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Silicon Image, Inc. (NASDAQ:SIMG)

Q1 2007 Earnings Call

May 3, 2007 5:00 pm ET

Executives

David Allen - Director of IR

Steve Tirado - President & CEO

Bob Freeman - CFO

Analysts

Tayyib Shah - Longbow Research

Mahesh Sanganeria - RBC Capital Markets

Jason Pflaum - Thomas Weisel Partners

Adam Benjamin - Jefferies & Co.

Jeff Schreiner - American Technology Research

Daniel Gelbtuch - CIBC World Markets

Scott Hirleman - Robert W. Baird

Presentation

Operator

Good day, everyone, and welcome to the Silicon Image's First Quarter 2007 Financial Results Conference Call. Please note that today's conference and question-and-answer session are being recorded. At this time, I will turn the conference over to Mr. David Allen for opening remarks. Mr. Allen, Please go ahead.

David Allen

Good afternoon, and welcome to Silicon Image's first quarter 2007 financial results conference call. I am Dave Allen, Silicon Image's Director of Investor Relations. Joining me today are Steve Tirado, the Company’s President and CEO, and Bob Freeman, our Chief Financial Officer.

Based up on feedback from many of our listeners at the last two conference calls, we are introducing a new conference call format this quarter. This format will be supplemented with more detailed information in the accompany slides to this webcast.

Before I turn the call over to Steve, let me remind the listeners that we will be making forward-looking statements during the call regarding many aspects of our business and the markets in which we operate, including forward-looking statements about our future performance based on our current expectations. Actual company and market place results may differ materially from our forward-looking statements.

Moreover, our forward-looking statements and the company’s future results are subject to certain risks and uncertainties. We encourage you to familiarize yourself with our filing with the SEC, including but not limited to, today's press release and our most recent periodic reports on Form 10-K and Form 10-Q. These documents describe certain relevant risk factors that could affect our future results.

I also want to mention before we proceed, unless otherwise noted, all financial numbers are prepared in accordance with GAAP, or Generally Accepted Accounting Principles. We will also discuss certain non-GAAP financial information.

A reconciliation of non-GAAP financial information to the most directly comparable GAAP information is included in our first quarter financial results, which were issued today. Please note our non-GAAP financial measure may differ from those used by other companies. These non-GAAP measures should be considered in addition to and not as a substitute for the results prepared in accordance with GAAP.

For those who have not seen today's press release, let me quickly recap the first quarter results. Total revenues of $69.1 million were inline with our original guidance at February 8 and our updated guidance at April 5. GAAP gross margins were 55.5%. Non-GAAP gross margins were 56%, which were higher than our original guidance but inline with our updated guidance.

EBITDA was $9.3 million. EBITDA excluding stock compensation expense of $4 million was $13.3 million. GAAP net income was $2.9 million with $0.03 per share on a dilute basis. Non-GAAP net income was $6.3 million was $0.07 per share on a diluted basis. Bob will provide additional details on our financial results.

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

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Steve Tirado

Thank you, Dave and good afternoon everyone. As you can see from today’s agenda, I want to spend some time both reviewing our results for the first quarter and articulating our strategy for long-term revenue growth and profit generation. Let me start with a few key highlight from the marked quarter.

Number one, customer adoption of over VastLane HDMI 1.3 product has been very strong and accounted for approximately 25% of our CE product revenue in the marked quarter. Our success with these chips was the major factor behind our 17% year-over-year revenue growth for the quarter that just ended.

I am also pleased to report that we expect sales of our HDMI 1.3 chip to reach approximately 50% of our CE product revenue in Q2. Number two, we received our first major volume production order for our new line of input processors from a top tier CE company, where delivery starting this month.

Number three, our book-to-bill was significantly higher than one for the March quarter and the customer orders we have on the books for Q2 and Q3 provide us with a higher level of visibility that we have 90 days ago.

Number four; based on our current order backlog, we expect to see an approximate 20% sequential increase in our total products sales for Q2. Number five, the integration of Silicon Image Germany formally SiWorks, which was acquired in January is going quite well and should help drive more products into our 2007 and 2008 pipeline.

Number six, the Sunplus intellectual property acquisitions, which we licensed in February is being integrated into our IP library and should begin to show up in customer products by 2008. Number seven, our non-GAAP gross margin came in at 56% above our previous guidance of 53% to 55% and was driven largely by increase licensing activity in Q1.

I would like to now turn to the key drivers of growth for Silicon Image, as we look into the next 24 or 36 months. Number one, we believe we can continue to innovate within the HDMI standard on a 12-month occasion with compelling features for consumers and manufacturers alike.

Number two, based on each new HDMI standard’s release, we are targeting to achieve a product mix that drives approximately 50% of our CE product revenue from products based on these new standard releases.

Number three, our product roadmap is focused on providing customers with higher value, more integrated products, starting with the line of input processors we introduced at CES in January 2007. And number four, we’re using our expertise in the CE digital interconnect phase to enable a CE centric home networking for video, music and photos and expect to provide more information on this initiatives as the year progresses.

Now, let me spend a few minutes on each of these four growth drivers. Our first growth driver is derived from innovations; we and the other six founding members of HDMI standard bring to market. As you can see on slide eight here, we have four plus years of demonstrating our ability to innovate in line with product cycles of our customers on a consistent basis with the six releases of HDMI since December 2002.

