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Silicon Image, Inc. (NASDAQ:SIMG)

Q4 2007 Earnings Call

February 7, 2008 5:00 pm ET

Executives

David Allen - Director of Investor Relations

Steve Tirado - President and CEO

Harold Covert - Chief Financial Officer

Analysts

Sukhi Nagesh - Deutsche Bank

Tayyib Shah - Longbow Research

Heidi Poon - Thomas Weisel Partners

Adam Benjamin - Jefferies & Co.

James Schneider - Goldman, Sachs & Co.

[Irv Chen] - [inaudible]

Analyst for Mahesh Sanganeria - RBC Capital Markets

Operator

Good day everyone and welcome to Silicon Images fourth quarter and full year 2007 financial results conference call. Please note that today’s call and question and answer session are being recorded. At this time I would like to turn the call over to Mr. David Allen for opening remarks. Mr. Allen, please go ahead.

David Allen

Good afternoon and welcome to Silicon Images fourth quarter 2007 financial results conference call. I am Dave Allen, Silicon Images’ Director of Investor Relations. Joining me today are Steve Tirado, the company's President and CEO, and Hal Covert, our Chief Financial Officer. The agenda for today's call includes a discussion of annual highlights from our CEO, a more in depth discussion of our financial results for the fourth quarter, and our guidance for Q1 '08 and for the full year 2008 by our CFO, and finally some comments regarding our company strategy for 2008 from our CEO. We will then open the call for Q&A.

Before I turn the call over to Steve 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 markets in which we operate including but not limited to, forward looking statements about our future products and the timing of new products, design wins, market demands, financial results and performance. Actual results may differ materially from our forward looking statements. Moreover, forward looking statements and the companies future results are subject to certain 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 form 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 will be posting a financial metrics table and have posted reconciliation of non-GAAP financial information to the directly comparable GAAP information in our fourth quarter 2007 financial results press release which is available on the Investor Relations section of our website, siliconimages.com. I will now turn the call over to Steve Tirado. Steve.

Steve Tirado

Thank you Dave, and good afternoon everyone. I'm going to start by covering the annual results in my opening remarks and characterize key highlights for the year. Hal will provide the quarterly performance results and more detail on the year, as well as our financial outlook for 2008. All my comments will be on a non-GAAP basis.

As I look back on 2007, we had initially expected a 20% to 25% growth rate. Our shortfall was a result of less demand for selected products in the game console, PC and storage markets, as well as a more competitive pricing environment for HDMI 1.2 and older products. As the market shifted to a stronger demand for HDMI 1.3 products, we were prepared with a full product line, which resulted in the improved product margins we are again experiencing this quarter and for all of 2007.

We also had been going through the process of integrating a lot of new intellectual property from the Sun Plus IP purchased in January of 2007 and organizing our newly expanded R&D organization of 140 engineers from our acquisition of SiWorks. The integration is now complete and I believe we are far better positioned to provide more innovations and integration across a new line of input processors as well as new products for mobile devices with our recently announce MHL or mobile high definition link products. We've also gained strong interest for new products underlying the personal entertainment network architecture which we will be rolling out into products this year for revenue in 2009.

While all of this has positioned us to do what is necessary to have better time to market across more segments with more complex products, it has also delayed several of our product developments in '07 for '08 revenue. As a consequence, we noted in our last call that revenue would be flat to slightly down for 2008, and today we will give full guidance for 2008. It is important to note that the changes we have gone through over the last 12 months are meant to allow Silicon Image to better differentiate its products and technology, while raising the barriers to competition with much better price performance for our customers.

I'll now turn to some comments about the quarter and 2007.

I'm pleased to report annual and quarterly revenue in line with our most recent guidance, complemented by better than expected gross margins and operating margins for the fourth quarter and full year for 2007.

Key highlights are as follows; number one, we achieved top line annual revenue of $313.8 million for 2007 versus $287.9 million for 2006, or a 9% growth over 2006, which followed an extraordinary 35.6% growth year over 2005.

Number two, overall gross margins came in at 56.6% for 2007 with product margins at 50.7%. Q4 product margins reached 53.4%. The mix of new products, complemented by product cost reductions and increased licensing revenue enabled our overall gross margins to remain in line with our long-term target range of 55% to 57%. As we look into 2008 we believe that both product and overall gross margins will be similar to 2007. This is largely because of our broad product line up for source side products in the CE market, where HDMI 1.3 and general utilization is growing. Penetration into new mobile devices like cameras, camcorders, and newly emerging personal media players, an expected surge in HDMI penetration on the PC, good cost management of our HDMI 1.3 product for DTVs, and an attractive product line of more highly integrated input processors designed at the right cost targets.

Number three, operating margins came in at 15% for 2007, within our long-term target model range of 15% to 20%. Our consumer electronics business including product and licensing revenue demonstrated strong growth through the year at $241 million which represented a 23.8% growth over the $194.7 million achieved in 2006. Consumer electronic sales represented 75.2 % of our total revenue. Licensing also produced strong growth for the year at over $50.8 million dollars representing a 35.4% growth over 2006. Our non CE sales which comprised of PC and storage products and licensing revenue limited our overall growth and declined 22.1% or $22.2 million dollars in 2007 from our 2006 level. Looking ahead we are accelerating investment in our consumer products where we see good long term potential. We are maintaining a moderate investment in PC and storage to maintain some diversification in our business. New segment opportunities in mobile devices, broadband conductivity for DVTs, and for almost any entertainment device you can imagine reflect the focus of our innovation and through development going forward. As we succeed in leading the connective device world for premium digital content storage, distribution and presentation, we expect that there will be potential opportunity in the PC and storage markets we have serviced over the last several years.

