

Operator

Our next question comes from Ruben Roy with Pacific Crest Securities.

Ruben Roy - Pacific Crest Securities

Thanks, Bob, in terms of the guidance rates for the full year you talked about, would that based primarily of improving visibility and the PC business or build momentum on the consumer --?

Robert Freeman

No the driver is still on the consumer side although we do expect to see recovery in the second half on the PC side, and we think this quarter was you know, it was the same thing everybody else was experiencing in the industry but our order seem to indicate that PC is going to bounce back nicely.

Ruben Roy - Pacific Crest Securities

Okay, and did 1.3 have anything to do with the increase of guidance at all or didn’t do anything for that?

Robert Freeman

I think what we are saying is for the most part we’re going to see 1.3 in 2007 I’ll let Steve --

Steve Tirado

Yeah I mean we are getting some business now we have some really adopters on the 1.3 technology and this is impacting our result this year, but is you know, I wouldn’t say that you know, the biggest driver. I think the bigger driver is just the total market is moving pretty aggressively in HDMI this year.

Robert Freeman

And just looking at our backlog as Steve has mentioned you know that we feel that’s strong backlog is gearing in to the Q4 so.

Ruben Roy - Pacific Crest Securities

Okay and then, Steve, can you talk a little bit about the win in terms of the SteelVine Processor that’s going to be used in a motherboard type application, are you expecting any significant any differences between what you are seeing from sales in external storage devices margin differences or any other color you can add there will be great?

Steve Tirado

So you know these chips in this pretty high volume motherboard application they are in kind of $5 to $10 range and we’ve got a bigger that has more ports and that’s kind of a $10 to $15 range. There are three kinds of applications for the SteelVine board. One is they are selling kind of a high performance you know, retail motherboard in the marketplace, they are also going to be selling their own branded PC desktop, and then their own branded I believe there is also one notebook on line as well. So that’s how they are going to market it I think that it just take folks really like the idea of attacking this whole digital media storage issue for consumers and you know, we are excited about it and we are trying to again to leverage that into other OEM wings -- you know, PC OEM wins in the market.

Ruben Roy - Pacific Crest Securities

Great and one is what is going with your alliance in China, it sounds pretty exciting -- do any concessions on the licensing side do you expect that will do anything on the royalty side going forward?

Steve Tirado

You know, right now the royalties aren’t going to be changing this was as I said in my prepared comments you know, we thought a very good quick pro quo, the CDIA is composed of all the leading you know, CEOs from all the big electronics companies in China. We had a roundtable meeting with them in fact after the announcement that was very productive and there is a lot of interest both in what we are doing today but not just doing what we are doing today, but there is a real interest in doing a lot of new thing, going forward and so we are really honored to be the company that was chosen to be the key partner for driving those innovations in that market and of course, its going to give us some products advantage to just like we have today with the worldwide HDMI standard been close to the technology -- to get products out sooner and there is some economic advantage to that.

Ruben Roy - Pacific Crest Securities

Great, thanks guys.

Operator

And our next question comes from Tayyib Shah with Longbow Research.

Tayyib Shah - Longbow Research

Hi guys, congratulations on vision of the guidance.

Steve Tirado

Thank you.

Tayyib Shah - Longbow Research

Steve if you can talk about -- within the consumer space belt which is the main driver for raising the guidance I mean how much of the increased visibility that you are seeing is primarily a result of your game console exposure and if that’s most of it then once the initial bill is complete would you expect to see revenues decline in that segment?

Steve Tirado

Let me first of all tell you that I never said that there was exposure of the game console segment so we need to be very careful here. The PlayStation while support HDMI 1.3 features we have never said one way or the other how they are getting there. So it could be anything from a chip to a license to competitor could be anything, right.

Tayyib Shah - Longbow Research

Okay.

