Silicon Image, Inc. Q2 2008 Earnings Call Transcript

Aug. 4.08 | About: Silicon Image, (SIMG)

Silicon Image, Inc. (NASDAQ:SIMG)

Q2 2008 Earnings Call Transcript

July 24, 2008 5:00 pm ET

Executives

David Allen – Director, IR

Steve Tirado – President and CEO

Harold Covert – CFO

Analysts

Kate Kotlarsky – Goldman Sachs

Blaine Chris – Jefferies

Mahesh Sanganeria – RBC Capital Markets

Sukhi Nagesh – Deutsche Bank

Heidi Poon – Thomas Weisel Partners

Brian Alger – Strata Capital Management

Quinn Bolton – Needham & Co.

Operator

Good day everyone and welcome to the Silicon Image’s second quarter 2008 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 sir.

David Allen

Good afternoon and welcome to Silicon Image’s second quarter 2008 financial results conference call. I am Dave Allen, Silicon Image’s Director, Investor Relations. Joining me today are Steve Tirado, the company’s President and CEO and Harold Covert, our Chief Financial Officer.

The agenda for today’s call includes a discussion of second quarter results and the company’s strategy from our CEO, and an in-depth discussion of our financial results in the second quarter and our guidance for Q3, and the balance of 2008 by our chief financial officer. 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 upon our current expectations during the call regarding many aspects of our business and the markets in which we operate, including but not limited to forward-looking statements about our future products and the timing of new product introductions, design wins, market demands, financial results and performance. Actual 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 which are described in today’s press release as well as our filings with the SEC, including but not limited to our most recent periodic reports on Forms 10-K and 10-Q. These documents describe certain relevant risk factors that could affect our future results. I also want to mention that we have provided a financial metrics table and a reconciliation of our non-GAAP financial information to GAAP information in our second quarter financial results press release, which is available on the Investor Relations section of our Web site siliconimage.com.

Now, I would like to turn the call over to Steve. Steve?

Steve Tirado

Thank you Dave and good afternoon everyone. Before I begin my commentary I would like to let our listeners know that my financial comments will be made on a non-GAAP basis.

Our financial results for the second quarter of 2008 demonstrated better-than-expected revenue growth over Q1 2008 at $70.1 million. This growth was complemented by improvement in operating margin, which improved from 4.7% to 8.4% of revenue while overall gross margins improved from 58.6% to 59.1%. Additionally, expenses were well managed as we continue to focus on improving bottom line operating profitability and demonstrate that our operating model has leverage. We also completed our accelerated stock repurchase program which resulted in an approximate 12% reduction in diluted share count from Q4 2007. Based on our current view of the business, we are in a solid path to achieve our targeted financial goals for 2008 with improved profitability in the second half of the year.

Our Q2 performance was characterized by an 8% quarter-over-quarter growth in product sales. We saw better-than-expected performance in our PC and storage businesses with CE sales coming in slightly better than expected. HDMI continues to gain traction on notebooks as they become increasingly used as media players with many OEMs viewing Plug and Play connectivity with HDMI a requirement. We are also encouraged by SteelVine traction on several motherboard designs and have now built a healthy backlog for future SteelVine growth for the remainder of 2008. Our IP core sales were slightly lower than expected but should improve in the second half of this year.

The quarter was also characterized by several technology and product announcements which will be important to our business growth over the next several years. A good summary of our product and technology and organizational announcements can be found in our Q2 2008 earnings release published today.

Silicon Image is focused on bringing high value differentiations to our product offering. This is important in creating increased demand for our solutions as well as maintaining our overall gross margins. This year, we are focused on addressing the mobile market with two groundbreaking innovations, MHL the Mobile High Definition Link technology and SPMT or Serial Port Memory Technology. Both of these technologies address important performance, cost, power, and functionality problems for mobile devices as they become increasingly powerful entertainment devices. At the same time, we are addressing the emerging area of the broadband connected digital television with our PEN or Personal Entertainment Network technologies which will extend digital connectivity beyond the point-to-point connectivity provided by HDMI and allow entertainment content to flow from any source to any TV or display. These technology announcements represent both significant investments and advancements in digital connectivity and functionality. We will continue to productize these technologies in discrete, integrated and virtual IP core forms. However we are not only promoting technology, we have done significant outreach to broad segments of the mobile and consumer electronic industries to gain industry acceptance of these technologies while we also harness their potential to compelling product solutions.