The second major contributor for growth relates to our ability to drive our product mix to include new products based on success of HDMI releases to approximately 50% of our CE product revenues. We are off to a good start year, as approximately 25% of the CE product revenue in Q1 came from our VastLane HDMI products, like the 9125, 9135, 9134, 9185, 9181 and 9132.

The 9125 is our flagship DTV dual port 1.3 implementation, the 9135 is an audio enhance version of the 9125, the AV receiver market. The 9134 is a 1.3 transmitter for source devices that support deep color with high bit rate HD audio support.

The 9185 is a three-port switch with integrated CEC that offers very good interoperability when a single remote is used to cross manufacture. We believe we are the only product licensed in the market and have support services through Simplay Labs to help our customers take full advantage of hardware implemented CEC across their product lines.

The 1981, is a buffer chip for front-end HDMI connectors becoming popular on many 40-inch and above HDTV to accommodate emerging camcorder and cameras with HDMI OUT.

And finally, the 9132 is our game console chip. We believe that sales our VastLane HDMI 1.3 product line will constitute or could constitute up to 50% of our CE product sales for the full year in 2007.

We believe Sony’s recent product announcement of nine new 10-bit panels Bravia DTVs signals the beginning of an important DTV trend. A trend that our VastLane HDMI 1.3 product line is intended to serve.

Following our first major design win with PS3 game console last year, we have seen strong set of design wins for our HDMI 1.3 chips across a number of device categories like digital television, radio receivers, DVD’s, including new HD-DVD and Blu-Ray recorders.

Our VastLane HDMI 1.3 design wins over the last several quarters include wins with more than two dozen leading OEM such as Sony, Samsung, Sharp, Toshiba, JVC, Bose, Phillip etcetera, to name just a few. Slide of this presentation provides a larger list of OEM design wins.

Our third source of growth will be driven by the interaction of more integrated higher value chips starting with the new line of input processors. Recently released PinnaClear 9153 with Dual HDMI 1.3 and Dual 1080 ADCs just went into product.

I am very please to report that we received our first order for 600,000 parts from a top tier OEM and we’ll begin volume shipments this month. We believe this product can significantly -- can scale significantly this year.

During this summer, we also expect to begin sampling the PinnaClear 9155 with our higher performance Dual 1080p ADCs. To put the ASP contribution from this family of input processors into perspective, our discrete chips typically sell in the $2 to $4 range while these more highly integrated input processor chips of ASP is targeted in the $5 or $7 range.

We believe our input processors will also enable our top tier OEM customer to adapt faster to ever changing IO requirement and lower their cost by eliminating the need to continuously port I05 to different fabs and nodes.

By teaming up with our customers, we believe we can shorten their design cycles and lower their development and borne cost while at the same time letting our customer focus on their own differentiated image processing innovation.

Today, our DTV has many discrete and multi function chips. In the most basic term the DTV architecture can be split into front-end and back-end with each performing various functions. In a number of cases these functions will be combined overtime. These combinations represent and exciting opportunity for growth.

As one can see here on slide 12, slide 13, and slide 14 Sony Sharp and Samsung provide three examples of TV motherboard that include proprietary image or media processors to produce their own differentiating solutions.

One of the key issues faced by all TV OEM is how to keep introducing the back end image performance improvement, while at the same time keeping pace with changes and front end capability. The advancement in HDMI, the need for increasing number of ports, the need for solid interoperability all point to the value that Silicon Image’s integration strategy is designed to cost effectively bring to the market.

We believe that buying an integrated front end with all EOR switching at a scalable number of ports is important to customers at the top of the market in the 40 inch and above category, which is becoming the sweet spot for the global market even in China.

Earlier this year, we announced two strategic initiative, our acquisition with sci-worx and a cross licensing transaction with Sunplus. Both of these initiatives were designed to strengthen our ability to develop higher value integrated product. Our sci-worx acquisition is now Silicon Image in Germany was done in order to increase our engineering resources and to enhance our IP for example in the area of multi-format decoders.

I’m pleased to report that after one quarter the integration of the engineering team is on track. We have accelerated our original plans with respect to Silicon Image in Germany and have redirected our personnel in Germany to support an increased level of HDMI and new product development initiatives as well as our Simplay test and consulting services.

Earlier this year, we also announced a cross licensing agreement with Sunplus in the area of DTV and DVD IP. We believe that the IP licensing with Sunplus provides a great foundation upon which we can innovate as opposed to reinvent. We believe the talent and IP repurchase the sci-worx and the IP rights we obtain from Sunplus are very cost effective means to advance our product roadmap, when compared to the alternative of trying to reinvent this existing technology or buying an expensive competitor.

Looking beyond HDMI 1.3, we see continuing opportunities with mobile and content connectivity around the home as our fourth major growth driver. The mobile market represent an exciting opportunity, camcorders and digital still camera were all standard definition until recently and use composite video or as video connectors. With the transition to HD camcorders in full swing, the market is beginning to embrace the 1HD interface that has no format dependant, which is HDMI.

We believe the HDMI 1.3 certification new type seeking after for mobile application is very well done. Several major manufacturers have already announced HD camcorders with our Silicon products. We have also begun shipping DSD market. Overtime I expect we will report future design wins and need applications as well as with personal media players.

With respect to mobile phone, we see this as a large potential opportunity for HDMI, an opportunity that our product roadmap addresses through the development of solutions that are optimized with small connectors, incompatibility and low power consumption.