Number four, looking ahead to 2008, we expect to introduce 8 to 10 new products. These products are targeted as identified mobile device opportunities with major OEMs and the high end of the digital television market where advanced HTMI and other digital connectivity features are valued. These features include things like mobile connectivity, fast switching, power management and our well implemented software stack which allow customers to differentiate their products where margin preservation is most important. Digital connectivity features represent a rich area for innovation at Silicon Image but we’ve not stopped there. We have also worked hard to integrate analog features with state of the art performance to offer higher levels of integration and better price performance for our customers. We are uniquely focused on raising the bar for intelligent communication between and among devices and have been consistently been able to differentiate ourselves in the market. We are very encouraged by the reception we receive at CES 2008 for our input processors, mobile products and personal entertainment network architecture which will go into production later this year.

Number five, HGMI continues to strengthen in the consumer electronics market especially HGMI 1.3. We believe the average member of HGMI ports per television HDTV will likely increase from 2.5 to 3.5 in the 40 inch and above category by the end of 2008 while HGMI 1.3 will become main stream. At the end of the fourth quarter there were 758 HGMI adopters worldwide, an increase of approximately 39 adopters over the prior quarter and up from 543 adopters a year ago. While the HGMI standard did not add any new releases in 2007 we expect to advance the standard in 2008 with significant connectivity improvements that facilitate the movement of premium content within the home. These changes will bring a new set of products upgrade opportunity to Silicon Image and we are fully prepared to take advantage of it.

Number six, one very important part of Silicon Image's strategy in 2007 was to not only drive innovations, as we are with our mobile and personal entertainment architecture, but to offer better price performance for these innovations by integrating them into what we call an input processor. It is our belief that the rate of change in digital connectivity over the next several years cannot be addressed quickly enough by the video processor products in the market. It takes one to two generations of product development to get new digital connectivity features into their products.

By purchasing the Sun Plus IP and acquiring SiWorks, we positioned ourselves to intelligently partition the DTV into a front end input processor and a back end image processor, with the front end handling all the analog and digital connectivity important to the digital television and, very importantly, integrating new digital connectivity features one to two generations before they can be integrated into the video processor. This of course means that innovation and innovation acceptance is crucial to our business model. We believe that 2008 will be a productive design win year for the innovations that we have set to be embraced, both through the HGMI standard and through our own digital connectivity innovations. Our recently announced MHL or mobile high definition technology and products for the mobile device world have been well received, especially by high end cell phone makers and other mobile device companies focused on personal media players. Some OEMs who have businesses across the cell phone and DTV market see these new products as just way of differentiating and enhancing their value propositions for consumers in the market place. Likewise, our new personal entertainment technology and products that will get rolled out in 2008 have been well received by companies who now face the need to both screen premium content in a commodity network in the home in a wired or wireless fashion extending the rich and consistent user interface and do so in a cost effective manner. All of these technologies have been designed into various new products in 2008 to provide our customers a future-proof solution that differentiates us significantly in the market.

Number seven, as described in our press release today, Silicon Images Board of Directors has authorized an accelerated purchase of $62 million of Silicon Image stock over a 120 day period starting approximately on February 15, 2008. This will complete our previously announced $100 million buyback program announced earlier this year. They have also authorized, upon completion of the accelerated purchase program, a new stock repurchase program of up to $100 million over the subsequent three years. It is my, and the management team's goal, to make 2009 a banner year for Silicon Image, while we aggressively manage costs and design win traction in 2008. With that, I'll turn the call over to Hal for a financial update and forward guidance. Hal?

Harold Covert

Thanks Dave, good afternoon. I would like to cover three topics, highlights of our financial results for Q4 of ‘07 and the full year of 2007, our financial outlook for Q1 of ‘08, and some directional statements about our 2008 financial goals Before I discuss our financial results, I would like to provide a summary of how we recognize product revenue. For product sales we recognize revenue using two methods: for end users and distributors who do not have price protection or stock location rights, we recognize revenue upon shipment; and for distributors who do have these rights, we recognize revenue when products are sold to the end user. This lateral revenue recognition method is commonly referred to as a sell through method. We have historically, and will continue to, recognize product revenue using these two methods. However, due to improved business processes starting with Q407 and going forward, the company will recognize the third month of each quarters sell through revenue, in this case December in the same quarter. In the past there was a one-month delay in recognizing the third month of each quarters sell thought revenue as there was often not having the needed information from distributors and the related analysis to determine sell though for the month. Therefore, sell though revenue for the third month of each quarter was recognized in the following quarter. This one time change resulted in recognizing of sell through revenue in Q407 or $6.7 million dollars. There were no other changes in the methods that we used to recognize revenue.

Turning to our financial results unless otherwise indicated and gross margin, expense and earnings related items are reported on a non-GAAP basis which excludes stock based compensation and amortization of intangible assets and other discrete items. In addition revenue for 2007 does not include the $6.7 million for the one time change in recognition of distributed revenue and revenue for 2006 does not include $10.6 million in royalty revenue related to our settlement with Genesis that was recorded in December 2006. Revenue for Q407 was $78.6 million compared to $86.3 million for Q307 and $76.4 million for Q406. Product revenue for Q407 was $67.3 million, for Q307, $74.2 million, and Q406, $66.3 million. License revenue for the quarter was $11.3 million versus $12.1 million in Q307 and $10.1 million in Q406. Revenue for 2007 was $313.8 million compared to $287 million in 2006 or a 9.3% year over year increase. For 2007 product revenue was $263 million compared to $250.4 million for 2006, an increase of 5% while license revenue was $50.8 million representing an increase of 38.8% compared to $36.6 million in 2006.