Turning now to our Serial Port Memory announcement this quarter, together with ARM, Hynix Semiconductor, LG Electronics, Samsung Electronics, Sony Ericsson Mobile Communications AB, and ST Microelectronics, we announced the formation of a working group to promote a new serial memory interface technology called SPMT or Serial Port Memory Technology. The significance of SPMT is the ability to provide a low-power high-performance solution that can extend battery life, reduce pin count 50% or more over DDR interfaces, and offer a single or multi-ported capability in a single SPMT memory chip. Our business model for SPMT will be to primarily sell IP cores to SoC and memory manufacturers. We believe Serial Port Memory and the Mobile High-Definition Link technologies are highly complementary focused on the mobile device market and represent our largest addressable market opportunity over the next several quarters.

Our work in the areas of mobile connectivity with the MHL or Mobile High Definition Link standard represents a breakthrough in targeted capabilities for the mobile device market, especially cell phones. MHL offers a five-pin interface for a dramatically smaller connector that can run over micro USB while also supporting the key phone features like charging, analog video, headset and USB. Our strategy has been to launch a series of DTV and mobile products that support both standard HDMI and MHL in a single piece of silicon. This represents meaningful value to our customers that want to support increased connectivity especially as it relates to mobile devices.

Another important strategic technology announcement for Silicon Image was the announcement of the personal entertainment network architecture earlier this year. While it is still too early to announce design win traction for our PEN technologies, we are quite encouraged by the interest we are receiving from major OEMs for this freak-out technology.

2008 continues to be an important transition year for our products and technologies and we are highly focused on 2009 design wins. The progress we have made in the first half of 2008 has positioned us to offer greater differentiation in our products with industry-leading technologies from the MHL, SPMT and PEN initiatives. We have additionally added greater value to our products with unique features like InstaPort for fast port switching between HDMI sources connected to a television, Chromaviv for superior color calibration on component analog connections, and by integrating many of these features together in our products. We are also encouraged by SteelVine traction on PC motherboards, especially the increased number of platforms supported by ASUSTeK as well as the joint development project we recently concluded with them for their expert software solutions. It is mine and the management team’s goal to make 2009 a growth year driven by design wins for Silicon Image while we take advantage of the leverage in our operating model to increase earnings and cash flow.

With that, I will turn the call over to Harold for a financial update and forward guidance before we take questions. Harold?

Harold Covert

Thanks, Steve. Good afternoon, I would like to cover three topics

Highlights of our financial results for Q2 ’08, our financial goals for Q3 ’08, and our financial goals for the full year of 2008. Unless otherwise indicated, gross margin, expense and earnings related items are reported on a non-GAAP basis which excludes stock-based compensation expense and amortization of intangible assets.

Revenue for Q2 ’08 was $70.1 million compared to $67.1 million for Q1 ’08 and $79.8 million for Q2 ’07. The increase in revenue sequentially reflects normal seasonality patterns while the decrease in revenue year over year is a result of our product transition that we have previously discussed. Product revenue for Q2 ’08 was $61.8 million, for Q1 ’08 $57.2 million and Q2 ’07 $66.5 million. License revenue for the quarter was $8.2 million versus $9.9 million in Q1 ’08 and $13.2 million in Q2 ’07. The unfavorable sequential comparison for license revenue is due to not signing any large deals during the quarter, again essentially related to our product transition. Product revenue for CE applications accounted for 72% of our total product revenue in Q2 ’08. HDMI version 1.3 products included in our CE product revenue represented approximately 49% of that revenue. PC applications product revenue accounted for 18% of the total product revenue for Q2 and storage 10%. PC product revenue was higher sequentially and year over year as a result of more multi-media notebook computers being shipped with HDMI functionality.

Average selling prices for product sales during the quarter were in line with our internal expectations and historical patterns. Our overall gross margin for Q2 ’08 was 59.1% versus 58.6% for Q1 ’08 and 54.3% for Q2 ’07. Our overall gross margin percent was favorable sequentially, year over year and when compared to our target range of 55% to 57% in our long-term financial model primarily due to product mix and operational efficiencies. Product gross margin for Q2 ’08 was 54.4% compared to 52% in Q1 ’08 and 47.2% in Q2 ’07 while our license gross margin was 94% in Q2 ’08, 96.5% in Q1 ’08 and 89.8% in Q2 ’07.

Operating expenses for Q2 ’08 were $35.5 million compared to $36.2 million in Q1 ’08 and $31.4 million in Q2 ’07. On a year-over-year basis, the increase in operating expenses is for the most part related to R&D. Headcount as of June 30, ’08 was 643 compared to 642 as of March 31, ’08 and 591 as of June 30, ’07. The increase in headcount on a year-over-year basis essentially relates to R&D.

