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Silicon Image Inc. (NASDAQ:SIMG)

Company Conference Call

November 17, 2011 9:30 am ET

Executives

Noland Granberry – Chief Financial Officer

Analysts

Moderator

Good morning everyone. Thank you for joining us today on our third and final day of the UBS Technology and Services conference. Today we have with us Mr. Noland Granberry from Silicon Image. Silicon Image provides connectivity solutions for distributing high definition content for consumer electronics, mobile and PCs. And with that, I give you Noland.

Noland Granberry

Thank you. Good morning everyone. Welcome to UBS’ Global Technology and Services conference and Silicon Image. I’m glad to be here to speak with you.

Almost 10 years ago, Silicon Image along with six other CE companies revolutionized the TV connect—connecting TVs to various source devices through a new standard—introduction of a new standard called a high definition multimedia interface, or HDMI. Today, that standard has over 1,000 adopters. There are over 600 million HDMI devices shipping annually and it has been a very successful standard, and Silicon Image has done quite well. Last year, Silicon Image along with four other mobile and TV CE companies introduced a new standard that allows you to connect your mobile devices to TVs or a larger screen. That standard, the multimedia high definition linked, or MHL standard introduced last year is growing rapidly. Today there are over 65 adopters and that’s growing every day. Over the next 20 minutes, what I’ll do is I’ll actually spend a little time introducing you to Silicon Image as well as share in how we utilize those standards to grow our business and profitability.

So a quick look at the Safe Harbor.

So a little bit about Silicon Image. We’re a leading provider of wireless and wire connectivity solutions, and a couple points to make here – one is that prior year, we couldn’t say anything about being wireless, but we’ve introduced a wireless technology to our technology portfolio and we think that will serve us well in the near future. But more importantly, we’ve broadened our view. Historically we’ve only been about HDMI, but today we’re about connectivity in general. So the highlighted HDMI has been successful for us, we have a mobile standard so we’ve got a mobile connectivity, and with this wireless technology we’ve got a wireless view. We’ve broadened that view and that’s important because it actually has allowed us to broaden our product portfolio.

We’re targeting consumer electronics and mobile to PC markets, all very large markets and particularly when you look at the mobile market, it’s one that grown quite rapidly.

A little bit about Silicon Image – if you look at our revenue trend this year through nine months, we’re at about 162 million and on pace to grow our revenues year-over-year. Last year we ended up at a 191, which included about a 7.5 million revenue royalty catch-up. After that one-time pickup, we were growing our revenues about 20% year-over-year. We have 500 employees worldwide. We do have a contracting group in India which we expect to bring on board here in the near future as a part of the Company, and hence we have three R&D centers – there is Sunnyvale center, Shanghai center, and Hyderabad where we have the India group. We have 176 U.S. issued patents, 109 pending, and we continue to build our patent portfolio. We think this is a key piece to the value of the Company and we continue to look to build on that.

At the highest level, we actually view ourselves as playing in two different businesses – one is the product side of things and predominantly what we do, which is our chip business; and the other then is also our IP business. If you look at our product business we focus on mobile, CE and PC space and we do so with the use of the standards, and we have a standards-plus approach where we essentially drive a standard that we’ve created, aka HDMI and its mobile standard, but we then look to add Silicon Image features and functionality on top of it. That’s important for us as we look at how do we differentiate ourselves in the market, how do we actually fend off integration or other discrete chip manufacturers. That product business generally is about 80 to 85% of our total revenue and the margins there are usually mid-40s or better, and we’ve seen that trend to the higher end of that range in the last several quarters.

Also, we have an IP business and it serves us quite well. It is where we actually license Silicon Image standard core technology. We will provide implementation services to companies who are looking to develop products along those standards lines and additional services and what have you. In addition as a part of the standards body, we act as an agent and we collect adopter fees, and that’s a revenue stream to the Company, as well as royalties for devices that are shipped under the standard. Those royalties are collected and shared with the rest of the consortium members.

At the highest level, our IP revenues are generally 15 to 20% of our revenue, and that may fluctuate depending on the quarter, depending on the specific IP core licensing activity in a particular quarter; but at the end of the day, the margins on the IP side of business is in the high 90s. On a combined basis, we expect to see margins 55% or better, and I’ll show you a slide where we’ve actually demonstrated that over the last eight quarters or so.