Semiconductor sales for CE applications continued to draw product revenue and accounted for 75% of our total product revenue for Q407 and for the full year of 2007. Product gross margin for Q407 was 53.4% compared to 51.5% in Q307 and 51.3% in Q406. Total gross margins for Q407 was 59% versus 57% for Q307 and 56.9% for Q406. The improvement in gross margin in Q407 was due to more favorable product mix. Operating expenses for Q407 were $36 million compared to $32.4 million in Q307 and $29.9 million in Q406. The increase in operating expenses during Q407, when compared to Q307, is primarily due to R&D expense for tooling, marketing expense for trade shows, and G&A expense related to an accrual for potential employee compensation expense in 2007, which accounted for approximately $1.5 million of the total increase. On a year-over-year basis, the quarterly increase in expenses is essentially related to R&D as a result of the SiWorks acquisition in February, 2007. Headcount as of December 31st '07, was 635, compared to 617 as of September 30 '07 and 442 as of December 31st '06. The increase in headcount on a year-over-year basis essentially relates to the increase in R&D staff as a result of the SiWorks acquisition.

Operating profit for Q407 was $10.4 million or 13.2% of revenue versus $16.8 million or 19.5% for Q307 and $13.5 million or 17.7% for Q406. The decrease in operating profit sequentially is due to lower revenue and higher operating expenses partially offset by higher gross margin as a percent of revenue, while the decrease in operating profit year over year reflects higher revenue which was more than offset by higher R&D expenses related to the SiWorks acquisition. For Q407 other income was $2.8 million compared to $2.3 million for Q307 and $3 million for Q406. Non-GAAP net income for Q407 was $9.5 million or $0.11 per diluted share. For Q307 $8.3 million or $0.10 per diluted share and for Q406 $18.3 million or $0.21 per diluted share. The improvement in Q4 earnings for diluted share when compared to Q307 is primarily related to lower income tax expense while the unfavorable comparison of Q406 is due to higher R&D expense related to the SiWorks acquisition.

For 2007 our non-GAAP net income was $32.7 million or $0.37 per diluted share versus $67.2 million for 2006 or $0.77 per diluted share. The reduction in earnings per diluted share in 2007 is a result of higher income tax expense and operating expenses related to the SiWorks acquisition which was partially offset by improved revenue. GAAP net income for Q407 was $7.6 million or $0.09 per diluted share. For Q307, $4.1 million or $0.05 per diluted share and for Q406, $26.3 million or $0.29 per diluted share. The favorable comparison sequentially is primarily due to the one time change in distributor revenue recognition previously discussed, and lower income tax expense while the unfavorable comparison year over year is essentially due to the Genesis settlement that was recorded in December 2006. The one time change in distributor revenue recognition accounted for $0.03 in diluted share in Q407 while the Genesis settlement in Q406 accounted for $0.15 per diluted share. For 2007 GAAP net income was $19 million or $0.22 per diluted share versus $42.5 million for 2006 or $0.49 per diluted share. The unfavorable comparison for earning per share for 2007 when compared to 2006 is the result of the impact of the Genesis settlement recorded in December 2006, higher income tax expense and higher operating expenses related to the SiWorks acquisition in 2007 partially offset by improved revenue.

For 2007 our GAAP tax rate was approximately 51% compared to 25% for 2006. Stock based compensation which is not included in our non-GAAP net income was $4.9 million in Q407 compared to $5.3 million in Q307 and $4.8 million in Q406. For 2007 stock based compensation was $19.4 million versus $27.2 million in 2006. Diluted shares outstanding for Q407 were $85.2 million, for Q307 $85.9 million and Q406, $89.1 million.

Moving to the balance sheet, cash and investments as of December 31, 2007 were $249.7 million compared to $225.7 million as of September 30, 2007 and $250.6 million as of December 31, 2006. Capital expenses for Q407 were $3 million compared to $1.4 million for Q307 and $7.2 million for Q406. Net accounts receivable as of December 31, 2007 were $21.3 million which represents 22 days of sales outstanding. This compares to accounts receivable of $45.6 million on September 30, 2007 with 48 days of sales outstanding and $39.9 million of accounts receivable with 41 days of sales outstanding on December 31, 2006. The sequential annual year over year decrease in accounts receivable is a result of solid collections during the quarter. Going forward we expect that accounts receivable and days outstanding will resume the historical and target a level of 45 to 50 days starting with Q108.

Net inventory as of December 31, 2007 was $20.2 million which represents approximately 7 turns on an annualized basis. This compares to approximately 7 turns on September 30, 2007 and 6 turns on December 31, 2006.

Now I would like to discuss the companies common stock repurchase program. Since the inception of the companies 3 year $100 million dollar stock repurchase program that was announced in February 2007, Silicon Image has repurchased 5 million shares of common stock at an average price of $7.62 for a total of $38.1 million. During Q407 we did not repurchase any of our common stock. As Steve indicated earlier, as described in our press release today, our Board of Directors has authorized the company to move forward with an accelerated stock repurchase program. We are currently working with an investment banking firm in this regard and expect to enter into an agreement by the 15th of February.