Operating profit for Q2 ’08 was $5.9 million or 8.4% of revenue versus $3.1 million or 4.7% of revenue for Q1 ’08 and $11. 8 million or 14.8% of revenue for Q2 ’07. As just discussed the reasons for the increase in operating profit sequentially is due to higher revenue and gross margin with lower operating expenses while the decrease year over year reflects lower revenues and consequentially gross margin with higher operating expenses partially offset by a higher gross margin as a percent of revenue.

For Q2 ’08, other income, which is primarily interest income was $1.4 million compared to $1.9 million for Q1 ’08 and $3.3 million for Q2 ’07. The decrease both sequentially and on a year-over-year basis reflects the use of $62 million in cash in February 2008 for our stock repurchase plan and the lower interest rate environment in 2008. For Q2 ’08, our tax rate was 22.5% including discrete items. Non-GAAP net income for Q2 ’08 was $5 million or $0.07 per diluted share, for Q1 ’08 $3.4 million or $0.04 per diluted share, and for Q2 ’07 $8.5 million or $0.10 per diluted share. Our GAAP net loss for Q2 ’08 was $0.5 million or $0.01 per diluted share and for Q1 ’08 $0.6 million or $0.01 per diluted share. For Q2 ’07, our GAAP net income was $4.4 million or $0.05 per diluted share. Stock-based compensation, which is not included in our non-GAAP net income was $6.3 million in Q2 ’08 compared to $4 million in Q1 ’08 and $5.2 million in Q2 ’07. Non-GAAP diluted shares outstanding for Q2 ’08 were 74.8 million, for Q1 ’08 81.6 million, and Q2 ’07 88.8 million.

Moving to the balance sheet, cash and investments as of June 30, 2008 were $185.5 million compared to $194.4 million as of March 31, ’08 and $202.9 million as of June 30, ’07. The decrease in cash and investments reflects the use of cash for our stock repurchase plans. During Q2 ’08 we generated approximately $3 million in cash, excluding approximately $6 million used for the purchase of our common stock and $6 million for payment of intellectual property purchased in 2007.

Capital expenditures for Q2 08 were $2.2 million compared to $3.1 million for Q1 ’08 and a $6.1 million for Q2 ’07. Net accounts receivable as of June 30, ’08 were $28.6 million which represents 37 days of sales outstanding. This compares to 36 days of sales outstanding on March 31, ’08 and 52 days of sales outstanding on June 30, ’07.

Net inventories as of June 30, ’08 was $17.7 million which represents approximately 6.4 turns on an annualized basis, this compares to approximately 7.8 turns on March 31, ’08 and 6.2 turns on June 30, ’07. We normally increase our inventory level during Q2 in preparation for heading into Q3 which has historically been our strongest quarter for product revenue.

Now, I would like to discuss the company’s common stock repurchase programs. In February 2008 our Board of Directors authorized a $62 million accelerated stock repurchase plan as part of and to complete our $100 million stock repurchase program that was announced in February, 2007. Prior to implementing the accelerated stock repurchase plan, we had repurchased approximately 5 million shares of our common stock at a total cost of $38 million or an average price of approximately $7.67 per share under the February 2007 program. In conjunction with the $62 million accelerated stock repurchase plan, the company initially received advance delivery of approximately 11.5 million shares of common stock from Credit Suisse, the investment bank engaged by the company to execute the accelerated stock repurchase plan. The average purchase price for the 11.5 million shares which was paid by the company over the accelerated stock repurchase plan contractual period that started on February 13, 2008 and ended on June 30, 2008 was approximately $5. 82 per share for a total purchase price of $67 million.

In total, under the $100 million stock repurchase program that was announced in February 2007 and completed on June 30, 2008, the company repurchased approximately 15.6 million shares of our common stock at an average price of approximately $6.41 per share. The company provided Credit Suisse with an additional net $5 million, which when added to the initial $62 million for accelerated stock repurchase plan equaled the final transaction amount of $67 million. The $5 million which was over and above the $100 million stock repurchase program that was authorized in February 2007 will be credited against our new $100 million stock repurchase program that was previously authorized by our Board of Directors and announced in February 2008. Under this three-year stock repurchase program which began in June 2008 following the completion of our prior stock repurchase program, we can repurchase our common stock at our discretion at any time and from time to time over a 36-month period.

This completes the summary of our Q2 ’08 financial results. There is a reconciliation of our GAAP to non-GAAP measures referenced in today’s call on our Web site www.siliconimage.com.

