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Executives

Mike Bishop - IR

Camillo Martino - CEO

Noland Granberry CFO

Analysts

Rajiv Gill - Needham & Company

Richard Shannon - Northland Securities

Christopher Longiaru - Sidoti & Company

Todd Cohen - MTC Advisors

Silicon Image Inc. (SIMG) Q2 2010 Earnings Call July 27, 2010 5:00 PM ET

Operator

Welcome to Silicon Image’s Second Quarter 2010 Earnings Conference Call. Just a quick reminder, today’s call is being recorded.

Now, at this time I’ll turn things over to our host Mr. Mike Bishop. Please go ahead sir.

Mike Bishop

Thank you. Good afternoon and welcome to the Silicon Image’s second quarter of 2010 financial results conference call. I’m Mike Bishop from Silicon Image’s Investor Relations.

Joining me today is Camillo Martino, the Company’s Chief Executive Officer, and Noland Granberry, the Company’s Chief Financial Officer. The agenda for today’s call includes a discussion of the financial results and a product and market strategy from Camillo. Noland will then provide a more in-depth discussion of the financial results and provide a financial performance estimates for the third quarter of 2010. We will then open the call for Q&A.

Before I turn the call over to Camillo, let me remind the listeners that we will be making forward-looking statements based on our current expectations during the call regarding many aspects of our business and the markets in which we operate, including, but not limited to, forward-looking statements about our financial results and performance, our current and future products and technologies, the timing of new product introductions, average selling prices, design wins, market demand for our products and operating expenses.

Our actual results may differ materially from these forward-looking statements. And we disclaim any obligation to update any of our forward-looking statements. Moreover, the forward-looking statements and the company’s future results are subject to risks and uncertainties, which we described in today’s press release, as well as in our filings with the SEC, including, but not limited to, our most recent periodic reports on Forms 10-K and 10-Q. These documents describe certain relevant risk factors that could affect our future results.

I also want to mention that we have provided a financial metrics table and a reconciliation of non-GAAP financial information to GAAP information in our second quarter 2010 financial results press release, which is available on the Investor Relations section of our website at www.siliconimage.com.

And with that, I’d like to turn the call over to Camillo. Please go ahead.

Camillo Martino

Thanks Mike. Good afternoon and thank you for participating on our conference call today. Silicon Image had a great quarter. I’m looking forward to providing you some color on our results. I will first give a brief overview of the company’s performance followed by a market updates, and then Noland will go through the numbers in more detail and provide an outlook for Q3.

Today, we reported Q2 revenue of $44.6 million, and then we’re pleased to say, we swung to a profit on both a GAAP and non-GAAP basis. Non-GAAP net income was approximately $2 million or $0.03 per share exceeding our guidance due to robust demand for our products.

As we anticipated, when we gave our Q2 guidance back in April, our port processors featuring InstaPort and InstaPort is drove revenue growth. In addition, we experience broad-based traction across most of our product portfolio that drove revenue levels up above expectations.

As Noland and I will highlight later, we expect this momentum will carry over into the third quarter, as well. Product revenue showed growth in the quarter increasing 46% quarter-on-quarter with Japan leading the way, showing an 87% increase. APAC, including China, increased 61% and Korea increased 31%.

As has been widely reported, there continues to be an industry-wide supply chain constraint. However, we were still able to exceed our revenue objectives for the quarter. There were a couple of very solid trends in effect that drove product revenue during the quarter.

First, the number of digital TVs produced annually is increasing. The industry research firm DisplaySearch estimates that there were approximately 160 million units shipped in 2009, for 2010 they estimate they were 204 million digital TVs being shipped. This represents an increase of 28% this year.

Additionally, our market share within digital TVs has increased due to the fact that we are now shipping products that address both the mainstream and high-end market segments.

Outside of the digital TV space, our mobile product line is starting to see traction in HDMI-enabled smartphones. In addition, the home theater market segment, which includes audio/video receivers, and Blu-ray players did well, especially in Japan. Japan is unique and there is both a substantial producer and consumer of Name-Brand consumer electronics products.

Starting in 2009 and extending through 2010, the Japanese government implemented echo points, and this is an incentive program that encourages the purchase of energy efficient products. This program is lifting demand for many consumer electronics products that include Silicon Image ICs.

The growth in the [array] support-driven revenue confirms our strategy of providing standard plus port processes designed to co-exist with the digital TV to SoC. Consistent with what we said last quarter, we strived to offer the market products that are both compliant with industry standards and incorporate our latest enhancements and innovations. Our product strategy is to launch new products on an annual cycle, aligned with our customers’ product development schedule.

Our products feature new innovations and technologies that become designed into each year’s new models, providing a compelling value proposition to consumer electronics manufacturers.

