Silicon Image, Inc. Q1 2006 Earnings Conference Call Transcript (SIMG)

Apr.28.06 | About: Silicon Image, (SIMG)

Silicon Image, Inc. (NASDAQ:SIMG)

Q1 2006 Earnings Conference Call

April 26th 2006, 5:00 PM.

Executives:

Robert Freeman, Chief Financial Officer

Steve Tirado, President and Chief Executive Officer

Patrick Reutens, Chief Legal Officer

Analysts:

Charlie Glavin, Needham & Co.

Tayyib Shah, Longbow Research

Aalok Shah, D.A. Davidson

Jenny Hsu, Thomas Weisel Partners

Ed Marquand, Needham & Co.

Erik Rasmussen, Pacific Growth Equities

Operator

Good day everyone, and welcome to Silicon Image's First Quarter 2006 Financial Results Conference Call. Please note that today's call and question-and-answer session are being recorded. At this time I'd like to turn the call over to Mr. Robert Freeman for opening remarks. Mr. Freeman, please go ahead.

Robert Freeman, Chief Financial Officer

Thank you. Good afternoon everyone, and welcome to the Silicon Image first quarter 2006 financial results conference call. Joining me today is Steve Tirado, our President and Chief Executive Officer; and Patrick Reutens, our Chief Legal Officer.

By now you have all seen our press release and the associated 8-K filing for this afternoon. For purposes of this call we intend to present the company's financial performance on a non-GAAP basis as defined by the SEC in Reg G. The need for providing non-GAAP information is primarily due to the lack of comparability between periods presented with respect to stock-based compensation as a result of the adoption of 123R. In addition, we believe that the amortization of intangibles and the non-cash portion of the income tax provision recorded to additional paid-in capital are unrelated to our ongoing business operations.

We have chosen to provide this supplemental information to investors, analysts and other interested parties since management uses this information to evaluate operations, to manage and monitor performance and to determine bonus compensation. A reconciliation of the comparable GAAP financial measures are included in our press release and along with the audio replay of this conference today will be available on Silicon Image's Investor Relations website at www.siliconimage.com.

Please be cautioned that during this call, including our question-and-answer session, we will make forward-looking comments within the meaning of Section 27(a) of the Securities Act of 1933 as amended, and Section 21(e) of the Securities Exchange Act of 1934 as amended, regarding our future performance based on our current expectations. These include remarks concerning our expected operating results, product introductions, product production ramps, announcements relative to standards and technology adoption rates. We may also make comments regarding events that could potentially impact the future of the company.

Forward-looking statements in this call are generally defined by words such as “believes,” “anticipates,” “expects,” “intends,” “may,” “will,” and other similar expressions. Many factors taken individually or in combination could materially affect future business outcomes. Actual company results may differ materially from what are described in these forward-looking comments.

I encourage you to familiarize yourself with our most recent 10-K for the period ending December 31, 2005. This report describes relevant risk factors that could affect future financial results. Additionally, during the call this afternoon we may highlight other factors that could impact any projections or other forward-looking statements.

I will now turn the call over to Steve for comments on our operating results for the first quarter of 2006.

Steve Tirado, President and Chief Executive Officer

Thank you, Bob, and good afternoon everyone. I'd like to start the call by reviewing five key accomplishments for the quarter.

Number one, we finished our quarter at $59.1 million in total revenue, and $11.3 million in non-GAAP net income, or $0.13 earnings per share on a diluted basis. This represents a 33% growth in revenue over last year's Q1 2005 and a 47% increase in non-GAAP net income over Q1 of 2005. The results demonstrate both strong revenue growth and improved operating leverage as we start 2006.

Number two, we had another strong booking quarter. Our book-to-bill exceeded 1.3 and, as a result of our strong backlog position and visibility, we will be raising our annual 2006 guidance to 20% to 30% revenue growth over 2005 from the 15% to 25% guidance given in our Q4 conference call.