Next I would like to provide some highlights related to our financial goals for Q3 ’08 and for the total year of 2008. First for Q3 ’08, the company has targeted the following financial goals, revenue $75 million to $77 million, gross margin 56% to 57%, GAAP operating expenses $43 million to $44 million, which includes stock-based compensation expense of approximately $5 million, $2 million for the amortization of intangible assets and $2 million to $3 million for restructuring expense primarily for severance pay. These expenses are not included in non-GAAP expenses. Non-GAAP operating expenses $33 million to $34 million, interest income $0.9 million to $1 million, effective tax rate approximately 30% to 35%, diluted shares outstanding 75 million. The severance pay just highlighted is for actions that we are taking during Q3 to improve the effectiveness and efficiency of our operating model as part of our program to pursue continuous improvement. Our plans include a reduction in staff of less than 5% that will impact most functional areas.

Turning to 2008, based on our actual financial results in the first half of 2008 and with our current level of visibility into the second half of the year including the financial targets for Q3 just discussed, the following is our overall financial goals for the total year of 2008

revenue $284 million to $289 million; gross margin 57% to 58%; GAAP operating expenses $171 million to $173 million, which includes stock-based compensation expense of approximately $21 million; $7 million for the amortization of intangible assets and $2 million to $3 million for restructuring expense primarily for severance pay. These expenses are not included in non-GAAP expenses. Non-GAAP expense is $140 million to $142 million, effective tax rate approximately 30% to 35%. Diluted shares outstanding approximately 75 million on December 31, 2008. By having this level of shares outstanding, we will have reduced our outstanding shares by approximately 12% when compared to the 85 million shares outstanding as of December 31, 2007. With no additional planned repurchases of our common shares outstanding, which is the assumption in our Q3 and Q4 targets, for the full year of 2008 our average diluted shares outstanding is estimated to be approximately 77 million.

While our major focus remains on successfully addressing our product transition and entering 2009 with revenue generation momentum, we will continue to strive to achieve our gross margin goals, tightly control expenses and drive cash flow from operations in the second half of 2008 as we did in the first six months of the year. This concludes my remarks.

Operator, we will now take questions.

Question-and-Answer Session

Operator

Thank you (Operator instructions). We’ll take our first question from Jim Schneider with Goldman Sachs. Please go ahead sir.

Kate Kotlarsky – Goldman Sachs

Hi. This is Kate Kotlarsky for Jim Schneider, a couple of questions for you. First, I was hoping if you could give us a little bit more color on the inventory increase side, you mentioned that you took cumulative inventories ahead of the September quarter but it seems like the inventory increase was quite significant. So, just curious if there is anything else there.

Harold Covert

No, actually what we try to do is to maintain about seven turns with the exception of Q2 because again we do gear up to go into Q3. So, we positively watched our channel inventories and our overall inventories and part of the improvement in manufacturing efficiencies is a result of that. So, we feel pretty good about our inventories from a level standpoint and we will get back to the seven turns as we head into the back half of the year.

Kate Kotlarsky – Goldman Sachs

Okay, that’s helpful. And then generally speaking, just a question on the overall environment, obviously it seems like the overall environment especially for consumer electronics seems to be weakening a little bit, I was just wondering if there were any push-outs that maybe you saw in the consumer electronics side from Q2 into Q3.

Harold Covert

So, let me start to answer the question and then I will pass it to Steve. If you look at the guidance that we provided going into the second half of the year, it reflects an indication of the visibility that we have and we feel based on the guidance that we did provide that we have fairly good visibility in Q3 and then we think we have decent visibility heading into Q4. This is in conjunction with working with our customers, watching channel inventory and so on. So, with that, I will now pass it to Steve.

Steve Tirado

Yes, really from my perspective I think that at least as our business is concerned, the digital television market is a little bit weaker than of course we would like. In our case however, because we are on a variety of other platforms besides the TV, we basically have been performing according to our own expectations. We have very good visibility into Q3, so we know basically where that is at. So, we are going to be cautious just like everybody else. We have to see how consumers uptake on televisions although I saw the announcement related to some excess supply by I think it was LG. Usually what that does though is it lowers the price. So, it will make TVs more attractive going into the Christmas season. So, we just have to see how it plays out. But we feel really good about our visibility and what is going to happen for us at least the next quarter.

Harold Covert

One of the real positive factor for us is that we believe that our products help differentiate our customers’ products in the end market. So, going into a top economic environment and we are not, really I think we add a plus to our customers.

Kate Kotlarsky – Goldman Sachs

Okay, thanks so much. And just one more question. Given your visibility on design wins at this point for input processors, would you be able to quantify for us how many customers you expect to ship input processors during ’09?