The company anticipates repurchasing $62 million of its common stock over a period of up to 120 [inaudible] once this agreement is signed. When concluded, this accelerated stock repurchase program will complete the company's current stock option repurchase program. The Board also authorized a new stock repurchase program for the purchase of up to $100 million of our common stock over a three year period, beginning with the conclusion of the aforementioned accelerated program, on the terms and conditions described in our press release issued earlier today.

This completes the summary of our Q407 and full year financial results. There is a reconciliation of our GAAP to non-GAAP measures referenced in today's call on our website, www.siliconimage.com and one is also included with our press release issued earlier today.

Next I would like to provide some highlights related to our financial performance for Q108 and make some directional statements about selected financial goals for 2008. First for Q108, the company has targeted the following financial performance: revenue $61 million to $63 million, gross margin 55% to 57%, GAAP operating expenses $41 million to $42 million, non-GAAP expenses $34 million to $35 million, tax rate approximately 42% to 44%. GAAP operating expenses for Q108 include approximately $5 million dollars for stock based compensation and $2 million for amortization of intangible assets. These expenses are not included in the non-GAAP operating expenses.

Moving to 2008, this past December we completed our bottom up annual plan and budget. As we indicated during our Q307 investor conference call and on our analyst day event in New York City last November, 2008 will be a product transition year for Silicon Image.

As part of this transition, we plan to sample and subsequently announce a number of design wins throughout 2008. Volume shipments for the new products related to these design wins are projected to start occurring in the first half of 2009. There is some potential to generate revenue in the second half of 2008 from new products. However, at this point in time, it is too difficult to predict the level of such revenue with any degree of precision or certainty. Based on the situation just described, the following are directional statements related to our overall financial goals for 2008. Revenue is targeted to be in the range of $270 million to $290 million. Gross margin, as percent of revenue, is anticipated to be in the range of 55% to 57%. GAAP operating expenses are projected to be $166 million to $168 million, which includes stock-based compensation of approximately $22 million, and $6 million for the amortization of intangible assets.

These expenses are not included in the non-GAAP expenses. Non-GAAP operating expenses are projected in the range of $138 million to $140 million. Finally, a tax rate of approximately 42% to 44%. We will continue to update you during our quarterly investor conference calls on our progress as we work with customers to roll out new products. While our major focus is on successfully addressing our product transition in 2008 and entering 2009 with revenue generation momentum, we will continue to strive to achieve our gross margin goals, tightly control expenses inline with our operating plan and the economic environment, and drive cash flow from operations throughout 2008. This concludes my remarks. I will now turn the call over to Steve.

Steve Tirado

Thank you Hal. I believe this decade has only seen the first of 3 waves of digital conversion. The first was the move from analog to digital as the world’s TVs went flat and high definition. We were and are a pivotal part of that change in that Silicon Image provided the secure digital interface for premium content across an ever-expanding network of products in the consumer electronic and PC market. The second wave will revolve around mobile devices, particularly cell phones, which will provide a new channel for distribution for premium content and will require a whole new set of technologies for memory and digital conductivity. We have worked hard to offer innovation in these areas to our customers and expect to benefit from product sales over the next several years. As I have stated previously, cameras, camcorders, personal media players, in addition to cell phones, all support the move from a static to mobile world. Embraced by a generation of 18 to 34 year olds that want to be always connected, always entertained, and are fearless about the new technical choices that enable that life style.

Finally, the third wave will tie it all together as we enter into the era of the broadband connected digital television. In order to offer consumers an any source to any display world, significant advancement in networking, security and device discovery must be invented to make connections simple, transparent, secure, and beautiful. Over the last several years we have invested in technologies testing our ideas and now first generation implementations with strategic partners throughout the world. We believe we understand the complexity, necessity, cost, and business motivations for creating this wave of connectivity and have built our product strategy around bringing these capabilities to market. Through our input processors that grow and differentiate value relative to our competitors as the world goes mobile and connected. We believe we are uniquely qualified as a company to continue driving and benefiting from these three ways digital convergence which will likely consume the next decade. With that said, we would now like to open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will hear first from Sukhi Nagesh of Deutsche Bank.

Sukhi Nagesh - Deutsche Bank

Yes. Hi, thank you guys. Hal, did you do a breakdown by segments? I think I missed that. Could you go over that?

Harold Covert

We broke out the product and license. The best place to get that would actually be to go to our website and there will be a metrics page that lays it all out by product geography and so forth.

Sukhi Nagesh - Deutsche Bank

That is missing your fourth quarter numbers. I just checked it.

Harold Covert

It should be there within a very short period of time.

Sukhi Nagesh - Deutsche Bank

Okay, then just in terms of your HTMI 1.3 product this quarter, Steve, what was that as a percentage of total in your CE business?

Steve Tirado

For the year it is above 40% and it continues to increase and again as I think we have indicated on past calls that it is probably going to be coming pretty close to 100% of our shipments as we go into ‘08.

Sukhi Nagesh - Deutsche Bank

Okay, can you guys comment a little bit about pricing trends, what’s going on there and also maybe a little about the competitive landscape? Are there any changes there or how that is shaping up this year?

Steve Tirado

Actually our average selling prices were stable this quarter from Q3 and it is partially a result of the fact that we had some new product platforms we are getting into as well as increased 1.3 mixed effects. It has been recently stable on the pricing front. The competitive landscape really hasn’t changed much. While we are seeing greater number of integrated video processors claiming 1.3 support what we are finding in many cases, actually we are finding this on SOC’s both on source end and on the TV side, we have several customers who have decided not to use those for reasons that features, performance, and in some cases even some of the power management features we’ve integrated. So, the market is kind of shaken out in terms of what we think they are going to do in 2008 which was the basis for the guidance and what is going to be important for us obviously as I said in my prepared remarks, innovation is critical to our business model and the acceptance of those innovations is critical. The mobile high definition link and the work that we have done with the personal entertainment network architecture is really pivotal for us as we go into ‘08 and looking into ‘09.