Number three, HDMI adoption continues to grow strongly and we ended Q1 with over 383 adopters, up from 313 at the end of Q4 2005. We are particularly pleased to see more than 70 Chinese companies have now joined the HDMI standard. We expect that over 100 million HDMI devices will have shipped worldwide by the end of 2006.

Number four, Silicon Image prevailed in its litigation with Genesis Microchip and in addition to a cash and back royalty payment we will be receiving ongoing royalties for all DVI and HDMI products.

Number five, we continue to strengthen our board and I am pleased to welcome John Hodge, the former Head of Global Corporate Finance for Credit Suisse First Boston.

This was an exciting quarter for the company. We have made major strides in both strengthening the board and management team as well as improving the operational performance of Silicon Image.

I'll now discuss some key trends we're seeing in our markets. Let me start with consumer electronics.

Our consumer electronics business is now moving into a stronger demand cycle as our major customers begin building for the 2006 TV selling season. We have seen strong growth in the DVD set-top box and digital television markets as HD programming continues to rollout. Our TV customers are pushing aggressive timetables for their new products and this should be a strong product cycle across our OEMs. We also believe that the significant price drop in LCD TVs over the last 12 months should stimulate good consumer demand in 2006.

We are also beginning a ramp in production for a large OEM customer in Q2, that is both driving overall CE growth and will help foster a very favorable climate for deep color solutions later in the year and into 2007. This trend will be favorable in both ASP and margin or average selling price and margin as the year progresses.

We continue to receive interest in HDMI for new high-value platforms like personal media players, new media PCs and cameras and believe these explorations will lead to new chip and licensing revenue growth well into 2007 and 2008.

Let me turn to the PC market. Our PC business continues to see growth potential for DVI and HDMI on new PCs. HDMI has been announced on several new notebooks, media PCs and graphics cards.

The Toshiba announcement today is one of many expected during 2006. We believe that the desire for convergence with the consumer electronics environment will continue to expand HDMI's presence on the PC.

Let me talk about storage. Our storage business remains focused on serial ATA and external serial ATA in both the PC and CE markets, as well as the promotion of SteelVine for consumer electronics and home applications. I am pleased to say that we have won our first major OEM chip customer for SteelVine and expect to make a public announcement during Q2.

Overall strength in our business continues to build, allowing us to up our annual revenue guidance. We are encouraged by interest in our new deep color technology, as well as HDMI interest on the PC platform. Storage should become a bigger growth driver in 2007 and new platforms for HDMI should help drive our discrete business up, both this year and into 2007.

With that, I will turn the call back to Bob for some details on Q1 and our guidance for Q2.

Robert Freeman, Chief Financial Officer

Thank you, Steve. As mentioned at the beginning of the conference call, for purposes of this call we intend to present the company's financial performance on a non-GAAP pro forma basis.

As Steve mentioned in his remarks, revenue increased 33% from $44.3 million in Q1 of 2005 to $59.1 million in Q1 of 2006. This represents 6% above the consensus guidance.

Revenues declined sequentially 4% from $61.4 million in Q4 of 2005 due to seasonality of demand. This sequential decline was similar to what the company experienced in the same quarter last year.

Product revenue, which includes revenues from our consumer electronics, personal computers and storage systems was $53.3 million for the first quarter or 90% of total revenues. Product revenue increased 31% from $40.8 million in the first quarter of 2005 and decreased 4% sequentially from $55.4 million last quarter.

IT licensing revenues, which include licensing, royalty and development revenues, were $5.8 million or 10% of total revenue for the quarter. This compares to $3.5 million for the first quarter of 2005 and $6.0 million for last quarter. An increasing portion of licensing revenues came from HDMI licensees, as Steve mentioned earlier.

Consumer electronics product and IP revenues were $34.5 million for the quarter, an increase of 62% from the $21.2 million in the year-ago first quarter, and a 6% sequential decrease from the $36.4 million from the fourth quarter of 2005.

Personal computer product and IP revenues were $13.3 million, a 20% increase from the $11.1 million in the same quarter last year and a 15% decrease from the $15.7 million last quarter.