We are a world-class innovator, driving not only new technologies into our product lines but also advancing industry standards. Our innovation in HDMI has not stopped with the most recent release version 1.4. We are continuing to work with the HDMI consortium members to advance the standard and to enhance the end-user experience.

The most recent data shows HDMI has nearly 1,000 adopters and an installed base of over 1.5 billion products featuring HDMI technology. With such momentum, it is clear that HDMI is the global standard for HD video connectivity.

Furthermore, HDMI does not exist in a static technology environment. Since its introduction in 2003, there have been successive improvements and innovations. There are alternative technologies being developed to address emerging market needs and opportunities. However, we expect HDMI will have already improved prior to these alternatives becoming available for the broader market. The net result is that we are confident HDMI will remain the global standard for high-definition video connectivity for a very long time.

Moving on to the mobile market segment. Mobile is the next strategic opportunity for us. As you may recall, just prior to our last conference call, the formation of the MHL consortium was announced by Nokia, Samsung, Sony, Toshiba and Silicon Image. At that time, we anticipated the MHL 1.0 specification would be published within a quarter, and we’re pleased to report that the specification and adopter agreement were announced in June.

More than 1.6 billion mobile devices are expected to ship this year including mobile phones, digital still cameras and video camcorders. Of that number, a growing proportion will benefit from a high-definition video connection.

Near-term, we estimate the potential market is approximately 25% of the total mobile device market. Naturally, there will be an adoption code over the next few years. But needless to say, we believe this is a growth opportunity for Silicon Image.

To date we’ve been addressing the mobile market segment through our low-power HDMI transmitters, including the 9024, which is featured in some of the latest slot phones in the market.

In addition to HDMI, we expect that over time MHL will expand into a broader ray of mobile devices due to its key advantages. These advantages include the ability to leverage the existing connector on the phone, thereby enabling fewer connectors, and also to provide power to the device, charging the battery while simultaneously transmitting high-definition content. We expect to provide our key customers with early samples within a few months.

As we indicated last quarter, we expect MHL compliant products to contribute incremental revenue starting in early 2011 and more meaningful revenue in the second half of 2011.

In 2009, we have formed the Serial Port Memory Technology consortium, or SPMT, with ARM, Hynix, LG and Samsung. During this past quarter, we have seen solid progress with SPMT including the announcement of the new serial switch technology, which enables four times the bandwidth at half the power of the existing memory solutions.

We are also pleased that mobile has joined the consortium as a promoter. We expect that SPMT will contribute to our IP revenue at some point in time in the future.

With regard to our long-term strategy, there is a significant global shift underway in how video content is distributed to consumers. This shift from traditional broadcast TV to video content over the Internet commonly referred to the industry as over the top is creating significant opportunities for technology innovators.

Consumer-driven enhancements and connectivity, interoperability and picture quality for video over the Internet are driving increasing rates of technology change. With the global success of HDMI, Silicon Image is well positioned to be at the forefront of this technology change.

Our long-term strategy is to be the leader in advanced video connectivity solutions for the consumer. The ultimate goal is to enhance and simplify the consumer’s connected HD experience, whether that is experience via a connected digital TV or a mobile device.

I will now to turn the call over to Noland to provide a more detailed update of our financial results and our financial goals for Q3. Noland?

Noland Granberry

Thanks, Camillo. Good afternoon. I would like to cover two topics. Highlights of our financial results for Q2 2010 and our financial performance estimates for Q3 2010. Unless otherwise indicated, gross margin expenses and earnings related items are reported on a non-GAAP basis which excludes stock based compensation expense, amortization of intangible assets, restructuring charges and other non-recurring expenses. Our GAAP financial results and a reconciliation of non-GAAP measures referenced in today’s call are available on the Investor Relations page of our website, www.siliconimage.com.

Revenue for Q2 2010 was $44.6 million versus $34.3 million for Q1 2010 and $37.3 million for Q2 2009. The 30% sequential increase and 19.3% year-over-year increase was primarily a result of strong product demand during the quarter.

Product revenue totaled $38.4 million or 86.1% of total revenue for Q2 2010, versus $26.3 million, or 76.6% of total revenue for Q1 2010 and $29.4 million, or 78.8% of total revenue for Q2 2009.

The higher than expected product revenue was attributable to increased customer demand activity, primarily within our DTV and home theater market segments as a result of increased market share as well as an increase in market demand.

We also experienced stronger than expected sales within our PC storage business as we continue to see demand within these product offerings. IP license revenue for Q2 2010 was $6.2 million, or 13.9% of total revenue versus $8 million, or 23.4% of total revenue for Q1 2010, and $7.9 million or 21.2% of total revenue in Q2 2009.