Today HDMI is the fastest standard for point-to-point connectivity in HD home. We believe as do many others that consumers want a simple to setup end use, in expenses means, to reliably move display and store any content or feature anytime anywhere and on any device in their home, all via rich personalized interface.

We have used our expertise in the CE digital connect area to develop a CE centric home network for video, music and photos through development of new IP in three areas. Number one, a protocol that can run over any transport, Ethernet connect powerline or wireless and allow us to be automatic discovery of content across the commodity home network.

Number two, the security architecture that allows for compressed content and persistent security across connected and mobile devices. And finally a new protocol for robust performance in a commodity network over IP on any transport. And finally, an ability to project the user interface from any source to any display.

At CES this past January, we provided a technical demonstration of this technology to leading OEMs and content providers. The response to these demonstrations from industry participants has been very encouraging. Our goal is to begin sampling working products by early 2008.

With the knowledge we gained from creating the HDMI standard in this success, we think our approach for connectivity going beyond today’s point-to-point solution in the HD home, represents the four significant growth driver for our business in the future.

I am now going to provide some color on markets we currently serve starting with consumer electronics. From my earlier comments, you should know that I am quite pleased with our overall growth opportunities, both in 2007 and beyond for our CE products.

The only exception to this is in the game console area where we now have a reduced expectation from earlier this year. We are a supplier to a major game console manufacturer; we enjoyed a strong ramp from this company last year, as our customer launched its new platform.

While we continue to develop next generation chips for this segment. The near term order requirements for games consoles will likely be lower than we had previously anticipated.

Orders from other segment of the CE market including digital television, DVD, Set-Top Box, AB Receiver, emerging mobile applications on the other hand are very encouraging. And as I said earlier, new VastLane HDMI 1.3 product could account for 50% of our CE product revenue for the year.

I am looking forward to reporting throughout the year our continued progress on the ramp of these products. Our front-end input processors, as well as our activities in the new CE markets like mobile and home-networking applications that we expect will drive our growth.

On the PC side, the desire by consumers to move content between their digital devices including front PCs to digital televisions continues to grow. Recognizing its convergence trends, PC manufacturers are increasingly using HDMI and desktop, notebook, monitors and new products like the Apple iTV.

For the first quarter of ’07 our PC product sales accounted for 17.5% of total product revenue or $9.7million compared to $12.8 million in the same quarter a year ago. Despite a relatively weak PC market in Q1, we do expect to see a pickup in PC industry activity later this year.

Let me now turn to Storage. For the first quarter our Storage product sales accounted for 10.1% of our total product revenue or $5.6 million compared to $8.5 million in the same quarter of ’06.

While our SteelVine storage processors continue to gain traction with PC motherboard manufacturers, such as, the ASUSTeK and MSI we saw lower demand for certain non-core products such as Fibre Channel Parallel ATA and some of our Serial ATA products.

Overtime we believe high-bandwidth storage solutions like SteelVine will become important as consumers increasingly access and distribute high quality digital content throughout their homes and PCs and digital video recorders.

It’s easy to implement cost effective and scalable solution. We continue to think SteelVine represents a CE-friendly ways to provide reliable digital content storage in the home. After slow start in Q1, we expect our storage business will revolve during the year and be relatively flat on a year-over-year basis.

So let me now sum up our revenue in gross margin outlook. For Q2 we see revenue ranging between $75 million and $79 million, largely driven by growth and adoption of our new VastLane HDMI 1.3 product offering. As we note on slide 28, we expect our licensing revenues to dip this quarter due to the timing of certain program.

For the full year we see our revenues growing from $295 million to a new guidance range of $325 to $345, the shortfall from our previous guidance for the full year $340 to $350 is largely due as I noted early through a slowdown in demand for game consoles chips.

With respect to our non-GAAP gross margin expectation for Q2, the drop in licensing revenues will pressure our gross margin this quarter. We now anticipate our overall non-GAAP gross margin to range between 50% and 53%. Finally, we intend to maintain tight control over expenses and are targeting non-GAAP OpEx at the $30 million to $32 million level for Q2.

Bob will now provide a detail review of our Q1 financial results, as well as our forward-looking guidance relating to tax.

Bob Freeman

Thank you Steve. Good afternoon. Let me start with the income statement. Total revenue for our first quarter of 2007 was $59.1 million, an increase of 17% from the first quarter of 2006.

Excluding revenue of $10.6 million related to royalties earned prior to the fourth quarter of 2006 from our Genesis settlement. Our fourth quarter 2006, revenues was $76.4 million. Well the first quarter our product revenue totaled $55.7 million or 80.5% of totaled revenue. While licensing revenue totaled $15.5 million or 19.5% of total first quarter revenue.

I would also like to point out that our first quarter results include our acquisition of sci-worx, now Silicon Germany, Silicon Image Germany that occurred in early January. In Q1 Silicon Image Germany provided $4.1 million of product and licensing revenues.

For the first quarter CE, our consumer electronics revenue including licensing accounted for $49 million or 70.9% of our total revenues of the first quarter. PC revenue including licensing represented $11.1 million or 16.1% of our total revenue in that period.

And storage including licensing accounted for $9 million or 13% of total first quarter revenue.

First quarter 2007 unit shipments increased approximately to 22.2 million units or 35% over the same quarter of 2006, and declined less then 1% from the prior quarter. Q1 typically is a seasonally soft quarter, where we see our largest ASP pressures. Just as we did in Q1 2006 we experienced a 15% sequential decline in ASPs, during the March quarter of 2007.