Storage products and IP revenues were $11.3 million in the first quarter, a 6% decrease from the $12 million in the same quarter last year but a 7% increase from the $10.6 million last quarter.

The non-GAAP gross profit margin for the quarter was 58.2% compared to the 58.1% last quarter. The lower margins were the result of a shift in sales mix to lower price and lower margin products and price adjustments as the company increased efforts to protect market share.

Non-GAAP operating expenses for the first quarter were $24.4 million or 41.3% of revenues. This compares to $20.2 million or 45.6% of revenues in the same quarter last year. Last quarter, operating expenses were $22.8 million or 37% of revenues.

Next I will speak to both GAAP and non-GAAP net income. As noted in the beginning of the call, the company began expensing stock options under 123R in January 2006. For 2005, stock-based compensation under variable accounting treatment fluctuated based upon changes in our stock price.

Net income, prepared in accordance with generally accepted accounting principles or GAAP, for the first quarter of 2006 was $2.4 million or $0.03 per diluted share, a decrease of $14.3 million from $16.6 million or $0.19 per diluted share in the first quarter of 2005 and a decrease of $10.2 million from $12.6 million or $0.15 per diluted share in the fourth quarter of 2005.

Net income for the first quarter of 2006 included a $7.3 million or $0.09 per share charge for stock-based compensation expense under 123R. Conversely, net income for the first quarter of 2005 includes a stock-based compensation benefit of $9.3 million or $0.11 per share. Last quarter's net income included an expense of $0.9 million or $0.01 per share.

Non-GAAP net income excludes stock compensation expense, amortization of intangible assets and the non-cash portion of the income tax provision recorded to APIC, that's additional paid-in capital. This latter adjustment is excluded from net income because it depends on stock option exercises, which are outside of our control and unrelated to our ongoing operations.

Non-GAAP first quarter net income was $11.3 million or $0.13 per diluted share, a 47% increase from $7.7 million or $0.09 per diluted share in the same quarter last year and a decline of 19% from $13.8 million or $0.16 per diluted share last quarter.

I will now review a few balance sheet and cash flow items. Cash and investments totaled $167.5 million at the end of the quarter, an increase of $15.9 million from the $151.6 million at the end of 2005.

DSOs were 57 days, up from 44 days last quarter, and up from 45 days a year ago. While product sales were down 4% sequentially, receivables increased 21%. A portion of the revenues related to these receivables are to distributors and are generally deferred one quarter. A portion of this deferred revenue represents increased volume shipped to a large OEM where our product penetration has expanded to their full line of TVs.

Inventory turns were 5.6 times compared to 6 times last quarter and 5.1 times a year ago. We have increased our inventory levels within acceptable levels to ensure that during periods of capacity constraints we can meet expected increases in customer demand.

Capital spending for the quarter was $1.4 million, in line with depreciation of $1.6 million.

I will now summarize our financial guidance. As Steve mentioned, based on improved visibility and customer backlog commitments, we are raising our 2006 revenue guidance to 20% to 30% over 2005 revenue. This is an increase from last quarter's guidance of 15% to 25% for the year.

Total revenues for the second quarter are expected to increase to between 12% and 15%. In the second quarter more specifically, product revenue is expected to increase to $59 million to $62 million and IP licensing revenues should be between $5 million and $7 million for the quarter.

We are revising our non-GAAP gross margin outlook downward slightly based upon the last two quarters to approximately 58%. This lower outlook is due to increased unit sales of lower margin products and price adjustments as the company increases efforts to protect market share.

We expect non-GAAP operating expenses to increase approximately 10% to $27 million and increased spending is targeted for our expansion into China, our growth of Simplay Labs and increased spending for R&D.

Interest income will continue to increase in relation to cash investments and interest rates. The tax provision is projected to be 38% for GAAP reporting with a tax benefit from employee stock options that is charged to capital being excluded from the reconciliation of GAAP to non-GAAP reporting resulting in a 3% non-GAAP tax rate.