We’re about enhancing the connected HD experience, and as I highlighted, we are a technology company developing products and licensing IP. We also look—because we bring all these parties together, provide a means or value-add to our customers, a means allow to ensure that they actually are interoperable. We think it’s very important that as a consumer, if you were to go to a Best Buy or what have you and pick up a Samsung TV and, say, a Sony Blu-ray player, that when you get home and you plug those devices together that it will definitely work. The use of our Simply Labs testing and verification is a support mechanism for our consumers, and it’s actually an additional value-add that’s key to us in allowing us to better partner with our customers.

Highlighted that we’ve actually talked about HDMI and MHL standards, and with the wireless acquisition we do have a standard that we’re focused on there, and so we view ourselves as a standards champion but also in that line of being a plus – adding Silicon Image features and functionality on top of the standard.

The markets we play in, whether it’s CE, mobile and PC, as time is progressing we feel those markets are actually overlapping in quite a bit of areas, but at the end of the day there’s a lot of connectivity opportunities within that and we look to play in all those connectivity opportunities in one way or another, and it’s through our process of creating a standard, developing that standard, creating Silicon Image feature and functionality that sit on top of the standard to drive our growth.

Our customer base is quite diverse and actually quite impressive in our eyes. We, as a Company our size, feel very proud of the fact that we can have customers, interact with customers such as a Samsung, a Sony, Toshiba, Sharp – partner with them in essence in looking at where a standard would go, how we could actually bring out the next generation of a CE technology or a mobile technology, and we’ve demonstrated the ability to do that over the last several years.

If we look at our product offering, when you look at mobile devices, I highlighted the fact that we’ve created a standard. Today mobile device, particularly smart phones, are devices that are quite—becoming very high powered, lots of memory. They’re what many people are calling the set-top box that you can carry around with you with all your content, whether it’s music, videos, movies, pictures or what have you. The only downside typically with your smart phone is the screen size. It’s typically okay if you’re just looking at the screen yourself, but if there’s intent to share or at that point in time where you want to see it on a much broader scale, there is a desire to connect up to a larger screen. Our mobile solution provides what we call an elegant way to do that – one wire connection within the MHL ecosystem that allows you to, as a manufacturer, decide on how you want to connect, what connector you want to use – we call that a connector agnostic solution, so for example if you wanted to use a micro-USB connector, you could do so. And then you’re actually in the MHL ecosystem, you’re actually able to power the mobile device. In all cases when you talk about your smart phone, it’s a communication device; so when you’re done sharing something on a screen and you want to make a call, you don’t want to have used up all your battery life by doing that, and with our mobile solution you’re actually able to charge the phone.

Lastly, a feature of it is that through the interaction within our MHL technology, you can manipulate what’s happening on the phone through, say, your TV remote. So if you’re watching a movie from your phone that’s connected to the TV, you can use your TV remote to pause, fast forward, rewind or what have you, so it’s just an additional convenience for a consumer.

If you look at the market with which we operate in from the mobile opportunity for us, within this is that pretty large opportunity. The folks who report on unit shipping suggest that there’s over 480 million smart phone devices shipping in 2011, growing to over 600 million in 2012 and will exceed 1 billion to 1.5 billion as we get out to 2014 and ’15. So a fast growing market with a lot of opportunity. Today, the concept of having HD connectivity on smart phone devices, we think the penetration rate is about 20 to 25% today. We think that grows to 30 to 35% next year, and we expect that if we push the standard the way we’d like to see it, we’d want to see it actually be across all smart phones at some point in time. So very big opportunity, fast growing space, and Silicon Image looks to take advantage of that.

Talk about MHL ecosystem, and it’s key to note that in an MHL ecosystem, you’ll have MHL functionality on the mobile device but also MHL functionality on the larger screen. In the cleanest sense, you’d end up having MHL TV, and in that case you’d connect in with one simple cable, and in that case you’re also able to charge the phone and use the remote functionality I mentioned. But today, there is over 500 million DTVs out there that don’t have MHL capabilities built in, so the way we allow you to connect in that fashion is through an adapter, which we call an active adapter, and it actually has a Silicon Image chip built inside of it. So there’s a revenue opportunity for us as we look to attach to legacy TVs and then we actually have our continuous evolution of our CE business by adding MHL to our current port processor solution. I’ll talk a little bit about that.

We also see opportunities for MHL as far as the ecosystem goes in the home theater space, high-end PC monitors, as well as within laptops. Again, I think the feature of being able to charge your phone device is very compelling to many of the device manufacturers.