As a point of reference, Q1 2007 declined 22% over the same quarter of 2006 on a year-over-year basis. Increased competition on older products and higher sales of lower-priced HDMI switches contributed to this overall ASP decline in Q1 of 2007.

As we increased our percentage of HDMI 1.3 shipments and begin shipping our integrated input processors in Q2, we anticipate there will be a moderate impact on ASPs.

Now lets turn to our overall product gross margins in the first quarter. Our overall gross margins on a GAAP basis were 55.5% for the first quarter. Excluding stock compensation our non-GAAP overall gross margins were 56% for the quarter.

First quarter GAAP product gross margins were 49.5%, due in part to the issues I just mentioned about ASPs. On a non-GAAP basis after adjusting for stock compensation, first quarter product gross margins were 50.2%.

Turning to operating expenses, Q1 results reflect a very tight expense management as we added the Silicon Image, Germany personnel. Our GAAP operating expense for the first quarter of 2007 totaled $35 million, or 50.6% of total revenue in the first quarter. Our non-GAAP operating expenses in the first quarter of 2007 were $30.7 million or 44.3% of total revenue, in line with out guidance of $30 million to $32 million.

Our operating performance metrics as noted on 5/3, the GAAP operating margin was $3.4 million or 4.9% of total revenue for the first quarter. Our non-GAAP operating margin was $8.1 million or 11.7% of total revenue for the first quarter.

Another metric we think is important to monitor our progress is earnings before interest, taxes, depreciation and amortization or EBITDA. EBITDA for the first quarter of 2007 was $9.3 million. Excluding stock compensation expense of approximately $4 million, adjusted EBITDA was $13.3 million.

Let me add a few words about taxes. As you know, Silicon Image is making an investment in its global expansion strategy. A consequence of that is that in this quarter and in the next few quarters, we will be paying incremental tax. This increment is a fixed amount regardless of profitability.

Our tax provision is basically what we would have paid based upon profitability plus this increment. So this quarter the increment was about a $1 million. And we expect the same in the second quarter. For those of you with models, you have to forecast our tax provision and then compute the resulting tax rates.

We turn into the slide, the GAAP net income for the first quarter of 2007 was $2.9 million or $0.03 per diluted share and non-GAAP net income for the first quarter of 2007 was $6.3 million or $0.07 per diluted share.

I will now make a few comments on the balance sheet and cash flow statement. Our cash and short-term investments remained a healthy $224 million or $2.50 per diluted share at the end of the first quarter of 2007. This is a decline from the $250 million at the end of 2006 and this decline from those levels was primarily related to a $15.5 million tax payments for 2006 and estimated 2007 $13.6 million in net cash compensation for sci-worx and a $10 million payment for the Sunplus license.

Regarding our previously announced $100 million stock buyback authorization we have not yet initiated that activity because of trading window considerations. We expect to be free to enter the market as soon as next week on the company’s trading window we offer.

Net accounts receivable were $33.2 million at the end of the first quarter. Our DSO metrics were 43 days for that quarter.

Inventory decline sequentially to $24.6 million just below the $25 million level that we had targeted on our last conference call as our goal for the end of the second quarter.

Our annualized inventory returns for the first quarter were 4.8 times. And depreciation and amortization expense for property plans and equipments and intangible assets were $2.3 million for the first quarter of 2007.

This concludes our prepared remarks and we would like to open up the call for your questions. Operator?

Question-and-Answer session

(Operator Instruction) We’ll go first to Tayyib Shah with Longbow Research.

Tayyib Shah - Longbow Research

Hi, guys. First question on the margins, I mean over the last few quarter we've been seen a decline. Should we think about the low 50% range as sustainable level for your margins going forward?

Bob Freeman

Well, I think in this particular year we’re transitioning from the more legacy product to our new products. But I think as we see some improvement and the continued growth in the 1.3 introductions and on the input processors I would have expectations because of a higher ASPs in results margins growth.

Tayyib Shah - Longbow Research

Okay. And licensing revenue, you are seeing a dip here. We have seen a couple of announcements out of Trident and Genesis that they are using somebody else’s IP for 1.3. And I guess the rare case here is that since you are not licensing 1.3, anybody who wants to have an integrated solutions is going to use somebody else’s IP, and your licensing revenues will fall off in 2008. If you can help us understand where most of your IP revenue is coming from right now and why that will be sustainable in 2008, that could be very helpful.

Bob Freeman

First of all it’s not true to that we are not licensing HDMI 1.3, we are just being very selective in the way that we are doing that. The licensing revenue that we are seeing today is split between CE in stored with CE probably being almost two-third of the licensing revenue.

Bare in mind that we are getting royalties off the standard as well as, you know the annual subscription fee. And we actually have quite a bit of activity along several dimensions for new geometries along both old and new HDMI implementations. It’s just the market gotten very, very large now, and its gone beyond our ability to satisfy everybody’s need for support on an integration project.

Steve Tirado

We also picked up some licensing revenue in our silicon image Germany too as well. So, they generated licensing revenue on some their particular product lines, then added to that, and we also benefited from being able to recognize some deferred revenues this quarter that have been sitting on the balance sheet.

Bob Freeman

We think for the year, you know, we usually tell people we will be about 10% to 15% of revenue for the year. This year will be no different. In fact, we actually might even be a little bit higher i.e. little bit closer to the 15% rather than 10%.