Harold Covert

Just a quick follow up on the product break out. Roughly as in the past round 75% of our business was CE related, around 15% was personal computer, and the remaining 10% of our product revenue was storage. The split between license and product was roughly about 87% product and the balance license.

Sukhi Nagesh - Deutsche Bank

Got it, great, thank you. One last question I had, I think in the last earnings call you talked about you having to ship 300,000 input processors this quarter, was that roughly in line this quarter and how do you see that play out?

Harold Covert

We said a couple quarters ago that we expected to ship about 1.8 million input processors. We actually shipped out 1.9 million input processors for the full year.

Sukhi Nagesh - Deutsche Bank

And for ‘08, any estimates there or now?

Steve Tirado

Yes, I am not going to give an estimate today. Obviously we are deeply working with several customers. The one OEM platform that we had last year is going to continue into next year, into 2008. I think for the rest of the market we got a little late with our input processors, so it probably is not going to be a significant driveer beyond what we already currently have until 2009.

Sukhi Nagesh - Deutsche Bank

Okay, one last question I had for Hal. Hal, how should we look at OpEx going forward for ‘08 on a quarterly basis? I know that you gave guidance for March quarter but in terms the rest of the year.

Harold Covert

Our goal is, fundamentally, to keep OpEx flat as we head into next year, so for Q4 we were right around $36 million but $1.5 million of that included an accrual that we made that we don't expect to repeat. So we should bounce somewhere between $34 million to $35 million a quarter. Again holding a flat, actually being able to handle increases in the first quarter or second quarter for taxes and so forth, and still maintain a flat profile. As I indicated we're going to watch what goes on from an operating plan standpoint as well as the economic environment then we'll monitor expenses as we go through the year.

Steve Tirado

We are very committed to making sure that we adjust things as it relates to what we see in the market place and making sure the company remains profitable and cash flow positive.

Sukhi Nagesh - Deutsche Bank

Thank you.

Operator

We will now take our next question from Tayyib Shah with Longbow Research.

Tayyib Shah - Longbow Research

Hi guys. The first quarter revenue guidance is a bigger sequential decline that what we've seen in the last two years. Can you comment on how much of this is due to pricing pressure in HDMI products and to market share erosion?

Steve Tirado

It is the seasonal effect that we are seeing perhaps greater than in previous years but our analysis of prices, you know the products actually on an overall basis have been reasonably stable, which is why we are given gross margin guidance that we are giving. I don’t know how much of the decline is related to general conditions versus Silicon Image specific conditions. I don’t really believe from a market standpoint that we have changed much in terms of our position.

Harold Covert

May I just add also that the first half of the year we believe is going to be more difficult for us because of the product transition that we have talked about in the past and then our goal is to gain momentum in the second half of the year. Certainly if we can do it quicker then we will, but I think you are seeing some of the impact of the product transition in the first half of the year.

Tayyib Shah - Longbow Research

Okay. So the calendar '08 revenue guidance appears weaker than what we had been talking about previously which was flat to down revenues, now it's clearly in decline for 2008. What has changed in the last couple of months that led to this downward region? Was it more related to consumer demand patterns or is it more related to competitive issues?

Steve Tirado

I would say that nothing has really changed. When we gave that guidance on the Q3 call we had not completed our bottom up plan yet and we wanted to get the information out there at that point in time. I think we could have done a better job in giving a range instead of saying flat to down so the only thing that has really changed now is that we’ve completed our bottoms up plan. The bottoms up plan now ties directly with the guidance that we have given you, so there have been no changes from our outlook on the business or any operational aspects.

Tayyib Shah - Longbow Research

Okay, and then can you update us on the revenue trajectory for our mobile application? Given the new product you guys announced should we expect mobile applications to become a meaningful revenue driver this year, and should we see, and are we expecting to see the start of handset revenues in 2008?

Steve Tirado

Well, you know I can tell you from the small base that this will have very meaningful growth. I think in terms of making the claim that it has a meaningful impact on total revenue, I would say it probably does not. What we are seeing right now is that it is a fairly long selling cycle for a lot of these guys, especially the phone guys. It is pretty long. We do though however believe that we are going to see a lot more in the way of the camcorder, personal visual cameras. We have design wins that we have already identified and we are feeling good about it. If I was to say when I think it will get much more significant, it probably won’t be until 2009.

Tayyib Shah - Longbow Research

Steve, do expect some initial revenues from handsets this year?

Steve Tirado

It is possible. We have one OEM that is pretty excited and pretty interested. There is a possibility we could see something. I don’t think it will be ‘08, it might be either end of ‘08 or early ‘09, but this one OEM is pretty aggressive, who knows. They may decide to try to position something for their Christmas season. We are working with them and we are excited about that but I don’t want to build any expectations of anything around that yet. If it happens it will be a pleasant upside.

Tayyib Shah - Longbow Research

Okay, and one final question for me. When you were discussing margins for 2008 you cited a PC CMI [inaudible] and mobile devices supporting margins in 2008. Should we think that these products have higher than corporate margins at this point?

Steve Tirado

They actually do tend to be at the higher end of the range but the actual variance around it is not really that big. I don’t know how else to answer that.