IP license revenue was lower sequentially and on a year-over-year basis due in part to lower royalty revenue and to the timing of the closure of certain IP deals. Total CE revenue accounted for 86.1% of total revenue and PC storage combined accounted for 13.9% of total revenue.

Average selling price for product sales, was $1.41 per unit during Q2 2010. The higher ASP was primarily driven by mix. Product gross margin for Q2 2010 was 49.6% as compared to 44.3% for Q1 2010, and 42.2% for Q2 2009.

Product gross margin for Q2 2010 was higher than planned due to mix and to a certain degree favorable variances and better overhead absorption. Our IP license gross margin was 99.8% in Q2 2010, 99.7% in Q1 2010 and 96.5% in Q2, 2009.

The increase in IP license gross margin on a year-over-year basis is the result of a lower mix of IP customization projects when compared to Q2 ‘09. Our overall gross margin for Q2 2010 was 56.5%, exceeding our expected range of 54% to 55% as a result of the stronger than expected product margins.

Gross margin was 57.3% for Q1 2010, and 53.7% for Q2 2009. Our target gross margin continues to be in the 54% to 55% range. Operating expenses for Q2 2010 were $23 million, compared to $23.2 million in Q1 2010, and $26.3 million in Q2 2009.

Our operating expenses were essentially flat, sequentially and in line with expectations. Our operating expenses are lower on a year-over-year basis, primarily reflecting the results of our 2009 restructuring programs. As a part of our long-term strategy, we expect to start making additional R&D investments. And as a result, we expect our operating expenses to trend up slightly over the next two quarters. Headcount as of Q2 2010 was 415, as compared to 406 at the end of Q1 2010 and 574 at the end of Q2 2009.

For Q2 2010, we achieved an operating profit of $2.2 million, as compared to an operating loss of $3.5 million for Q1 2010, and an operating loss of $6.3 million for Q2 2009. Strong product revenues and margins with continued controlled spending provided a shift from an operating loss to profitability. For each of Q2 2010, Q1 2010, and Q2 2009, other income totaled $0.6 million. Stock-based compensation, which is excluded from our non-GAAP results was $2.0 million for Q2 2010, as compared to $2.2 million for Q1 2010, and $4.2 million for Q2 2009.

In the second quarter, we achieved profitability on both a GAAP and non-GAAP basis. Our non-GAAP net income was $2.0 million, or $0.03 per diluted share, versus a non-GAAP net loss for Q1 2010 of 3.6 million or $0.05 per share, for Q2 2009, our non-GAAP net loss was $4.3 million, or $0.06 per share.

On a GAAP basis, our net income was $1.8 million or $0.02 per diluted share for Q2 2010 as compared to our Q1 2010 GAAP net loss of $7.2 million or $0.10 per share. And our GAAP net loss for Q2 2009 of $13.3 million or $0.18 per share. Diluted weighted average shares outstanding for Q2 2010 was $77.5 million. For Q1 2010 and Q2 2009, basic weighted average shares outstanding were $76 million and $74.8 million, respectively.

With respect to the balance sheet, as of June 30, 2010, cash and investments amounted to $168.7 million, versus $163.3 million at March 31, 2010, and $162.9 million at June 30, 2009. In addition to higher product shipments during the quarter, the linearity of such shipments was better than anticipated. As a result our collections were higher than we’ve been expecting and we are able to grow our cash balance during the quarter. Our restructuring payments, previously discussed, were completed during the quarter.

For Q2 2010, our accounts receivable totaled $17.5 million, resulting in 35 days sales outstanding. For both Q1 2010, and Q2 2009, our DSOs was 46 days. The lower DSO both sequentially and on a year-over-year basis was a result of timely collections on higher revenues during the quarter.

Net inventory as of June 30, 2010, was $10.2 million, representing 7.6 turns on an annualized basis exceeding our target of seven turns. This compares a 9.0 turns at March 31, 2010, at 7.4 turns at June 30, 2009. Capital expenditures for Q2 2010 were $1.2 million compared to $1.0 million for Q1 2010 and $1.6 million for Q2 2009.

This completes my summary of our Q2 2010 financial results. Next I would like to discus our Q3 2010 financial outlook. The following are our financial estimates for Q3 2010. Revenue, approximately $48 million to $50 million, gross margin approximately 54% to 55%, GAAP operating expenses approximately $25 million to $26 million, non-GAAP operating expenses approximately $23 million to $24 million, interest income approximately $0.6 million, diluted shares outstanding, approximately $78 million, non-GAAP tax rate, approximately 2% of revenue. We anticipate generating cash in Q3 and expect to exit the quarter with over $170 million in cash.

In summary, Silicon Image has experienced increased product revenue activity in Q2 resulting in a greater than typical seasonal product growth rates. Our guidance for Q3 considers the strength of Q2 demand and reflect the return to normal seasonable growth patterns. In addition with our Q3 guidance, we anticipate Q4 revenues to be seasonally down in the range of 5% to 10% from Q3. This concludes my remarks.

Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We take our first question this afternoon from Rajiv Gill with Needham & Company.

Rajiv Gill - Needham & Company

Yes. Thank you and congratulations on excellent results and excellent guidance. Quick question on what’s driving the above seasonal growth in the second quarter and the third quarter. Well above your guidance, well above the estimates. You talked a little bit about strong product demand. Maybe if you could dig a little bit deeper in terms of what’s happening in terms of the customer buying patterns, what’s happening by may be particular customers, which is driving that growth, and also if you could maybe perhaps mentioned is the growth being driven by an upgrade cycle to say 3D TVs or connected TVs? Any color there would be helpful.

Camillo Martino

Sure Raj. This is Camillo. So really, we experienced broad-based improvement, all of our product lines. That’s the first comment. Secondly, the DTV business grew substantially, as we had guided earlier, primarily due to the features that we are driving outside of the standards committee activity.

And thirdly is increase in market share. We talked about in this call and in previous calls, our ability to address not only the high-end right now, but we’re starting to address the mid-range as well. So you’re increasing market share, as well. So they’ve got three pretty important factors there.

In addition to that, we also experienced increases in our other product lines. Noland talked about PC and storage activity also growing. There was another program we talked about in my prepared remarks was specific to Japan. There was a government incentive program to encourage increase in purchases of eco-friendly consumer electronics products, for example. So there were a number of factors when you combine them all together that really drove the growth in this quarter.

Rajiv Gill - Needham & Company

Okay. That’s helpful. And in terms of kind of the 3D TV question. I think DisplaySearch and the Consumer Electronics Association doubled their forecast for the number of 3D TVs occurring in 2011. Are you seeing that the industry transitioning to 1.4 driven by that upgrade cycle, or is that just kind of just gravy on what you’re already experiencing in the core business?

Camillo Martino

You know, 3D, we all start to see momentum. We all see the reports. We probably guess, based on the traction that we see with our key customers, probably approaching 10% a share, in the high single digits, maybe 10% this year of the overall market size.

So, yes, it is contributing revenue. It’s showing some strong momentum, but it’s not the overall material number for our revenue. But definitely, we do see the momentum. Next year, we’ll see it increasing yet again. So next year, we’ll see more significant impact of 3D. But this year, it’s probably high single-digits to probably 10% maximum of the overall market size for this year.

Rajiv Gill - Needham & Company

Okay, very good. And you mentioned you’re kind of taking market share in conjunction with an overall recovery in the DTV industry. Are you taking share away from like lower end Taiwanese competitors? Could you maybe describe the competitive landscape and who you’re taking share from?

Camillo Martino

Sure. Look, competition, there’s a number of competitors. There’s discrete solutions that we’ve talked about in the past and there is SoC solutions as well. So, when we talk about increasing market share, we believe it’s against both. It’s against discrete solutions which, we’ve talked about in the past companies like an ADI or NXP and also SoC vendors as well.

Rajiv Gill - Needham & Company

And you talked about fourth quarter kind of being down. The normal seasonality pattern is 5% to 10%. You know, would you not expect that to be conservative, given kind of what you’re seeing, given the dynamics that you outlined in terms of market share, new product cycles coming on line, the standards-plus business model picking up? Maybe any color around that fourth quarter number?

Noland Granberry

Yes. While we actually highlighted that to provide color around the seasonality aspect, we really were looking to guide for Q3. We think that we see in Q3 continued demand as we have seen in Q2, and because of that strength, we do expect Q4 to be down somewhat.

Rajiv Gill - Needham & Company

Switching to the mobile side, you mentioned that you are excited to see some revenue from the mobile HDMI. You know, is it possible for you to quantify that? And secondly, maybe, could you provide any color of which phones you’re in? Obviously the HTC EVO, the Droid X, I believe is using HDMI connection to the TV, so it seems like some of the hottest phones are using that. Maybe if you can provide a little color on where you see that opportunity progressing going forward, and should we be expecting some design wins using MHL in the not too distant future?

Camillo Martino

You are seeing lots of announcements out there in the marketplace. There’s more and more activity occurring where smartphone vendors do want to have HD connectivity attached to their phone. That’s a plus. Really that’s fantastic news for everyone in the industry. It’s great news for us as a company, who is pioneering this particular trend.

So, we see, if you look at the smartphone specifically, we see HDMI. As I have mentioned previously, it really is the first phase of mobile revenues. The second phase is going to be more MHL for the obvious reasons that technically there are some great advantages of why a consumer would really want to use an MHL based smartphone and that’s really for next year. We talk about more meaningful revenues in the back half of next year.