Steve Tirado

So but you know, as I saying earlier that the growth, the strong that we are seeing is really broad adoption across a lot of devices. I made a comment that the tradesmen side of the market, the DVDs, the setup boxes, and the AV receive markets just has exploded I mean we are up probably double of what we saw last year so that’s been a nice surprise and then the TV market continues to be just very strong. So I wouldn’t say that there is a -- I would say the bigger driver is really these new devices coming on you know the new source boxes like the DVD and setup box and then the continued option on the television so I was describing the business versus you know anything else.

Tayyib Shah - Longbow Research

Okay, and Bob on the margin front, do we see the margin striking lower in Q4 as well and once you have your patience the efficiency is in place and you have deep colored and other high ESP products shipping in 2007. What kind of range do we expect margins to rebound to?

Robert Freeman

Well we keep talking about our target ranges been kind of in the 60% range it will take a couple of percentage points and as Steve said we have consistently shown product margins you know on the 50% to 55%. So sometimes its impacted by the level of licensing revenues that you do that particular coder we think this cost adjustment that we are making a significant that’s going to help and the newer introductions of the products was with a higher ASP’s will offset some of the more maturing products and/or the products has been experiencing lower margins because of outsource manufacturing. So we are just kind of you know transition period and I think right now in terms of how plays out.

Tayyib Shah - Longbow Research

And then the CDIA arrangement, would you give us an idea of how much R&D dollars that entails the joint development with them and the reduction in the fee structures, is that going to have a material impact in itself on the licensing or revenue side?

Robert Freeman

Yeah so as I was -- I said in my prepared remarks for ’06 its all that factor into the guidance and part of what’s going to happen is we expect -- we have been constantly surprised by the number of companies that have joined the HDMI standard, so there will be some offset by the number of companies joining, I could use a math -- you got to add another 100 plus companies. I can't imagine that we would necessarily do that but again I think the real reason that we wanted to do this, we wanted to be well positioned for the Chinese market in terms of the way they go about deploying digital technology there so we think the trade off was worked it and with respect to the way we are going to work with them, the investment associated with that, we are -- we put two Simplay Labs and combined with an HDMI ATC, Authorized Testing Centers together, we got one in Shenzen, one in Shanghai, we are going to open another. We didn’t announce the location yet but we are working that with the CDIA. We have already started putting R&D into China and that’s only going to increase, I suppose from kind of an investment standpoint and we are looking at for some of the R&D development, we are looking at, its not that huge as, we are talking may be four to five engineers that will work on some of the innovations. Where we have larger numbers of people as around the test center operations and all that, I haven’t looked lately but I bet its up there around, somewhere around 15 to 20 people.

Tayyib Shah - Longbow Research

Okay, and finally where do you see the SteelVine maybe if you can give us an idea of the revenue run rate once ASUSTeK is up there, up and running.

Steve Tirado

Yeah, I am not going to give that out yet. We will see how they goes, they -- actually the volumes are pretty good but I want to see this thing really kick in the gear before we share any information on that.

Tayyib Shah - Longbow Research

All right, excellent thank you so much.

Steve Tirado

You are welcome.

Tayyib Shah - Longbow Research

Thank you.

Operator

The next question comes from Adam Benjamin with Jefferies.

Adam Benjamin - Jefferies & Co

Thanks guys, nice quarter. Just a couple of questions, first can you give your split both on a unit and a revenue basis as it relates to the receiver and transmitter for the current quarter as well as your expectations for the for year ‘06 and for year ‘07 and the reason I asked Steve is you say that transmitters are gaining some traction, I am just trying to get an idea of how that business is going to shift overtime.

Steve Tirado

Yeah, it continually -- ask for that and essentially we do track our receiver and transmitter. You wanted to focus on the CE side?

Adam Benjamin - Jefferies & Co

If you can give it for the CE or for the whole company either way, whichever way you are willing to do it.