Tayyib Shah - Longbow Research

Okay. And then the next generation HDMI standard you talked about that standard are just in mobile devices in a major way, what could be so compelling about that from a DV OEM perspective that they will begin to choose it over 1.3 for the 2008 timeframe, because you are able to leverage and monetize the chip to 10 ADP revolution, by rolling out deep color at 10 ADP, but if the HD standard remains less than ADP is there room to add more compelling features in the standard?

Bob Freeman

We think so, we have had tremendous enquires from the, and evident movement towards more and more content going on to mobile devices, that’s pretty high quality and I think the biggest market obviously, the handset market that shown a lot of interest. And in order to accommodate those folks we need to have an ability to get down you know lower number of pins and there is some changes, we going to have to make in order to accommodate them in a really good way. You have to bear in mind also that many of the CE companies we sell through who had TBs, also sell mobile products like cameras and camcorders for medium players.

So, you know we are in a market that really values differentiation and innovation and really doesn’t want us to get the beat with respect to any trend they see in the market. So, I can assure you that there is a great deal of interest in this and that we fully expect to get there with new verification, hopefully for the end of this year.

Tayyib Shah - Longbow Research

And finally what give you confidence that you will be able to hit that $325 million, $245 million number for the full year. I mean what sort of visibility do you have in the second half?

Bob Freeman

Yeah, it’s really just our best estimate of where we are relative to the sockets that we’ve won. So, I don’t know how much more I can tell you. I mean our visibility is limited in terms of the -- you know what actually happened in future quarter, the only thing I do know is, is I know where the socket wins are.

And so since we are in all the major top tier guys in many of their high volume platforms you think that it’s a reasonable estimate.

Tayyib Shah - Longbow Research

Thank you guys.

Bob Freeman

You’re welcome.

Operator

We’ll hear next from Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Yes, thank you. Then some more questions on the gross margin. So you said non-GAAP product for the gross margin was 50.2%. How is that likely to trend over September and for the rest of the year?

Bob Freeman

Well, what’s going to happen, there’s going to be a moderating effect of the new product hitting the mix. So, we did about 25%, HDMI won about 3 in the CE bucket, we think that number is going to move up to cover that 50% of shipments in Q2. And so that tends to have an uplift with respect to margins.

You know we’ve always talked about 50% to 55% as the range in which our products will live. We think it will stay there. I think the question earlier was, they are going to be at the lower end of that. It looks that way right now, that will probably be in the closer to 50 and 55, but again depending on how far the new product go, to the extent we can move the dial even higher than 50% we might see a little bit better improvement.

Mahesh Sanganeria - RBC Capital Markets

And so will the gross margins on input processors is better than HDMI 1.3. Will that be a good assumption?

Bob Freeman

No, I mean most of our stuff we target in the 50% to 55% range. And so you know these new products are also similar in their margin characteristic.

Mahesh Sanganeria - RBC Capital Markets

And you are saying on the licensing there is a dip in Q2 and then it recovers in Q3, Q4 because you said 50% of your revenues will be licensing. How should we model the licensing revenue? Just give some ideas.

Bob Freeman

Well you know we take 10 to 15 probably you pick the middle point you’re okay. We might be a little better than that this year. We had a tremendous year last year because we did almost $45 million in licensing, but 10 of that remember came from the one time Genesis settlement. But, nevertheless we think that the 10 to 15 if you pick the middle point, I think you are in good shape.

Mahesh Sanganeria - RBC Capital Markets

But how, is there going to be a large variability quarter-to-quarter or flattish?

Bob Freeman

Well I think we were like I said we were benefited by a couple of things in Q1, but basically the new implementations that we do, we do on a percentage completion basis and so we might have to sign contracts, but we may have to spread that revenue recognition over several quarters.

Steve Tirado

The other moderating impact is when you get into Q2, Q3, Q4 that’s when those larger volume of product shipments goes out. So we tend to get more royalty revenue on the HDMI standard.

Mahesh Sanganeria - RBC Capital Markets

On the sci-worx revenue 4.1, is that more on the product revenue or the licensing revenue?

Bob Freeman

It’s mostly licensing.

Mahesh Sanganeria - RBC Capital Markets

Mostly licensing.

Steve Tirado

Yeah. It was less than $1 million in products. Then these are just some sort of the spring up boards that they have been selling. I think the important thing though to note that on the sci-worx side we are fazing a lot of engineers over on the product programs just because the ROI and their time is better spent that way. So, we’re not expecting to see, that much contribution from those products in terms of licensing revenue as we get into the latter part of the year.

Mahesh Sanganeria - RBC Capital Markets

But on the sci-worx your licensing revenue is not really 100% right, you have some cost associated with that because you have engineers working on those licensing projects?

Bob Freeman

Very good point, yeah. They basically loaded their labor into the, because they were a pure IT company. The reason our calculation is different is because we derive a lot of the license products out of the R&D for the product. So, it doesn’t hit the margin line, it just hit the OpEx line.

Mahesh Sanganeria - RBC Capital Markets

There’s one quick question on taxes now. You said we can take your statutory tax rate close to 40% and then add $1 million to that and that’s a good way to model that -- taxes?

Bob Freeman

Yes.

Mahesh Sanganeria - RBC Capital Markets

So, the question I have. Why don’t you pro forma that $1 million out, because that’s something your making a payment on your future lower taxes rates, and so that’s not your -- that’s not ideal tax rate, that shouldn’t be accorded towards this years -- this quarters taxes?