So that’s really the sequence of events in terms of the transition from HDMI to MHL and by the way there’s other category of mobile products like a video camcorder, they may still want to use HDMI. I mean HDMI is still going to coexist with MHL. It’s not necessarily that one is going to do a complete blanket replacement of HDMI. They are going to, in some places, coexist, but clearly for a smartphone, the value proposition is very strong as to why a consumer would like MHL in particular.

Rajiv Gill - Needham & Company

So the HDMI phones that are out there right now, are you collecting a royalty or you are supplying the actually HDMI transmitter chip for just the current phones that are using the HDMI mobile TV connection?

Camillo Martino

It’s mixed. In some places it could be discreet chip revenue in the event that an SOC vendor may have integrated this feature into their SOC. Well, in that case there would be an adopter of the HDMI standard and then they have to pay the necessary royalties as well. So it’s mixed at this point in time. But the market is still young, it’s growing, and the serious end of the business is going to start towards the back end of next year and going to continue after that.

Rajiv Gill - Needham & Company

Just staying on MHL, are you looking at kind of adjacent markets outside of mobile devices and cameras, for example tablet PCs or connected displays? Or is your business strategy kind of pursuing other areas as well?

Camillo Martino

No, it really, although the primary intention was for smartphone, and obviously that’s supported by the fact that Nokia, as you can see and Sony and Samsung and Toshiba, all cell phone manufacturers. At the same time we see a big opportunity for non-smartphone applications as well. For example, a camera as you mentioned, a camcorder, even monitors by the way. You don’t necessarily have to plug in your mobile device to a TV, but you can imagine a monitor, a PC monitor, any large size display, even notebooks for that matter. So MHL as a feature, we would expect pretty broad based adoption over time. Now, it’s not all discreet revenue sales. So it’s going to follow a similar model but that we’ve had in HDMI and in some cases it is discreet sales where the value proposition is strong. In other cases, it’s an IP sale, but in both cases we think that Silicon Image is well positioned.

Rajiv Gill - Needham & Company

And last question on MHL, maybe could you talk a little about some alternative technologies that could, perhaps, compete with MHL for example wireless USB or USB3.0, the wire standard or the Wi-Fi network? Maybe if you could talk a little bit about the sustainability of MHL as a viable technology in this connection and what advantages that you feel it has over those burgeoning technologies that we’ve talked about.

Camillo Martino

Frankly speaking, the real competitor today is HDMI. I mean, that’s the honest truth of the matter. It’s the only technology that provides HD transfer content in a secured manner, and so that’s the key point here. So if you look at other technologies, like USB, I think USB frankly is coexisting. Maybe you want to transfer photographs, maybe you want to transfer files, word document files that potentially don’t need to have Hollywood secured security for example, at the same time.

So these are all coexisting technologies. Wireless is the same thing. Wi-Fi for example, doesn’t necessarily replace it. In our vision of the connectivity strategy of the future Wi-Fi will coexist for example with HDMI, at the same time. It really depends on the application but if you’re looking at the application of transferring high-definition video content in particular let’s say movies the only real viable competitor today is HDMI and again in both cases we’re well positioned.

Operator

We will take our next question now from Richard Shannon with Northland Securities.

Richard Shannon - Northland Securities

Very nice quarter and also nice guidance, too. I guess my first question maybe just kind of drill down on one of the previous questions here. Just kind of looking at your overall TV business in the second quarter, you’ve identified a number of trends that seem to drive them, much about seasonal, I have obviously identified the eco-friendly policies in Japan. How much do you think that had a contribution to this very nice growth versus perhaps some share gains with new customers like [Sony] for instance, where you didn’t have them in 2009. And as opposed to any benefit you have from kind of mid-range TVs? Can you kind of ballpark which one of the more important drivers?

Camillo Martino

Yeah, probably not in a position to tell you exactly the percentage split for each, but again, I would say it is broad based, the reasons, we did increase our market share. We’re shipping to more Tier 1 vendors, for example. So that’s pretty clear and the Japanese program, it did contribute. It wasn’t the number one primary reason why we grew.

And don’t forget, we’re coming off an unusually low year in 2009, where economic climate and sentiment was down this year. Although, there’s some lumpiness so to speak, depending on the month-to-month that you read different reports. But frankly speaking if we and all of us just sit back in our chair and compare how we feel today versus one year ago, we’d probably feel a little bit better. Is it where exactly we want to be? Probably not. But it’s a lot better than a year ago. So really, it is across the board. It wasn’t necessarily specific to one program or another.

Noland Granberry

And if I can just add to that I think as Camillo is saying across the board, if you look at where our storage increase came from, which was more than expected. But I think the one point, we highlighted last quarter and before that we thought things would pick up in Q2, which happened as expected. But then the unexpected portion, the upside the eco-friendly program, the China storage upside where things are sort of driven the increase over what we had out looked.