Steve Tirado

Yes. It is too early. We are right at the front of kind of the decision point. We have done all the sampling, we have been in all the competitive ballots [ph] we know who we are up against, but the actual decisions will start to come this quarter. So, coming into the next call I should have a little bit more color on that. I won’t be able to share names but at least I would be able to give you a little bit better idea on what is happening. But the products were announced, they are all out, they are sampling, they look very good from our position. So, we just have to wait and see one more quarter now how good the traction really is.

Kate Kotlarsky – Goldman Sachs

Great and then just one final question. Would you be able to give us a little bit more color on units and ASPs, changes in units and ASPs you saw this quarter?

Harold Covert

Yes. Again I would say as I mentioned in the script that we haven’t really seen changed in ASPs. The competitive environment, it is pretty close this time, it is pretty tough out there, but we have not seen any more of the decline than we typically see and I think the best indicator of that is if we look at our gross margins, our gross margins have held up quite well, we think they will over the balance of the year, again based on the guidance that we have provided, so no real changes.

Kate Kotlarsky – Goldman Sachs

Thank you so much. That’s it from me.

Operator

We’ll take our next question from Adam Benjamin with Jefferies.

Blaine Chris – Jefferies

Thanks. This is Blaine Chris for Adam. I was trying to reconcile the higher product gross margin in Q2 with your guidance for the second half, are you thinking product gross margin a follow up or license revenues continue to be lower?

Harold Covert

No, I think it is a couple of things. We have some manufacturing efficiencies and some other efficiencies that helped us in Q2 and we are not 100% sure if they are going to carry over into the second half of the year, so we talk about what we believe is a cautious approach or a conservative approach. We don’t believe there is going to be much of a change in our mix and we don’t believe there is going to be much of a change in our pricing environment. So, it primarily relates to manufacturing efficiencies and again trying to be fairly cautious about predicting gross margins in a tough environment.

Blaine Chris – Jefferies

I understand. When you say manufacturing efficiencies, are you referring to sales written off inventory or why wouldn’t the lower cost carry through, or are you expecting a seasonal come down?

Harold Covert

No, again. I am actually referring to combinations of things on the manufacturing side better logistics or control of our products, testing costs and a number of things that – there is a good likelihood that they will continue and there were some inventory favorability impact too. So, again we will see what happens in the back half of the year. As I said, we are trying to be fairly conservative about gross margins going into a tough economic environment.

Blaine Chris – Jefferies

Okay and then can you talk about as the ’08 model begin to ramp here in Q2, Q3. Can you talk about integration trends, as the next generation of DTV processors come in how it affects your license revenue?

Steve Tirado

Our strategy has been to bring out differentiated technology this year to position ourselves against the competitors better. We have primarily been a discrete provider. What is happening in that business is it’s moving to requiring you to do a lot more in the way of ports, so up to five ports. We have done some really excellent work on port switching time with the InstaPort technology bringing to port all of the latest features and really are still viewed as the kind of the high performance, high quality company, MHL, the Mobile High Definition Link is a differentiator for us beyond anybody else out there in the marketplace. So, we think we have done something that position us fairly well relative to the competition.

Harold Covert

Yes, and I think another indicator is that our license revenue to a large degree is following our product transition patterns and we think that the 15% that we have talked about in the past is still the number that we are going to achieve and that’s what we are targeted at right now. Even though it was down somewhat in Q2, we think it will come back up and stay in line with our overall target.

Steve Tirado

Let [ph] me comment on that specifically but the licensing tends to be a little bit lumpy and so sometimes a big deal will make a big difference in any given quarter. But as Harold was saying, we still think overall it will be about 15% for the year.

Blaine Chris – Jefferies

Going back on that question, I guess if licensing does come back, I guess that it implies a product gross margin closer to 50%. I am just trying to reconcile whether you are actually being that conservative or really those efficiencies can go away by that magnitude?

Harold Covert

So, I think if you look at it, our target range is 55% to 57%. We were above that certainly in the first half of the year, a little bit above 58% and we have given guidance for the full year that says we are going to be 57% to 58%. So, I think it is an indication that we expect the gross margins to continue to be strong. However, we are going into a tough second half of the year with an economic environment. This gives us flexibility to deal with our customers if we need to.

Blaine Chris – Jefferies

Okay, perfect. And then finally on the PC side, you have clearly been investing from HDMI adoption to kind of offset some DVI. Could you give any color on the mix between the two, how substantial is HDMI as opposed to your PC revenue at this point?

Harold Covert

Interestingly enough, certainly we are happy about the HDMI adoption on the PC side because it’s actually going to result in a year-over-year increase in our PC revenues as opposed to a decline. But I would say that the DVI piece of it is still actually holding up fairly decently. But again it is been driven by HDMI side. So, DVI is still a meaningful part of that overall PC revenue stream.