Bob Freeman

Yeah, we can discuss that kind of client, but essentially in terms of computing the thing, I don’t want to focus in on the rates. I think basically, we need to -- because the rates are affected by the profitability.

So, I think the better way to look at it, is what’s your provision on your tax expense. And then to that you have this additional amount.

Mahesh Sanganeria - RBC Capital Markets

And so your cash cost is the pro forma amount or the GAA. I mean you have the pro forma tax amount and GAAP tax amount those are likely $1.2 million, so which one are repaying cash, the pro forma numbers?

Bob Freeman

Like I said, I don’t want to get into the detail of that. I’ll be happy to work with you in terms of understanding.

Mahesh Sanganeria - RBC Capital Markets

Okay. All right. Thank you. Thank you Bob, that’s all I have.

Bob Freeman

Sure, thank you.

Operator

We’ll hear next from Jason Pflaum with Thomas Weisel.

Jason Pflaum - Thomas Weisel Partners

Yes, good afternoon guys.

Bob Freeman

Good afternoon.

Jason Pflaum - Thomas Weisel Partners

So, just I guess two quick questions here. On the input processor side, you mentioned that you’d be shifting into a top tier starting this quarter. Are there other customers that you’ve engaged with and will be entering the mix in the second half or is it just that one this year?

Steve Tirado

No, we’ve got potential for probably one other account, but it will mainly be that first stock tier guy. We’ve got two products out there -- we’ll have two products out this year. We’ve got in the production with the first one will begin sampling the second one in the summer timeframe and that will really start to hit 2008 revenue.

Jason Pflaum - Thomas Weisel Partners

Okay. And I think you mentioned initial PL of 600,000, is that…

Steve Tirado

That’s correct.

Jason Pflaum - Thomas Weisel Partners

Is that -- think of that as the full year opportunity for you guys, as a starting point or?

Steve Tirado

It’s a starting point, it will be much more than that.

Jason Pflaum - Thomas Weisel Partners

This year or…

Steve Tirado

This year, yeah, for that one top tier, this is the first order.

Jason Pflaum - Thomas Weisel Partners

Got you. And then just a last question, just -- if you can just discuss the pricing environment that you’re seeing on some of the 1.1, 1.2 part. It seems like you’re probably seeing acceleration in pricing pressure there. I am just curious to hear your thoughts there?

Steve Tirado

Yeah, there is. There are definitely more competitors in that 1.1, 1.2 space, which is why we got our strategy geared around the full 1.3 product line is here. So, pricing is aggressive. If you had asked me on the TX side you are seeing prices in the you know the $1.50 to $2.50 range and then on receiver side, it’s lower now then even $2 and maybe $2.50, some I maybe $1.50 kind of similar range on the HDMI 1.2 and below product.

Jason Pflaum - Thomas Weisel Partners

Okay. So, what you see, it’s a pretty dramatic shift towards 1.3 here in Q2?

Steve Tirado

Correct.

Jason Pflaum - Thomas Weisel Partners

Were they been overwhelmed by the price and interesting on some of the legacy stuff?

Steve Tirado

Yeah. I mean that’s just allowing the blended rate to be, remain in that 50 to 55% capital range. We’ve pretty much the exclusive supply for 1.3 chip this year.

Jason Pflaum - Thomas Weisel Partners

Okay. And do you expect to see any competition to 1.3 in the back half of this year?

Steve Tirado

Well, there are a lot of -- there’ve been lot of announcement about product being available. We haven’t seen anything yet, but I suspect that by the end of the year, we’ll start to see the new 1.3 products from competitors coming out.

Jason Pflaum - Thomas Weisel Partners

Okay.

Steve Tirado

It’s a little late because for 2008 we’re starting to have a lot of pretty serious discussions about 2008 already. So, we’ll see how this goes.

Jason Pflaum - Thomas Weisel Partners

Sure. Great. Thanks guys, good luck.

Steve Tirado

Thank you

Operator

(Operator Instructions) We’ll go next to Adam Benjamin with Jefferies & Co.

Adam Benjamin - Jefferies & Co.

Thanks guys, good afternoon.

Bob Freeman

Good afternoon.

Adam Benjamin - Jefferies & Co.

Steve, did you mentioned 1.3 percentages revenue in Q4?

Steve Tirado

No.

Adam Benjamin - Jefferies & Co.

Okay. But we should assume it was less than 25%?

Steve Tirado

In the Q4 of ’06?

Adam Benjamin - Jefferies & Co.

Yeah.

Steve Tirado

I didn’t out break out percentage at that point, it was definitely less than 25%.

Adam Benjamin - Jefferies & Co.

Okay. So we should -- maybe like 10% level is that fair?

Steve Tirado

Adam, I’ll be happy to go check that I don’t have that one at the tip of my fingers.

Adam Benjamin - Jefferies & Co.

Okay. I guess I was just trying to drill down a little bit more and understand the mix and how that plays in the gross margin so you have seen your mix shift towards 1.3 and then you’re going to see a mix shift again to about 50% you CE revenue instead of 1.3 in Q2 your gross margin guidance is lower than when you were in Q1 and obviously that’s due to some of the license mix away I guess but…

Steve Tirado

Your license has pretty heavy impact on the total gross margin.

Adam Benjamin - Jefferies & Co.

Okay. So can you talk about just your product gross margin and from the mix from Q1 to Q2 is that offer that flattish?

Steve Tirado

We didn’t expect the product gross margin to be probably a little bit up relative to this quarter.