Where does the ecosystem stand today? There have been a number of phones announced through Samsung and HTC, LG, An Maizo – a Chinese phone manufacturer – have announced phones for us. If you look at our revenue opportunity, if you go back one year to Q3 of 2010 and look at our mobile revenue, we reported about 3 million in revenue and that was predominantly HDMI mobile revenue. This year, Q3 2011, we reported over 21 million in mobile revenue. That was predominantly MHL revenue, so we’ve seen a lot of good traction on the mobile side of our business, particularly with the new standard, and we expect that to continue.

Building out that ecosystem, there now are TVs out there that actually have MHL functionality. Samsung has announces TVs – their 7000, 8000 series – with MHL functionality built in, and Toshiba has also announced TVs with MHL built in. We anticipate that as you get into 2012 and new TV offerings come out that there will be more TV manufacturers that have MHL included.

Who else are actually adopting on the phone side? There are a number of them. We expect four or five other players to actually announce phones, and one thing you can check and see what’s the progress of the standard, how it’s going, is if you were to go the MHLconsortium.org, go to the website and look at the adopters list, you can see players that are there. Other players you could find are, say, Lenovo, Acer, a few other Chinese manufacturers; so there’s a number of players out there that we think would be device manufacturers looking to adopt the MHL at some point in time in the near future.

While this has been focused just on the mobile device to a DTV, we did come across an opportunity with auto manufacturers who are looking at the makeup of their screens and how they are managing their screens in the cars, and there’s an interesting connection point with the auto manufacturers in that they’re looking for ways to simplify the ability to utilize those screens, and the view is that most folks are used to their interface on their smart phones and it would be great if there was a way to connect that smart phone to those screens. We think MHL is a great solution for that – one, because a manufacturer can decide which type of connector they want to use, but also the fact that you can actually provide power back to the device through the MHL connector. So this is an opportunity we think will play itself out in a couple years, but it’s actually one that we’re very excited about, talking about actually being about connectivity in various ways. This is another spread on that connectivity view.

CE side of our business, or consumer electronics – we continue to have a very strong position in this space. We continue to do the things that we’ve done historically with respect to maintaining a strong position, and that’s actually looking to develop the standard, continue to push the standard along but also to add Silicon’s feature and functionality on top of that standard. We’ve talked about historically about one of our successful adds, InstaPort S, where it provides a fast switching capability between the source devices connected to your TV. Last year we introduced ViaPort which simplified the process of connecting your TV to your AVR, which has been favorably received.

Currently, about a month or so ago, we announced InstaPrevue. InstaPrevue is a simplification of looking at the devices that are connected to your TV. In essence, it provides you a visual view via picture-in-picture look at what’s connected. For example, if you had your Blu-ray player and a movie in, you’ll see a picture that actually shows what’s playing on your screen instead of seeing HDMI-1 or HDMI-2, HDMI-3. You actually will see what’s actually playing on the source devices. And lastly, I talked about MHL becoming a part of the TV side of things, building out that ecosystem. We have introduced a number of parts that actually have MHL built in.

So when we think of MHL today, we are the only provider of chips that are MHL-enabled, whether that’s on the phone side of things or even creating chips to go into the TV. We’re the only provider today. We anticipate that that will change over the course of 2012. We anticipate that that will even change as you get into ’13, and we welcome that change because we want the standard to be successful. We want it to follow the track of the HDMI standard – over 1,000 adopters, create where there is billions and billions of devices in the market with MHL. We really want to make it a checklist item when you talk about a mobile device or a TV device, and that’s our focus.

I highlighted our introduction in the wireless. We actually have been in conversations as we’ve gone around meeting with folks, addressing the question of I see what you’re doing that’s a wired solution, but what about wireless? And we definitely realize that wireless is a key part of our ability to say that we’re a connectivity company. So in May, we acquired a company called SiBeam. They were a founder of the 60 GHz wireless HD technology. They created the standard along with some other players, and we felt that it was very important for us as a way to get into wireless to pursue a company like SiBeam for a number of reasons. One is that it actually was not along the same lines of many of the wireless opportunities out there today, such as Wi-Fi 2.4 5GHz or a Bluetooth solution or what have you. It actually followed the strategy of Silicon Image – it was a standard that would be updated and further developed to build out broad market adoption, but also it was actually a technology in the context of SiBeam that was proven. They were actually selling produce in the market that was a proven technology and not one that was still being developed. So with all those things, we acquired the wireless solution and feel very confident that we’ve selected the right strategy to bring this into our product portfolio.