Richard Shannon - Northland Securities

Okay. Camillo, how many of like, Tier 1 TV customers are using InstaPort today are top 10, or how ever you look at it? How many are using it and how many more do you think you can still capture?

Camillo Martino

I think we’ve been pretty consistent for some time in saying that we are shipping in eight of the top 10 brands today. And the two that we don’t have, I think we’ve also been pretty vocal about who they are as well. One is Panasonic, for example, and they obviously have an in-house semiconductor group, and pretty competitive. And the other is in Korea. So I think you understand our largest customer, or certainly a very significant customer of ours today is Samsung. So if you do business with Samsung, it does place some constraints on you relative to other companies that you can do business with in Korea, so…

Richard Shannon - Northland Securities

Okay. And Camillo, just to confirm, is that talking about HDMI or InstaPort specifically?

Camillo Martino

That’s referring to both.

Richard Shannon - Northland Securities

Okay.

Camillo Martino

Both processes using the InstaPort feature.

Richard Shannon - Northland Securities

Okay. Great. Next question from me, gross margins obviously a very nice result there. You mentioned a few drivers of that, kind of curious to the extent of which this is sustainable. Obviously volumes that you are talking about, are going to be increasing here. But I would imagine that you’re getting some benefit from InstaPort-based device that obviously don’t have any direct competition. But your guidance seems to be a little conservative for the third quarter. I am trying to figure out, are you just being purposely conservative, or is there a down draft here, or I am trying to figure out what’s going on with gross margins?

Noland Granberry

Well, if you look at our growth quarter-over-quarter, it’s about 14%, which is pretty strong. I think that’s not that bad. But when you look at the factors that I’ve pointed to is mix related, and some of that is InstaPort feature, as well as some of our home theater and storage activity that actually was stronger in the quarter. And as those would continue on, we hope to see continued strength in the margins, as well as the volumes relative to our overhead absorption. We talk about leveraging our expenses. This is one of the areas where we’ve actually been able to get some positive leverage at the margin line with the growth in unit activity relative to our fixed expenses.

Richard Shannon - Northland Securities

Okay, great. Maybe couple of last quick questions from me on handsets. Kind of curious, how many opportunities are out there available for, I guess initially HDMI that sit out there that either you’ve won or they’re currently existing and it might be ramping in the revenues at some point this year. It seems like there is a number of opportunities. But any way as you can give us some sort of scale of what’s positive out here in the relative near term, even before MHL starts to hit?

Camillo Martino

Yes. That’s little bit difficult. But it’s fair to say that every Tier 1 and other mobile phone companies today are considering or developing or have in production a smartphone with high-definition connectivity. So the trend is solid. There’s no question. It’s a solid trend. But it’s going to take time. It’s a new feature. It’s going to take its natural adoption curve. Some could argue, as we’ve spoken previously, that the MHL adoption curve may be even a little bit faster than HDMI.

If you go back years ago when HDMI took off, there was a number of things that had to happen in the ecosystem for HDMI to take off. Well, frankly, MHL leverages a lot of that hard work that HDMI did, and it just got some more compelling features. So, there’s arguments both ways, but frankly in some respects, the adoption curve for MHL may be a little bit faster than HDMI.

Operator

(Operator Instructions) We go next now to Christopher Longiaru with Sidoti & Company.

Christopher Longiaru - Sidoti & Company

Hey, guys, congratulations; great quarter, great guidance.

Camillo Martino

Thanks.

Christopher Longiaru - Sidoti & Company

My question is, talking about the adoption curve here, can you describe the process that OEMs use to adopt MHL and basically how the progressions work so far and how you expect it to work as it gets fine-tuned?

Camillo Martino

We’re obviously not in a position to tell you exactly the current status of each of our customers and the way they are in the process. But, the specification was made available publicly towards the end of June of this year. So that’s in the last four weeks. That’s the first step.

In addition to that, we have also mentioned, based on that date, we anticipate to introduce samples of our products within a few months at that point in time. So, if you kind of extrapolate this out and you look at a Tier 1 brand, who is going to be selling to a major cell phone operator which has to go through quality control testing and what have you, that quickly gets you for the back half of next year. So, yes, we’ll see some opportunities earlier than that, but the back half of next year is probably a more of a typical, let’s say, Tier 1 design and cycle.

Christopher Longiaru - Sidoti & Company

Got you, okay. And that’s your timing on it. And just as far as operating expenses go, you grew revenue and I think you even came in below what I expected on the operating expense line. How do you expect your operating expenses to trend from here, with the revenue jumping like it has?

Noland Granberry

This is Noland, Chris.

Christopher Longiaru - Sidoti & Company

Hey, Noland.