Steve Tirado

I really, I think we have given a kind of enough sort of information there. The transmit side of the business for CE again as a function of DVDs and set top boxes and all that wanting to get, actually there is two drivers one is they wanted to sport HD out sooner out than later and then surprisingly even in the case where they have got integrated capability. We had several customers come in and lock in designs for because they want to support 1.3. They are very concerned about being able to support Deep Color going in 2007, so there have been two good influences there. Look the vast -- I have talked about this before about 89% of our revenue last year was really driven by the TV side. The receiver side, that’s moderating some, maybe 10% of that maybe instead of 80% to 90%, now 70% to 80% TV and the rest is coming from the source side. So, even though there is been an increase from the source side our greatest exposure is on the TV side. That’s really where the bulk of the business and margin dollars are.

Adam Benjamin - Jefferies & Co

And so the 70%, 80% that’s revenue --

Steve Tirado

Of revenue.

Adam Benjamin - Jefferies & Co

What is it on a unit basis?

Steve Tirado

Yeah, I don’t think that we are going to give that out.

Can you just give rough --?

Robert Freeman

I would say right, now year over year your transmitter and your receiver on just total volumes are roughly comparable now and but the growth has really kind of come in the transmitter side.

Adam Benjamin - Jefferies & Co

Okay, great thanks a lot. With respect to HDMI 1.3 can you give us some perspective as you look out with the design wins near the cycle ending you know, September, October timeframe kind of a best case, and worst case scenario. If you had your crystal ball, Steve of how many the percentage of TVs that would have HDMI 1.3 in ‘07 on a best case and on the worst case?

Steve Tirado

You know, the best what I could say is because this is all that going on kind of real time right now but I would suspect that we were trying to drive somewhere between 30% to 50% of our total sales you know, off of the 1.3 base. We don’t have to do that but that’s really where we want to get, I think it’s looking more possible given that since that 1.3 respect finalization and then the PlayStation announcement it’s been pretty impressive the amount of interest we got in so, we will see how it goes but that would be sort of what I would say we would be targeting.

Adam Benjamin - Jefferies & Co

So on a most optimistic scenario you think that 30% to 50% of TV’s next year on a conservative basis it’s may be only 10% or something?

Steve Tirado

No, I’m saying 30% to 50% of our revenue would be based on that type of silicon, from a total market standpoint I have to sit down and do some thinking about that.

Adam Benjamin - Jefferies & Co

Okay, just one last question on SteelVine, can you give us some view as to how many quarters out there we can see some material revenue on a quarterly basis of state you know, $2 to $3 million?

Robert Freeman

You know, I would expect we would get there you know, moving in Q1 of ’07.

Adam Benjamin - Jefferies & Co

Okay, great thanks for all you guys.

Robert Freeman

Welcome.

Operator

Our next question comes from Dylan Moore, with Robert W. Baird.

Dylan Moore - Robert W. Baird & Co., Inc.

Hi Steve, hi, Bob this is Dylan Moore for Tristan Gerra. I just want to -- we saw some good results to night you guys are getting good results, good guidance but we have also kind of heard news of TV buildup in the channel, I just want to get a sense of as you seen anything out there? What gives you the confidence that is not an issue for you -- just any more color that would be helpful?

Robert Freeman

Hey, listen our confidence comes from backlog visibility -- pure and simple I mean we are almost completely down with the quarter.

Dylan Moore - Robert W. Baird & Co., Inc.

Can you, may be give us an idea of what your turns requirements for the Q3 guidance?

Robert Freeman

Very low, very low yeah.

Dylan Moore - Robert W. Baird & Co., Inc.

May be below 10% or something like that?

Robert Freeman

I don’t want to give a number out but we are in very good shape with respect to Q3 we have excellent visibility, and if you look at our pattern we have done very well in terms of giving you guys a good guidance on the Q1 and the next quarter out.

Dylan Moore - Robert W. Baird & Co., Inc.