So today, products that we have with the wireless is focused on the CE and PC activity. We announced a solution with Epson in their high-end projector—home theater projector, very positive impact, again telling us that the solution, the technology works. Vizio – there is adapters that are sold through Costco that’s Vizio-branded that allows you to connect your source devices to your TV on a wireless HD basis. But at the end of the day when you say what does Silicon Image really want to get out this wireless acquisition, it’s really pushing wireless into the mobile devices. We think there’s a very big opportunity that when you take the mobile device and look at our opportunity on MHL as a wire capability to bring about a similar functionality in a wireless fashion that’s video focused, that allows you to get what we call the most cable-like experience you can have through a wireless connection, we think that would be a great opportunity for us.

I talked about the number of devices as you move out to ’14 and ’15 – 1 billion, 1.5 billion devices. It doesn’t take a lot of market share or a real high ASP to recognize that that could be a very compelling revenue opportunity for the Company, and we’re very focused on making that happen. If you ask what does it actually do as far as wireless HD versus a Wi-Fi, our wireless HD solution – no compression, no latency, very fast, and again back to that point of being close as you can get to a wire—the HDMI experience, the HDMI cable-like experience.

So we feel very confident at pushing it, and just as an example, we think gaming is one of the key use cases that you’ll find with the wireless capability. Many phone companies are providing various gaming alternatives. To provide that in a fashion that you don’t have any latency issues in a gaming environment is a very positive opportunity for us.

Just going to spend a few minutes on the financials. I think probably one of the key points to talk about here is that when you look at our revenue by segment, historically CE has been our largest revenue contributor. We see that transitioning to mobile. We think in Q4 mobile will exceed and be our largest contributor in Q4 this year, and we expect that to continue into next year. If you look at revenue by region, Samsung has been the biggest player with us so far on the mobile side of things, so Korea from a ship-to region is our largest. Japan had historically been our largest region, but today it’s Korea. And we actually sell through—when you look at our revenue channel, we actually sell through distributors as well as direct.

From a financial model perspective, we look to grow revenue at 20% or better, our margins at 55% or better, and actually really to achieve a 15 to 20% operating profit. We actually have done a pretty good job of showing revenue growth year-over-year, and I talked about 2010, 2011 getting to that 20% range; but if you look year-over-year for each quarter, we did demonstrate good growth. I highlighted that over the last several quarters, our margins have been well. We’ve actually had very strong product margins as well as our IP business, and we believe that we can maintain margins over 55% in the near future for sure.

Our operating profit – we haven’t been able to hit that target of 15 to 20% but our belief is that it’s not a function of just cutting expenses. We made a decision that we think the best way for us to get to that point is to actually grow our revenue, and we think with our mobile opportunity we have a shot at that in the not-too-distant future.

So if you step back and look at our business, we’ve had a strong position in CE, continue to have that strong position in CE. We look at mobile as our growth story for 2011, 2012, 2013; and then we look at the wireless business actually coming into play in 2013.

From a balance sheet perspective, 155 million in cash, no debt, so almost $2 in cash. We’ve made some investments this past year. We’re generally cash flow positive. If you were looking at our shares outstanding, we did issue some shares in the one acquisition but we also had a share exchange that impacted our shares outstanding. We don’t expect our share growth to continue at that same level. At the same time, we have a very clean balance sheet, very strong cash position.

So how are we driving for our long-term growth? It’s looking at having an advanced connectivity focus, not being focused on one specific area but broadening our opportunities by looking at multiple connectivity areas, whether it’s the automotive example I mentioned, whether it’s mobile, whether it’s wireless. Obviously CE will continue to be a focus of ours.

High volume growth markets – being focused in this mobile area, where I mentioned the growth from 480 million units to over a billion over the next five years. We think we can have a key position within that space.

Standards champion – for us, we believe the best way for us to be successful is to create that standard, drive that standard, create additional Silicon Image features and functionality on top of that standard, broaden the adoption of a technology, and move forward.

Strategic customer relations – very important to our future. And then product portfolio expansion – again, we’ve actually broadened our product portfolio quite a bit over the last year, and we look to continue to do so over the next year as well.

Strategic acquisitions, and this is not honed in on some particular acquisition that we have in place, but we believe there are some things in our strategic roadmap that we still need to capture, whether it’s a licensing opportunity, whether it’s an investment to get to some technology, or maybe a small acquisition; but nothing on the table at this point. But we think all of these things are key to our ability to drive to our long-term growth.

And with that, I’ll conclude the presentation. I think we’ll have a breakout session—

Moderator

Thanks Noland. We are out of time for Q&A, but there’s a breakout session right after this, and Noland will be available for answering questions. Thank you.

Noland Granberry

Thank you very much.

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