Bob Freeman

We’re still working through. Remember, I think, we discussed over the last couple of quarters that for a couple of our product lines, we were have we were buying the product from outside vendor and that will continue into the Q2 but then that should be the end of it.

Steve Tirado

And the other thing is the product revenue is going to be up close to 20% quarter-to-quarter

Adam Benjamin - Jefferies & Co.

Okay.

Steve Tirado

Overall product revenue. So that growth has been driven by 1.3 pretty hard.

Adam Benjamin - Jefferies & Co.

Okay. And where do you think you finish the year Steve for 1.3 as a percentage CE.

Steve Tirado

We think that we’ll probably get pretty darned close to averaging for the year for CE about maybe a little bit less than 50% of total CE revenue comes from1.3

Adam Benjamin - Jefferies & Co.

Got you. And then just a follow-up on your largest customer there or your gaming customer, you obviously have a lower expectations for that, how conservative are you being in terms of your full year guidance and breaking that in?

Are you being conservative or do you think there is more risk to that?

Steve Tirado

You know, I think we’re being realistic. With respect to what will happen, I think the expectation was pretty high on the part of our customer. It would not surprise me that something happens latter in the year in order to get more aggressive with their platform but at this point in time there is nothing more I can give you in terms of information related to that.

Adam Benjamin - Jefferies & Co.

That’s all I have guys. Thanks.

Steve Tirado

Thank you.

Operator

We’ll go now to American Tech Research, Jeff Schreiner.

Jeff Schreiner - American Technology Research

Good afternoon gentlemen.

Steve Tirado

Hi, Jeff.

Jeff Schreiner - American Technology Research

I was wondering if you could talk a little bit about the HDMI 1.3 and the margin impact, I guess sticking with the group here. And how the company sees the impact in terms of contribution from HDMI 1.3 this year?

If we’re already seeing 25% shipment in this quarter, moving to a larger number next quarter and as the move in each quarter significantly larger, obviously there is licensing impacting Q2, should we start to see a lot more by the time of Q3 of a 1.3 impact, because otherwise when we see the competition start coming on in the back half, which you discussed earlier, you didn’t really rod the benefit factor that you may have, by this new 1.3 offering?

Steve Tirado

No, the stocking decisions are already made. For 2007, I don't see any impact from competitors.

Jeff Schreiner - American Technology Research

Okay.

Steve Tirado

It’s too late, I mean these guys are going in the mass production now and order new TV. If you are not even sampling your 1.3 chips there is absolutely no way you can get on a platform.

So, the battle really now is for 2008 and then it becomes the question of how does our product lines stack up against competitor product line, which is why we work really hard to get the integrated, the input profits are aligned together on top of preparing ourselves and beginning to work on some of the mobile capabilities that we think will be important going into next year.

Jeff Schreiner - American Technology Research

Okay. So, you feel very comfortable that as we ramp away from the legacy product and HDMI 1.3 this year or later in the year becomes your larger portion of your shipment that we should start to seen that reflecting within your gross margin line?

Steve Tirado

Yeah, but I don't want you guys to expect too much from that. I mean, it’s also true that is a highly competitive 1.1, 1.2 we owned and so tends to drag it down a little bit.

What I do believe is we’ll stay in our 50% to55% range, probably at the lower end of that, as we continue to defend market share on the older side and of course we’re very much helped by the 1.3 sales as they become a larger percentage of our total sales.

Jeff Schreiner - American Technology Research

Okay. Do you happen to have any insight into the amounts of units that HDMI shipped in Q1 ’07?

Steve Tirado

I think Bob broke our total units, is that right Bob?

Bob Freeman

Yeah.

Steve Tirado

We have to get back to you on that one.

Jeff Schreiner - American Technology Research

Okay, fair enough. Just trying to move to a little bit legal here, you know, some individuals brought up and obviously there is going to lot of hoop lot of around comments from customers and possibly now former customers in some arenas relating to the use of your force and licensing and what have?

There has been talked to the certain company that you are in litigation with, its whom, others are now choosing 1.3. What legal strategy is the company looking to employ regarding company’s who choose to use? IP from the company you are currently in litigation with?

And are there indemnification agreements in place from software licensing agreements with the tech companies we are currently using that product. Even though you feel your IP or the other claims have been violet?

Steve Tirado

I’m going to let our Chief Legal Counsel answer that, Edward Lopez.

Edward Lopez

Hi. This is Ed Lopez. First in respect to the company that were in litigation with Analogic the case against MS looking forward were entering into the discovery space with the litigation and we look to be entering into the pretrial motions phase later in (inaudible) and then we'll move on from there into next year.

With respect to the reserve people who we feel maybe using our software license agreement, we need to address those situations on a case-by-case basis. But the focus of our attention right now is moving forward with our litigation against Analogic.

Jeff Schreiner - American Technology Research

Okay. Thank you very much. I mean, that’s all for now.

Edward Lopez

Thank you.

Operator

We will hear now from Daniel Gelbtuch with CIBC.

Steve Tirado

Go ahead Daniel, are you there?

Operator

Daniel your line is open. Hearing no response. We’ll move on to Scott Hirleman with Robert Baird.

Scott Hirleman - Robert W. Baird

Hi, guys. This is Scott Hirleman calling in for Tristan Gerra. I was just wondering, if you could give me a little bit of visibility into kind of your operating model exiting the year, are we going to see any kind of an R&D increase with the increase in revenues especially from the sci-worx engineers?