Noland Granberry

Hi. As we highlighted on the call is that, we think with some of the investments we’re going to be making in the next quarter, relative to activities focused on our long-term strategy, we will OpEx see trend up some. We’ve laid out #23 million and #24 million as our guidance, and we think that’s probably the range we would look to be in. But we believe, at this level, and we’ve talked about it before, that we expect to be able to leverage that amount of OpEx to drive our revenue growth in the to future. Feel pretty good about that.

Christopher Longiaru - Sidoti & Company

And what revenue level would that be able to handle? I’ve got $24 million, $25 million dollar range. At what point would you have to kind of ramp that up?

Noland Granberry

It would depend. I mean, I think a lot of things that come into play as we get to certain levels of activity is whether we need any additional testing equipment, so there may need to be some investments there. I think you get up in the higher end within the $200 million range and above that to some degree. We will provide you little more update on that as we get out into the next quarter and beyond.

Operator

Next now to Todd Cohen with MTC Advisors.

Todd Cohen - MTC Advisors

Camillo, just a couple of questions. How many phones as it relates to HDMI are you currently in with a phone actually on the market today?

Noland Granberry

Wow! That is a very direct question.

Todd Cohen - MTC Advisors

I didn’t ask the name yet.

Noland Granberry

I know, that’s part two of the question, right? Look, I think there’s an obvious one that probably everyone has dissected backwards and forwards. But that’s the [EVO] platform, the relationship with HDC is becoming stronger all the time. Beyond that, I don’t think it’s fair for us to comment publicly since we’re not in a position to be able to comment publicly on the other platforms.

Todd Cohen - MTC Advisers

Okay. So are there other phones out there in the market yet?

Noland Granberry

There are other phones out there today with HDMI and I think there’s more.

Todd Cohen - MTC Advisers

No, but I mean that you guys are in.

Noland Granberry

Todd, you just asked the same question backwards, come on.

Todd Cohen - MTC Advisers

No, I am not asking for the name. You should be able to discuss.

Noland Granberry

It’s possible.

Todd Cohen - MTC Advisers

Okay. And then the other question is, as you said, the relationship with HDC is becoming stronger, so does that mean you have an opportunity and some of their many other models that are kind of coming out, going forward, is that, you’ve got a shot there?

Noland Granberry

Sure. Look, the general comment, we absolutely have a shot. Absolutely.

Todd Cohen - MTC Advisers

And then the other question was earlier, I forget the exact question that was asked, but you said we are now starting to address the mid-range. So are you pretty early on in that process in terms of the penetration and that you’ve been able to get and market share you’ve been able to get thus far? We are kind of in the early stages there or kind of, can you clarify that?

Noland Granberry

Yeah, if the word starting was used, probably that’s not the best representation. I think we’re pretty much in full swing in terms of the high end and mid-range. And we expect that trend to continue next year.

Todd Cohen - MTC Advisers

Okay. And then I may have missed this earlier on, and I know Noland you referenced product mix but separate and apart, so licensing was down modestly. So that’s not where you got the margin benefit.

Noland Granberry

Correct.

Todd Cohen - MTC Advisers

So in what other areas separate and apart from the HDMI TV business, what were the other areas that performed better than you would have thought, and what do you attribute to that?

Noland Granberry

So if you look at, we’ve mentioned that our strength was across all the product lines. And I highlighted the storage activity that we had that was stronger than we expected, and very strong margins there. In our home theater space, we had some very good strength in that space as well, and there are strong margins there. So those were the major contributors to that.

Todd Cohen - MTC Advisers

In the home theater, would you attribute that predominantly to Japan or was that kind of across the board?

Noland Granberry

Japan played a big part in that, but it was across the board. We did see strength across the board, but Japan and its eco-program did play a part in that.

Todd Cohen - MTC Advisers

Okay. And then I guess the last questions, could you refresh me as to what you do specifically in the storage area?

Noland Granberry

So we have technology, storage technology that actually within the China market, we have SATA controllers and other storage technology and within the China market, actually we’ve seen some strength where customers that build surveillance systems use our product and imbed our product into their technology and that was one of the major drivers that we saw for this quarter.

Todd Cohen - MTC Advisers

And could that potentially be an ongoing kind of activity?

Noland Granberry

We’re looking and seeing. As we’ve said in the past, we weren’t making meaningful investments in storage, but this is an opportunity that we think if it bodes well we will continue to take advantage of it.

Operator

We will take a follow-up question from now from Rajiv Gill at Needham.

Rajiv Gill - Needham & Company

Yes, just on the storage and PC, I know in the past you were thinking about deemphasizing that market. Maybe we could just drill on the PC side, was the growth also strong on the actual PC side. And do you see the PC HDMI business continuing to progress at that level, or is this more kind of a one quarter pop.