Blaine Chris – Jefferies

Great, thank you guys.

Operator

And the next question will come from Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria – RBC Capital Markets

Thank you. Steve, the questions on the new products, you have several products in the pipeline, and if you can give us some indication of when do we actually see those in terms of timing? Are we going to see something a step function jump in the revenues somewhere in Q2 of next year? And which product do you think is the most likely to drive the revenue growth?

Steve Tirado

I think it is a little bit too far out for me to be that precise about step function for Q2. I will give a little bit more color. We are getting a pretty positive reception on the new port processors, and actually we already have a small design win for the new input processor. But I can’t tell you who it is it is not that large. But it is a good indicator of how the market is perceiving our products. So, the goal here is really to lock those design wins. We are in the critical period right now in the July through September period to really make sure that all the questions are answered and that customers really understand the differentiated value that we are bringing, but the products that were announced this year are getting a pretty good reception. Like I said, I will know more about it in the quarter.

Mahesh Sanganeria – RBC Capital Markets

So, you are most optimistic on the input processor of all the things like MHL and the smaller port HDMI for the digital camera, video camera, which one is likely to provide the most growth?

Steve Tirado

I think the MHL technology which is by the way integrated into all the new products. So, it is not like we are just providing a more highly integrated front end. We are also putting all the new stuff in there. So, they all have InstaPort, they all had MHL and so these represent things you don’t see in the competitive products, which I believe is helping us with respect to retaining an increasing market share with our customers. In fact, if I was to take – I think InstaPort and MHL are the real big features this year that are helping to drive some of the design win positive commentary I am getting back right now.

Mahesh Sanganeria – RBC Capital Markets

On the expense side, with your reduction in force which you are forecasting. I guess some of your early guidance I can figure it out, but if you can give me the answers it will be easier. How should we look at R&D and SG&A going forward?

Harold Covert

Well, again, I think based on the guidance that we provided in the two quarters in the back half of the year, we are going to be down from the $35 million level that we were at in Q2. So, $2 to $3 million range and I think the cuts in expenses will be across all three of the major expense categories R&D, sales and marketing and G&A. Now what we are really trying to do is to push into our longer term model for sales and marketing and G&A somewhere into the 9% to 10% range. We should be there as we exit this year and then our goal is to get R&D down from the 25%, 26% or so that it is at now down to 20%. We won’t get there with R&D until next year but our goal is to get back into the 15% to 20% operating profit that the company has historically operated at. And as we exit this year, we are not going to be far from that from an exit rate, the bottom end of that range. So, that’s where we are pushing right now.

Mahesh Sanganeria – RBC Capital Markets

Okay, that’s great. Thanks.

Operator

And our next question comes from Sukhi Nagesh with Deutsche Bank.

Sukhi Nagesh – Deutsche Bank

Sound results. Congratulations. Just in terms of the PC and storage businesses that kind of gave you the upside this quarter, how would you characterize the sustainability of that upside moving into the second half of this year and then into next year?

Harold Covert

I will start now and then pass it to Steve. I think based on the visibility that we have right now, we believe that the traction that we have now is going to continue, so that on a year-over-year basis both of those product lines are actually going to grow. The PC is going to grow on double digits and storage actually has the chance to do it. So, it is a good positive for us in particular given the DTV environment. So, we think that that traction is going to continue into the back half of this year. And at that point in time we will take a look at it and see what it looks like in 2009 and give you an update later on.

Steve Tirado

I think the good news on the storage side is we have been promoting SteelVine now for I don’t know how many years but we are finally getting some really attractive traction in the marketplace. You saw the announcement with ASUSTeK but it is not just ASUSTeK, we have now several companies who have really bought into the architecture. We are going to see some significant growth for SteelVine now, storage overall is going to do well with SteelVine being the major reason why.

Sukhi Nagesh – Deutsche Bank

What would be your prognosis for the CE business, Steve, for this year?

Steve Tirado

For CE business, it is the dominant portion of our business. It is down this year relative to last year and I think that’s somewhat consistent with the weakness people are talking about in the DTV business. But with respect to our guidance and the expectation we have I think we have got a reasonable outlook for you.

Harold Covert

Yes, and the only other point that I would add is that we view that the revenue situation that we have in 2008 is primarily related to our product transition in that as we get these new products out there to help our customers again differentiate themselves, we will get a good pick up. I think we have been saying all along that the economy certainly is not helping the matter.

Sukhi Nagesh – Deutsche Bank

What I was trying to get at was if you were to assume a worst case scenarios for the macro economy is your annual guidance for 2008 take that worst case scenario into the CE business or how do should we look at it from a worst case scenario?