Harold Covert

I think as Steve indicated, it does help hold up our margins at the corporate level that we set so I think he covered it. It has higher margins, it is balanced off by some declining margins on our older products.

Steve Tirado

Correct.

Tayyib Shah - Longbow Research

Thank you.

Steve Tirado

Thank you, Tayyib.

Operator

Our next question will come from Heidi Poon with Thomas Weisel Partners.

Heidi Poon - Thomas Weisel Partners

Hi guys. I just want a little bit more color on the 2008 forecast. Could you give us a break out between your assumption of unit versus ASP impact for the top line guidance?

Steve Tirado

I think in general at this point we don’t really have a lot more detail. Based on the analysis that we have done we believe that ASPs and cost reductions and the mix of new products and older products as we just talked about are going to position us to maintain the targeted margin of 55% to 57%. As we get more details as we roll into the year we will certainly provide that to you.

Heidi Poon - Thomas Weisel Partners

Can you give a sense of your assumption of price erosion for any of your products, the HGMI 1.3 given that your competitors already have designs in areas such as HDTV?

Steve Tirado

Somebody on the line has music playing.

Heidi Poon - Thomas Weisel Partners

Definitely not me

Steve Tirado

Okay, it is coming through. Okay, so you know our ASP decline is typically average about 4% to 5 % a quarter. That is about what we see, roughly about 20% to 25%. Last year was probably a little bit higher. It might have been in some quarters as high as on a run rate basis kind of 30%. We are not expecting to see a dramatic shift in ASP. In other words, erosion changes that we expect to see which are roughly in that range, somewhere between 4% to 6% per quarter. We have factored all that into our guidance. This year I think we didn’t get as many products out as we would have liked but we did a pretty job of figuring out how to get our costs positioned in the right place for the prices we needed to sell the products at in the market place. Yes, there is competition. We are still considered kind of the gold standard with respect to certainly anything discrete. With the introduction of MHL, which by the way we are building into several of the products we are offering in the market, it is a clear differentiator for us relative to anybody in the market.

Heidi Poon - Thomas Weisel Partners

Could you take a stab at what do you think your market share for HDMI 1.3 will be by the end of this year?

Steve Tirado

By the end of this 2008?

Heidi Poon - Thomas Weisel Partners

Right.

Steve Tirado

I know that for our sales coming out of this quarter we were up around 45% to 50% of our sales being HGMI.3 for the CE market and as I have said in my prepared remarks, I am expecting that number to drive close to 100% by the end of the year. With respect to the total market its... for just 1.3 I think we are probably for last year really, really high, for this year coming up obviously it is going to go down some. I don’t know, probably, if I had to take a guess, I would say somewhere around 60%.

Heidi Poon - Thomas Weisel Partners

Great, also just to go back to we have seen a lot of product focus right now for 2009 growth opportunity, so what metrics can we track in 2008 to see that progress.? I know you are going ship or introduce some products in the first half, but what would be sort of the catalyst? Are we going to see more design win use, maybe toward that?

Steve Tirado

I think there are three things, you got two of them. One would be product announcements, the second would be design win announcements, and the third will be any changes to the standards that get announced in the year. Those are the biggest catalysts that you can look toward to see how we are doing.

Heidi Poon - Thomas Weisel Partners

And the time frame will be throughout the year or…?

Steve Tirado

Yes, this is going to happen throughout the year, we think we have got some things that will happen in the first half. I don’t want to get myself into a particular date, I would just say throughout the year you will start to see these as we roll.

Heidi Poon - Thomas Weisel Partners

One last question since you guys have such a strong exposure to the consumer electronics sector. Do you see any pocket of inventory in the channel, and perhaps take a stab at Q2? Could we see some overhang from what is going on in the environment right now?

Steve Tirado

I would say in general that in the environment we are watching it just like everybody else is. We are concerned about it. We haven’t seen any major events or things that we could point to say that things are changing from our customer standpoint. From a channel inventory standpoint, we currently and always have monitored the channel inventory very closely. At this point in time I would say there is nothing dramatically out of line or things that would cause us to be overly concerned.

Harold Covert

Given a lot of the uncertainty you see reflected in news articles who knows what is going to happen but that is where we stand today and based on our back log visibility and bookings received we are pretty confident about Q1. We don’t see any problems there.

Heidi Poon - Thomas Weisel Partners

Thank you very much.

Harold Covert

You’re welcome.

Operator

We will go ahead and take our next question from Adam Benjamin with Jeffries.

Adam Benjamin - Jefferies & Co.

Thanks. I'm just trying to reconcile, Steve, some of your commentary with the reduced guidance. I mean, you brought the '08 guidance down by about 10%. And so you also talked about an increased attraction by some of your customers, to not use an integrated solution on HDMI. So, I'm trying to reconcile your reducing your forecast by about 10% versus commentary that the customers are still not going to the fully integrated solution and sticking with the discrete.

Steve Tirado

You know, with respect to the guidance, I don't think we actually -- we were probably too vague in the Q3 call. We said flat to down and we didn't specify and I know that, so shame on us. We probably should've been more specific but now that we've done a lot more work on next year, we believe this is a reasonable range. With respect to my comment regarding being able to get design wins where there is a discrete product, it is not across the board, there are video processors where the performance on the HGMI stuff is completely acceptable and in many of those cases we are just selling probably just a $1 switch in those designs. There is some impact from the integration of HGMI in the market. There is no question. What I think I would want you to take and kind of watch for this year is the extent to which we are able to get penetration with mobile high definition link technology and/or anything around the personal entertainment network. What that would indicate is that as we start to see some acceptance or design wins announced there that the integration of those technologies into our input processors and other products is gaining some attraction. One think I do know, the VTV guys do value innovation, they do digital input and they know that the video processing guys cannot keep pace with all this new stuff in the year that we’ll announce it whereas we can. So, it is our belief, and this is why we did the whole input processor architecture that the rate of change is going to be fairly high. Admittedly, it didn’t happen in ‘07 like we thought it would but we are pretty confident that in ‘08 we are going to see some not only changes in the standard but a lot more interest in some of this new technology we have introduced.