Okay, great. And then another question going back o the China announcement could you give us the sense of how the HDMI ___ adoption in China is line -- what percentage wise compared to may be the US in the rest of the world seeming that much lower that become helpful to get as -- product?

Steve Tirado

You know, I can give you a few statistics I don’t know if I can give you the exact answer I can tell you that of the umber of adopters we have roughly 20% of them are from China, I’m expecting their number to go up quite a bit as a result of the announcement that we’ve made so I know there was a lot more companies from China. The use of HDMI is really going to be a function of how successful you know, the new TVs are, you know, the LCD etc. As you know for most of the country they are completely out of price reach, it’s really the large metro you know city area, the Shanghai, Shenzhen and Beijing areas where you’ve got enough middle class and affluent people to buy these kind of TV. We did this really with a long-term view we think ultimately there are going to be an enormous, prices will be reasonable and the electronics manufacturing base there and the governments are really interested in being at absolutely innovation end of the curve with respect to digital, I mean there’s a fervor -- there’s a real interesting and so we see that as pretty exciting opportunity and it’s really meant to position us for growth down the road here I’m talking about you know, ‘08, ‘09, you know, 2010 kind of a volume increases. Today it’s not huge you know, you know it’s not. Now they are buying you know, by statistical numbers, a third of the world’s TVs and manufacturing about half of them, but a lot of that consumption today is on you know, really chip tube based TVs, the transition into the modern you know, a little bit pricier stuff you know, it’s still probably not that big.

Dylan Moore - Robert W. Baird & Co., Inc.

Okay great, that’s very helpful. And then I guess just the last housekeeping item, is that the way we should model for tax rate of GAAP and pro forma, has that changed or is that -- you talked about before?

Robert Freeman

It’s kind of a little bit on a pro forma basis to about 7% because of our increased overseas taxes.

Dylan Moore - Robert W. Baird & Co., Inc.

Yeah and probably the best way to models in the next quarter?

Robert Freeman

Yes, so I’d say probably in that range on a non-GAAP basis and the GAAP number is really being driven by our use of the methodology to essentially utilize the stock compensation related tax losses first which essentially don’t do to the tax provision, you don’t in credit to the tax provision for those but we’ll essentially utilize them.

Dylan Moore - Robert W. Baird & Co., Inc.

What would the rate be?

Robert Freeman

So this year -- this quarter the rate is in the neighborhood of 7, so the non-cash rate this quarter is going to be about 5% but the GAAP rate is going to be closer to 47%.

Dylan Moore - Robert W. Baird & Co., Inc.

For the quarter?

Robert Freeman

Quarter.

Dylan Moore - Robert W. Baird & Co., Inc.

Okay, all right that’s helpful and --

Robert Freeman

If you look at the press release it should show you dollar wise the impact on reconciliation.

Dylan Moore - Robert W. Baird & Co., Inc.

Yeah, thanks.

Operator

At this time we have one question remaining in the queue. [Operator instruction]. We’ll take our next question from Aalok Shah with D. A. Davidson.

Aalok Shah - D. A. Davidson

Hi guys, couple of questions for you, Steve. First on the PC front, you know we starting to see I guess the AMD ATI deal and a couple of other things that are leading us to believe maybe HDMI is going to kick off a little bit faster in the PC space, what’s your take on that and then maybe if you can talk a little bit about HDCP and what roles you guys are going to have with that as well as the HDMI going into PC market. And then, Bob, one question again on the tax rate just to give a clarification you said 5% for the non-cash or - is that for next quarter and then for next year are we still looking for a full tax rate of 25% or 30%, I wasn’t clear on what you told us.

Robert Freeman

Not really kind of giving you any guidance right now on 2007. I think we are working through our deferred tax assets through the strong performance that we are experiencing in 2006.

Aalok Shah - D. A. Davidson

Okay, what do you think of full tax rate would be though, if you didn’t have any or and was there any kind of --?