Harold Covert

Yes, I think that the best way to look at it is, as I indicated earlier, we have fairly good visibility into the current quarter Q3. We have decent visibility into Q4. We are in contact with our customers, we know what is going on, we are watching our inventory levels, unless we got really a bad surprise I think that the guidance we gave is realistic and we believe that we are going to be able to achieve it.

Steve Tirado

And I think the kind of the hard proof of that is the order rates actually kicked up a quite a bit. Our bookings rate actually went up significantly. Our channels are fairly cautious they are not going to give you orders if they don’t think they are going to push the product through. So, we are seeing real indicators that show us at least for the short term they are expecting to be able to sell through okay.

Sukhi Nagesh – Deutsche Bank

Couple of more follow-ups here, on the inventory levels, what should we expect your inventory to trend to in the third quarter?

Harold Covert

I think in particular as we exit the year our belief is we will be back to the seven turns. It basically says the inventory levels are going to be down $2 to $3 million as we exit the year from the level that we ended at in Q2.

Sukhi Nagesh – Deutsche Bank

Okay, last question from me. How should we model your product gross margin for the third and fourth quarter?

Harold Covert

I gave you the guidance already.

Sukhi Nagesh – Deutsche Bank

Product gross margin?

Harold Covert

I would say the best way to do it is take the trends that we have had in Q1 and Q2 and they are not going to dramatically change, the thing that would come down slightly if you take those trends depending upon where you want to end up at would be the product gross margins because they were higher in the first half.

Sukhi Nagesh – Deutsche Bank

Nice of getting me around that. Thank you.

Operator

And as a reminder, star one to ask a question. Our next question comes from Heidi Poon with Thomas Weisel Partners.

Heidi Poon – Thomas Weisel Partners

Hi, sorry if I am beating a dead horse but in terms of your backlog can you give us a sense of the CTV versus the rest of the home theater and consumer electronics mix?

Steve Tirado

Again, looking at our backlog, keep in mind that we recognize a large part of our revenue on sell-through. But as we indicated before, the strong parts of our business right now relative to our plan had been the PC and storage side and other than DTV sources and devices and so forth have been pretty good. So, DTV is the one we are watching but we think we have got that targeted properly and we don’t see any big differences than what we achieved in the first half of the year other than a normal seasonality pick up that we typically have in Q3.

Heidi Poon – Thomas Weisel Partners

But what is your forecast for DVD ramp [ph]?

Steve Tirado

See again, we don’t really get into that kind of detail.

Heidi Poon – Thomas Weisel Partners

Okay, but aren’t your gross margin for PC and storage typically a little bit lower. So, if they are stronger than normal in the second half there would be more of an impact on the gross margin?

Steve Tirado

Not really. I mean, if you look at it storage is probably typically a little bit lower than the overall average. PC is a little bit higher, so they kind of balances out. I don’t think that there is any major swing factor.

Heidi Poon – Thomas Weisel Partners

Also I know this is probably a couple of years out before it gets results but there is some consortium regarding wireless HD standards and they talk about some of the new products coming out next year. So, what is your take on that?

Steve Tirado

Are you talking about –? Well there have been several actually announcements on –

Heidi Poon – Thomas Weisel Partners

Standards think they are making more news these days.

Steve Tirado

Yes. Right now if you look at those solutions in the market they are really very high end focused. You pay anywhere from $800 to $1000 for a pair of transmitters that you need, one on the source and one near the television. So, they are pretty expensive. I think that there is also a battle about standards. So, you have got several consortiums not just one promoting a technology and they are different and they are not interoperable or compatible. So, I think it is going to take a little while for the industry to sort out. Now, you will see a lot of talk about this and you will see these high-end solutions, but I think in terms of a meaningful impact on the kind of the mass market, I think we are still quite a ways away from seeing that.

Heidi Poon – Thomas Weisel Partners

In terms of your mobile link product, I guess the target, I am assuming that would be more than 10% next year, would you be breaking that out and can you give us a sense of the ramp pattern?

Harold Covert

Yes, again, I think Steve indicated earlier on, we are just right at the front end of the design win cycle. We are excited about that product. We don’t really have any more to say about that at this point in time. As we get closer to 2009 we get to the major part of the design win cycle we may have more input.

Heidi Poon – Thomas Weisel Partners

One final question, what about HDMI 1.4. When are we going to start seeing the product and maybe the standards come out?

Steve Tirado

I am expecting to see a revision to the standard probably towards the end of the year, and so that will be exciting and it will play a role in some of the product decisions even in 2009. But it will probably be an even bigger impact in 2010. But we are excited about that, we are doing a lot of work on it. You probably will see something right around the end of the year or maybe early 2008 – I am sorry 2009.