Adam Benjamin - Jefferies & Co.

Got ya. As you look out there, I mean pretty much for design wins that you are going to ship for ‘08, it is done for the input processor. It seems that you were saying that one design that you had that shipped in ‘07 would continue into ‘08 but that is probably all you are going to see in ‘08 in terms of revenue and then you will seek to get wins in ‘08 for ‘09 revenue for the other input processors. Is that right?

Steve Tirado

I think that is a fair comment, yes. And you know if by some chance we do get something incremental what I do know is that all the major volume platform designs they are done. They are not continued, however there is a mid year cycle that few of the OEMs have, there is a chance we can get into those, but those are much lower volume. What we really wanted to do was concentrate very hard on getting the ‘09 wins which that battle is occurring starting now. You have to be sampling products to get them into the ‘09 cycle.

Adam Benjamin - Jefferies & Co.

Right, so just as you look out at the ‘09 cycle. What is giving you confidence and that should give us confidence that you are actually going to get a lot of traction with the input processor? Given the dynamics with integrating SOCs and you see that trend continuing, we have seen it with other companies, it is increasing as you talk to TV OEM’s? How do you fight that tide and how do you actually get traction with the input processor?

Steve Tirado

So I think that, at least from an evidence standpoint, the only things you can look at are the three things I mentioned earlier; you know, product announcements, which would probably be on the pecking order, for you guys, the lowest one. But certainly, design win announcements and then any new releases of the standard. You would expect that we would be prepared with product lines that support all those new key capabilities. That would be a positive sign for Silicon Image. Okay?

Adam Benjamin - Jefferies & Co.

Great, thanks that is all I have guys.

Steve Tirado

Thank you Adam.

Operator

We will go ahead and take our next question from James Schneider at Goldman Sachs.

James Schneider - Goldman, Sachs & Co.

Hi, good afternoon. Just quickly on your Q1 guidance what does that imply in terms of how much of your revenue you expect to get from licensing?

Harold Covert

We believe that the historical patterns are probably going to stay pretty consistent so, somewhere again in the 85% to 86% range for product to balance from license.

James Schneider - Goldman, Sachs & Co.

Okay, great. Then in terms of the ASP expectation for the hardware units in Q1?

Harold Covert

What I said earlier was that we typically see about a 4% to 5% to 6% price erosion on a quarter to quarter basis. We are expecting things to be within those parameters as we go through the year.

James Schneider - Goldman, Sachs & Co.

Okay. Then if you look at the 3 segments, PC, storage, and consumer. Can you just rank those in terms of which one you expect to be down the most versus the least in Q1?

Steve Tirado

Down the least. Well, I don’t have that mapped right in front of me, but I would say that down the most would be CE because we are getting into the low point of the cycle. Down the least would probably be PC, storage would be next and CE would be third.

James Schneider - Goldman, Sachs & Co.

Great and then, just last, can you comment on kind of linearity of the bookings as you've gone through Q1 so far? And what your percent booked is for the quarter?

Steve Tirado

I don’t have that one either, but we had a very strong booking quarter coming out of 2007. Q4 was very, very strong and we are in the midst of Q1. We really did have an excellent booking quarter in Q4 and we had a very strong booking quarter in Q3. Now bear in mind that those bookings are typically distributed over a couple of quarters. There were good signs coming out of Q4, stronger than last year actually in terms of how we booked so that was a good sign. In Q1 we are just still in the middle of that.

Harold Covert

Keep in mind also that a large percentage of our revenue is recognized on sell to so it means that it is already basically out there in the channel. Based on the sell to reports that we have seen so far things look like it is moving along as we would have expected it to.

James Schneider - Goldman, Sachs & Co.

Okay, perfect, thanks much.

Steve Tirado

You are welcome

Operator

We will take our next question from [Irv Chen] with [inaudible].

Unidentified Analyst

Hi, how are you? The current HGMI 1.3 standard uses I think 340 megahertz of through put and I think that you guys don’t even offer a chip that that takes full advantage of that standard. Why would you be talking about moving to an even higher or next generation standard and when do you think the reality will be that the full standard is utilized?

Steve Tirado

We do have products in our line that do 340 megahertz. To your point many of the implementations out here don’t utilize that because with respect to deep color sources that would need that kind of bandwidth only the PlayStation 3 today is out there that could possibly take advantage of that. You know when you look at what could the next generation standard look like. Performance is not the only issue, i.e. bandwidth is not the only issue that we are looking at. We are looking at things like more intelligence within the link itself, being able to much more readily network the products, even if they are only in a single room, then also accommodating things like mobile devices. There is a notion in the standards group that we have to broaden out the capabilities of digital connection. As time marches on largely in response with what people want to do with products and what they want to plug into the television. It is not just a performance game. There are also interesting features that we are entertaining. A lot of that comes from companies that actually come to our meetings and say, hey, here is what we would like out of the standard.

Unidentified Analyst

What percentage of your shipments are the 340 megahertz and when do you expect that to be the bulk of the shipments?