Noland Granberry

It was stronger, but it wasn’t to the same degree as the other areas and we’ve highlighted that. We thought that this would be a declining space for us at this point in time. So I think our outlook is that it still would be declining but as we see some favorable inputs there’s some things that we thought were going away and continue to provide demand, we’ll continue to fill it.

Camillo Martino

Yeah, and if PC specifically, that category, we may choose to develop a product maybe that has MHL in it in some form of another specifically targeted for the PC segment. So although we may have made some comments in the past that we’re deemphasizing or not investing materially in the storage, there may be an opportunity for us to go and develop something specifically for the PC market especially that leverage is given to newer technologies that we’ve developed.

Rajiv Gill - Needham & Company

Wonderful. And then just the housekeeping on the tax rate. You did 2% tax rate. Where do you see that in 2011? What should be the normal tax rate?

Noland Granberry

Right now we haven’t, while we’re putting our plans together for 2011, we’re not able to provide any real good color on that at this point in time. But as we finalize our plans, we definitely will give you a better look. Understand that we are in this valuation allowance position and that will probably continue into 2011. So there will be the impact on the rate that folds into 2011.

Rajiv Gill - Needham & Company

All right. So if you can reduce the taxes, just flow through the valuation allowance.

Noland Granberry

Yes, well, the valuation allowance impacts where our tax rate is and so we’re right now, we’re at 2% of revenue and we expect that to be the same as we go through the rest of this year. And we’ll give you better feedback on that in the next few quarters.

Rajiv Gill - Needham & Company

Last question, I mean, you got robust cash and it looks like you’re managing the cash excellently. And it seems like OpEx is not going to really jump up too much in 2011. You’ve done a good job in 2009 to kind of reduce that OpEx. Any plans for the cash buyback, especially if you really see value for the shares, significantly higher than where they are now? Or any thoughts on that or you’re just using it more of a cushion as of now?

Noland Granberry

Right now, Roger, I think the short answer is no, we don’t have any plans to do any buybacks. I think at this point, we’ve talked about it before that we want to make sure, we’re getting ourselves back into a cash generation mode. We actually have demonstrated at this last quarter in a favorable way.

We want to make sure that we are really set to go before we make any considerations. And the other piece to it is that we continue to look at ways that we can best utilize that cash. So it may not be just be with the repurchase or whatever, but at this point, like I said the short answer is no plans for that.

Camillo Martino

Yes, so as we’ve discussed in the past, we’re executing on our long-term strategy. We talked about that a little earlier in the prepared remarks, as we continue marching down that path. We may identify some opportunities that technology gaps that we need to go and license perhaps to fill the portfolio in a long-term strategy or even acquire some technologies as well. So, we’re looking at all the things possible to drive long-term shareholder wealth here.

Operator

Back now to Richard at Northland Securities.

Richard Shannon - Northland Securities

Just one quick follow-up question kind of generally for you Camillo. And not to throw any water on what, you’ve had some very good success here so far in 2010, but kind of curious about what you’re seeing for the TV design cycles for next year, kind of curious and kind of the big picture things that your customers are looking for, how your product plans are fitting in with their and with them? I mean do you see yourself kind of stretching the envelope of the innovations like within support, kind of being an offense or of do you see this more as a defensive position and kind of keep what you have? Can you characterize what you’re seeing and how you’re going to approach the market for next year?

Camillo Martino

Sure. I think the short answer to that question is an offensive strategy, if you had to choose between the two. We’ve talked about on in past calls and in also today’s call about the standards-plus business model. So we’re continuing to innovate outside the standards activity.

The second thing we’ve talked about is launching and announcing new product on a regular and consistent timing in such a way that our customers can take their product and launch it for the start of their New Year models, for example, in their next year cycle.

Our product introductions match the customer requirements, and that is a program that we are marching towards very aggressively here. It drives the culture of the engineering team to be able to deliver our product on a certain time every year at the expense of everything else, so timing is important. If you’re three months late, frankly, you miss an entire annual cycle. So that’s a disastrous position to be in. So, I think from that standpoint, again just in summary, it’s an offensive strategy. It’s our schedules; we believe are in line with customers’ requirements. And we’re continuing to innovate using the standards-plus business model.

Operator

Gentlemen, it appears we have no further questions this afternoon. Camillo, I’ll hand the conference back to you for any closing comments.

Camillo Martino

Okay. So thank you for participating everyone on today’s call. It is a very exciting time for Silicon Image. I look forward to speaking with you again to discuss the third quarter. Thank you.

Operator

And again that does conclude today’s conference call. Thank you for joining us, wish you all a great afternoon. Good-bye.

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Source: Silicon Image Inc. Q2 2010 Earnings Call Transcript
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