Heidi Poon – Thomas Weisel Partners

Thank you.

Steve Tirado

You are welcome.

Operator

For our next question, we have Brian Alger with Strata Capital Management.

Brian Alger – Strata Capital Management

Good afternoon guys.

Steve Tirado

Good afternoon.

Brian Alger – Strata Capital Management

Just a quick question. Hally, you mentioned earlier that there were a number of things that helped out the product gross margins in terms of this particular quarter manufacturing and testing logistics, I think you said – I think you also mentioned that there were some favorable inventory factors that play, can you describe that a little bit more and maybe quantify it?

Harold Covert

Yes, it was not a large enough number for me to highlight or I would have. Again I think it relates more to tightly controlling our inventories and watching what’s going on in the channel, so we minimize any excess in obsolete inventory. If you go and look at the actual improvements that have happened again, I think the bigger factors were mixed and manufacturing efficiencies as opposed to the inventory side.

Brian Alger – Strata Capital Management

They are just getting betting prices out at your vendors?

Harold Covert

Well, it’s more product mix not necessarily pricing.

Brian Alger – Strata Capital Management

Okay, fair enough. As we look at the competitive landscape, you mentioned that it hasn’t really changed. But given the weaker consumer out there, are we seeing more price pressure in the CE space than we are say in your PC and storage markets?

Steve Tirado

I would say that’s probably generally true but the kind of ASP erosions that we typically see are about what we are seeing this year. We will see anywhere from 4% to 5% quarter over quarter, 20%, 25%, and that is about what we are seeing. We are not seeing anything out of the normal range of ASP erosions than we normally see.

Brian Alger – Strata Capital Management

Okay. Great. And Steve just coming back towards the next year visibility and kind of the product cycle, I just want to probe that a little bit, in speaking with the number of contacts in the space, it seems to be that they either want to go year out with the input processor or they want to remove the socket altogether and pull the Mac directly on to the SoC, you have a sense of how the market is splitting up in terms of how many are going SoC versus an input processor on their design architecture?

Steve Tirado

Yes, I would say that certainly for the low end and a lot of the mid range it’s just a full SoC and they will limit to the connectivity to whatever is there. In the, I guess, upper end of the mid range and the high end is where they will look for higher quality features. The way we are playing it is the input processor is something we are really promoting at the higher end of the market, the port processors however are all across the market. We are noticing even down in the smaller TVs that they want a lot of ports and we have come up with a kind of a very cost-effective way for them to do that including adding in these new features like InstaPort which is actually getting a tremendously good reception. If you look at standard switching times between your DVD and your set-top etc, four to seven seconds as we’ve measured it and InstaPort takes that down significantly below a second. So, it’s been a really nice feature and at times when the market is really struggling both with price and trying to get differentiation, actually I think it’s helping us.

Brian Alger – Strata Capital Management

Good. On that InstaPort type of implementation, what’s the ballpark ASP for an implementation in the kind of low in there?

Steve Tirado

You know the port processors are in this sort of $1 to $2 range.

Brian Alger – Strata Capital Management

Is that per port or just per –

Steve Tirado

That’s per chip.

Brian Alger – Strata Capital Management

Okay, great. That’s helpful guys. Thanks for answering the questions.

Steve Tirado

Okay.

Operator

Our next question comes from Quinn Bolton of Needham & Co.

Quinn Bolton – Needham & Co.

Hi guys, I jumped on the call really late so I apologize if you have addressed this but can you talk about – the last conference call you talked about being in a position later this year to talk about your first win with MHL in the cell phone space, I was just wondering if you had provided any update there?

Steve Tirado

No. What we said earlier Quinn was that we are at the front end of design cycle a lot of decisions will get made over the next 90 days. I won’t be able to tell, as we never can, we can’t tell you who we might have won. We give a little bit more color on how much success we are having with the new products.

Quinn Bolton – Needham & Co.

Okay, great. I will just grab that on the transcript. Thank you.

Steve Tirado

You are welcome.

Operator

There aren’t any more questions in the queue. I will turn it back to you Mr. Allen.

David Allen

Thank you, operator. We would like to remind the listeners on this call that we will be participating in two upcoming investment conferences in August, the RBC Capital Markets Communication Media and Technology Conference on August 6 at 10 o’clock Pacific Time and the B. Riley Cash Rich Tech Stock Conference on August 12 also at 10 am Pacific Time. Webcast for each of these events can be accessed on siliconimage.com. Want to thank you for joining us today. This concludes our call today. Have a great day.

Operator

And this concludes today’s call, thank you for attending. Have a great day.

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