Steve Tirado

I know for example the parts that we were shipping into the PlayStation last year are the high performance parts and we shipped many millions of those. What I would say is that probably even in 2008 there probably won’t be a large number of those other than what are going into that game console. It will take a little while and the main reason for that is that the deeper 10 bit content and the higher performance machines are still not out there in huge volume.

Unidentified Analyst

When do you think they will be and when will that become the reality when you walk into Best Buy and that is what you get?

Steve Tirado

If I was a betting man, you will probably start to see a little bit more of that this Christmas coming out. There will be a little bit more advertising around deep color capability etc. It will be just one of those things that will gradually increase over time. I think the key negating item is, when do you have content rendered in these high performance source devices out there? It is gong to take some time.

Unidentified Analyst

Thank you.

Steve Tirado

You’re welcome.

Operator

We will take our next question from Mahesh Sanganeria of RBC Capital Markets.

Analyst for Mahesh Sanganeria - RBC Capital Markets

This is [Sandeep Chansaka], calling in for Mahesh. The first question I had was regarding licensing growth in 2008. In 2007 you had strong growth with what seemed like quarter over quarter the licensing revenues have been declining. How should we monitor the licensing revenues moving forward?

Harold Covert

I think, as I indicated earlier, we believe that the percentages, in particular, going through 2008, are going to stay pretty consistent with the past patterns. So, the growth rate is going to slow down because we had kind of a banner year in 2007. But again, the overall split between product and license should be pretty consistent at around 85%, 15%; 85% product, 15% license.

Analyst for Mahesh Sanganeria - RBC Capital Markets

Okay, sounds good. Regarding your PC business how do you see the adoption of HGMI? Can you give some sort of number, like what percentage of PC do you expect to have as HGMI interface and what sort of a market share do you expect to have in that market?

Steve Tirado

Well, it's definitely growing. I don't know if you saw the new Mac Air that got introduced, but that has our chip in it. And we've actually announced a few different platforms but we think HDMI is going to start to go mainstream in the PC, starting in this year.

We know, from looking at our backlog, we got very strong order growth around the HDMI chips for the PC. So, we're excited about that. And I think that, you know, that's just going to be an ongoing trend for greater and greater desire to hook the -- you know more and more being positioned as an entertainment, you know, notebook, for example, into the television. And HDMI really is the way they're going to go do that. So, I don't have -- you know, if you're asking me for penetration, I'd probably have to quote something out of Gartner or Display Search; something like that. But I know, from looking at our backlog in business, we have really strong order flow for those parts now.

Analyst for Mahesh Sanganeria - RBC Capital Markets

Okay, is it possible that you might see growth in the PC sector for 2008?

Steve Tirado

It is possible, it’s possible

Analyst for Mahesh Sanganeria - RBC Capital Markets

Okay, when do you see threat from Integrated Products in the PC space?

Steve Tirado

Probably, that's going to start to surface around 2009, because Intel's plan is to integrate everything, you know, HDMI, DVI, Display Port, several interfaces in their Southbridge. But, we'll have to wait and see exactly how this plays out. We do believe that it'll have an impact but not until 2009. And so, what's required for us is to advance the mobile high definition link capability; build that into our products. And then also, the personal entertainment network technology. We're actually, surprisingly, finding there's interest on the PCs from some of the big PC OEMs and what we're doing there because they, very much, would like the media PC to be kind of the hub in the home. And so, having the capability of distributing content out of their device that will bear, you know, all the security issues and performance issues are handled is pretty interesting to them. So, it'll take an innovation for us to really grow in the PC market. And for us, that's what's critical. If it stagnates and people only want, let's say, HDMI 1.2 or low end 1.3 performance, then that's probably a negative for us.

Harold Covert

Operator, we will take one more question.

Operator

Certainly, our final question will be a follow up question from Tayyib Shah with Longbow.

Tayyib Shah - Longbow Research

Hi guys, Steve if I heard you correctly you talked about a 60% share in 2008. When you talk about that is that only from discrete products and how much share do you think you can get through your licensing in 2008?

Steve Tirado

Yes, that doesn’t include what is going on with licensing. That is if you look at the projection for 2008, I think it is somewhere around 300 million devices. That is my rough estimate of what kind of share we can have. I am not including in that the license fees. I would have to go back and see what that is but it will obviously drive it up.

Tayyib Shah - Longbow Research

Okay. And in the handset space, have you seen the OEM customers that you are approaching consider any competing IP vendor for the HDMI solution?

Steve Tirado

Well, there are competing IP vendors out there. But for the new things that we're talking about, like the mobile high def link, there's no alternative. So if they want to go with a reduced pin count interface and have a strategy for connecting into traditional HDMI, we have all the chip sets for that. They're already out there, we're selling them aggressively in the market place. So there aren't alternatives for that yet. And probably until, if and until it gets rolled into the big HDMI standard, it will take yet another period of time before you'll really see competitors out there. So that's my view on it today.

Tayyib Shah - Longbow Research

Thank you.

Steve Tirado

You're welcome.

Dave Allen

I want to thank everybody, and thank you operator. We'd like to remind listeners on the call that we'll be participating in the Goldman Sachs Technology Symposium on February 26. A webcast of that event will be accessible from www.siliconimage.com. This concludes today's call, and once again we'd want to thank you for your interest in Silicon Image, and hope you have a great day.

Operator

And that will conclude our conference. Again thank you all for your participation, we do hope that you enjoy the rest of your day.

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Source: Silicon Image, Inc. Q4 2007 Earnings Call Transcript

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