Steve Tirado

No, I don’t see anything unusual happening with respect to R&D expenses. I think the big goal we took was in doing this sci-worx acquisition. It was kind of -- I think I have might have said or maybe haven’t but it was like hiring about a year to year and half worth of R&D talent in one group. So we’re going to just work on driving topline and bottom line improvements and try to hold our expenses pretty flat.

Scott Hirleman - Robert W. Baird

Okay. So when I’m looking at as a percent of revenues to more as just kind of a…

Steve Tirado

No, no.

Bob Freeman

I think our percentage revenue and our R&D is technically in the 17, 18% range, a little bit higher this year initially because of sci-worx but as the revenues picked up that’s essentially we’re going to wind up.

Steve Tirado

Yeah, we feel a pretty well staff there to go after the price we have outlined for next couple of years and we’re going to really work on driving topline and bottom line numbers as we hold the expenses constant.

Scott Hirleman - Robert W. Baird

Okay. Its great. And then I was kind of wondering if you could us a little bit of visibility not like an exact number but a little bit of visibility into the customers that are currently for their 2007 designs and maybe for the 2008 designs that are going to be using your 1.3 chips, how many of them were actually using your 1.2 chips, kind of trying to get an idea of how long of a timeframe it takes to force someone can integrate the 1.3 IP into the round kind of solutions?

Steve Tirado

Well, I would say that almost all of those customers were previous customers. One of the reasons the top tier guidance and I think sixth grade customers of us is that they know what kind of quality we’re putting into the product and we talk about this all the time but I think its going to become a more dominant being as a market gets larger and that is they want to make sure they’ve got very good interoperability between all their product because we’ve got such a large market share. And you know they know with a pretty high degree of confidence that they’re going to get good interoperability with Silicon Image product. And for the top tier guys, you know to take a little bit of a discount on an unknown or unproven core and/or product is a big deal. So the second part of your question was how long before they integrate, I think, one of the points I keep trying to get across is that the rate of innovation in the standard is such that it's very difficult for them to keep pace, and these large integrated video processors take at least 12 to 18 months to get done, and so it's very tough. Because people want a lot of pork, they want to make sure the interoperability is really solid; they're looking for all the bells and whistles.

When we put the spec out, for example HDMI 1.3, there are many people who did not implement all of the spec. We're one of the companies that gives you a broad product line, allowing you to pick a chip that has everything in it or some select parts in it, because we segment the market. So there's some things we're doing that probably aren't painfully obvious. Everyone says, well if it’s HDMI, its HDMI. The truth is even within a particular release there are differences.

Scott Hirleman - Robert W. Baird

Okay, that's great. And then I was kind of also wondering how you feel about display port down the road, it's also targeting at a 10 bit kind of video transfer rate. I was wondering do you see that as only being in kind of the PC space, or how do you see that kind of coming into the CE space and how that competes with HDMI going forward.

Steve Tirado

The only way I know how to answer that is to say what would compel the CE market to adopt another digital interface? And I don't know that, I don't see yet why they would want to add another visual interface like display port. Because they have to do HDMI now, there are over 100 million products out there with HDMI. It is a dominant interface now; it's not going to go away.

So then the question is would they add another, and unless there's a compelling reason to do so, I just don't see the CE market embracing display port. Now the PCE market's a different story. I think the DVI interface is basically going to transition.

But here's the other dilemma I see in the PC space, a lot of the PC companies that I talk to are telling me they must do HDMI. And so now you're going to have, unfortunately for the PC guys, probably a VGA an HDMI and a display port connector. So I'm just not sure this all makes sense yet. We're going to have to wait and see how the display port crowd does going forward.

Scott Hirleman - Robert W. Baird

Okay, great. That's all I've got. Thanks.

Steve Tirado

Thank you.

Operator

(Operator Instructions) Gentlemen there appear to be no further questions; I'll turn the conference back to you for closing remarks.

Steve Tirado

Thank you operator. Before wrapping up the call let me recap several important points. HDMI continues to gain traction; industry analysts project that HDMI enabled devices will more than double this year to over 130 million.

Silicon Image is well positioned with virtually all the top tier CE OEMs. We're excited about our current product line up and customer interest we see for our industry leading HDMI 1.3 chip, and initial orders we have for our front end integrated input processor.

Through our Simplay Labs unit we continue to distinguish our reputation as the industry leader in reliability, quality and innovative components that support true interoperability. Our product and technology roadmap clearly addresses the challenges and opportunities we face from commoditization and integration.

I am looking forward to reporting to you our progress over the coming quarters in years of our work in designing lower cost products, driving new standards in that, innovating ahead of our competitors and being an integrator ourselves, initially with input processors and longer term with industry leading video processing SoCs.

Finally with the additional resources in IP we acquired earlier this year, we now have I believe the IP development channel and products strategy in place, to grow the company, and drive the architecture and implementation of the storage, distribution and presentation of Hi-Def content in the HD connected home and mobile environment.

David Allen

Thank you, Steve.

In addition to the slides for those on the webcast, for viewing, there will be additional slides posted on the website for those who are on the phone call and didn’t see them. Those will up a little later this afternoon. Those additional slides are relating to income statement, GAAP and non-GAAP reconciliation, balance sheet and a couple of slides on revenue sources.

That concludes our call today and once again, I want to thank you for your interest in Silicon Image and have a great day.

Operator

That does conclude today's conference. You may now disconnect. Have a pleasant day.

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Source: Silicon Image Q1 2007 Earnings Call Transcript
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