Robert Freeman

Yeah, I would love to be able to give that, but right until we really kind of complete with that analysis that we are going to through and the tax planning that we are going through, it’s a bit of premature.

Aalok Shah - D. A. Davidson

Okay.

Steve Tirado

Okay, can you re-say your question?

Aalok Shah - D. A. Davidson

Yeah sure I see just in terms of the PC space with ATI and AMD now merging. Can you talk a little bit about the whole HDMI packaging?

Steve Tirado

I have no idea how that’s going to shake out the whole ATI-AMD merger, it’s just so -– you know, I mean I can see from the right out there two people are kind of on both side of the equation I mean from my reaction points it looks like strategically kind of makes a lot of sense for AMD but I still think they’ve got a you know rough road -- HDMI, we are seeing you know just a lot design wins for it, the volumes are huge but they are slowly creeping, helping to creep the number up and I think ‘07 is going to a very important year for HDMI on the PC platform so I’m you know fairly I guess I’m sort of a bullish cap on that one, HDMI adoption on the PC. I don’t -– I can’t speak to the AMD-ATI merger’s impact on that. I will say though that we have had a significant amount of design activity for HDMI on the PC platform, lot on notebooks we just continue to keep getting wings and so you know again the volume or the revenue benefit from that really start to -- we should start to see that in 2007 in a more significant way.

Aalok Shah - D. A. Davidson

And then mini HDMI product that you guys are developing when do you think we can actually start to see some real design wing for that?

Steve Tirado

Using the mini connector?

Aalok Shah - D. A. Davidson

Yeah the mini connector.

Steve Tirado

You know they are still arguing about some of the details of that you know the locking clamps and a few things like that, but I don’t think you’ll start to see products using that until ‘07

Aalok Shah - D. A. Davidson

Okay and that will be what you think maybe with some mobile devices or cameras or --?

Steve Tirado

Yeah well, you know I talked about this, we have some wings with still cameras and video cameras you know like camcorders they are already in production we are already selling and we are getting more traction but that is exactly where you are going to see that because it’s on those devices that you are most space constrained and then you have the problems, the cable pulling out which is why they are, they are arguing about locking clamps now. So they are kind of clicks into place, but I fully expect that there is enough pool in the market place for starting in ‘07 you’ll start to see products they will start using mini connector.

Aalok Shah - D. A. Davidson

Okay great thanks Steve.

Steve Tirado

You are welcome.

Operator

Our last question comes from John (inaudible).

John

Congratulation guys, in the last several weeks you know, can you hear me? In last several weeks we raise guys for three times you know from the conference in Boston to the analyst meeting today and I’m wondering if there is the book to bill is continue you have another big book-to-bill that we have many more –- three more in front of us there because we get up to 50% or 60% instead of 30% to 35% growth.

Steve Tirado

Yeah, it would be give only –- you know, I think we have given enough visibility data and things are just going really well right now and we are really focused ’07, that’s really what this whole year’s been about, the results then we see this year are really a function of all the hard work we did last year. I am happy about the way the whole HDMI 1.3 is going and we are seeing really good response like I said earlier especially as a result of the PlayStation supporting -- you know Deep Color on its boxes, so you know I -- right now the market looks very good. I mean we are in a period and I think our results will be affected by -- you know how the consumer markets actually play out through the rest of the year, going in to next year.

John

Congratulations, great job, thank you.

Steve Tirado

Thank you.

Robert Freeman

Okay, I think that concluded the questions for today?

Operator

There are no questions remaining in the queue at this time, I would like to turn the conference back to you Mr. Freeman for your closing remarks.

Robert Freeman

Thank you. Thank you for joining us today, our second quarter was a very good quarter and we look forward to speaking with you at all the coming meetings and investor conferences and thank you for participating in the call.

Operator

Ladies and gentleman, that’s does end today’s conference. We thank you for your participation.

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Source: Silicon Image Q2 2006 Earnings Conference Call Transcript (SIMG)
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