I will now turn the call over to our Chief Legal Officer, Patrick Reutens, for an update on the status of the Genesis lawsuit.

Patrick Reutens, Chief Legal Officer

Thank you, Bob, and good afternoon everyone. On April 6th, 2006, the Court of Appeals for the Federal Circuit issued a decision in our favor in our lawsuit against Genesis Microchips.

The lawsuit started in April of 2001 when we sued Genesis in the District Court for the Eastern District of Virginia for infringement of two of our patents. In December 2002, we entered into a memorandum of understanding or MOU with Genesis that was intended to settle our patent claims against Genesis.

Shortly after executing the MOU, Genesis tried to reinterpret certain key provisions. The District Court rejected Genesis' interpretation of the MOU and Genesis twice appeals the District Court's opinion to the Federal Circuit.

The April 6th, 2006, decision by the Federal Circuit upheld the District Court's findings of fact and conclusions of law in every respect, including the District Court's conclusion that Genesis should pay a lump sum monetary settlement and royalties on all Genesis products that comply with the DVI and HDMI standards.

Genesis had until April 20th, 2006, to petition the Federal Circuit to reconsider its April 6th decision but did not file such a petition. At this point, Genesis may still petition the United States Supreme Court to accept this case for review. We believe that it is unlikely that such a petition, if filed, would be granted.

While the case is on appeal, Genesis was ordered to pay certain sums due to us under the MOU into a segregated interest-bearing account. By order of the trial court, our ability to take control of and use these funds is tied to the outcome of the appellate process. Unless Genesis takes steps to delay the issuance of the appellate court's mandate, which is currently scheduled to issue on or about April 27th, 2006, under the trial court's order we could take control of the funds as early as May 11th, 2006.

We look forward to working with Genesis to ensure that both parties fully comply with the terms of the MOU that has not been affirmed. Bob?

Robert Freeman, Chief Financial Officer

Thank you, Patrick. This concludes the formal portion of our presentation, and we would now like to open up the call for your questions. Operator, may we please have our first question?

Question-and-Answer Session

Operator

Certainly. Operator Instructions And we'll take our first question from Charlie Glavin from Needham & Company.

Q - Charlie Glavin

Thanks. Steve, if I can ask a pricing question, I want to understand whether or not there's been a slight shift in terms of some of the strategic approach. Last year you guys were pretty proactive in terms of cutting price so as to migrate a lot of the single port HDMI over to dual port. Now it sounds as if-- I believe you said that it was more to protect existing share. The two questions are: where is the pricing coming from? Is it more single versus dual port? And where in particular are you seeing the price competition coming from? Is it from people who are selling integrated or which merchandise are you trying to cut against?

A - Steve Tirado

So first of all the pricing pressure actually was greater in the PC market than it was in any of our other markets, so that had some impact. On the CE front, which clearly is the bigger swing for us, there's been more competition on the discrete side and in some cases we've had to respond to that. We've done the analysis and here's what it basically says, Charlie. I mean, it is worth it for us to sacrifice some of the unit margins in order to protect the bigger picture, which is the total gross margin dollars for the company and I think we're in a very good position. Most companies do not want to switch away from Silicon Image and so it's important for us, however, to stay within a reasonable range of any of the competitors out there. But some of this also had to with the fact that some of the cost savings that we thought we were going to receive in this quarter and just didn't happen in the way that we wanted to. So those are issues that we're going to continue to work on.

Q - Charlie Glavin

Steve, in regards to -- just to be clear, are the price cuts relative to winning designs that would be rolling out in '07? And secondly, is it so much that price cuts as opposed to using a different type of product? I believe it's a 9001, if I'm not mistaken, that was launched about a year, year and a half ago, I thought to address kind of the low-end discrete market as well.

A - Steve Tirado

Yes, it's kind of all of those things, right? Some of it is migration to some of our newer products, which are lower priced and that was planned, right? So we brought prices down on both the single and dual input parts and we had a little bit larger volume swing than we were anticipating and, in fact, in general, the volumes have been a lot more -- not a lot, but I should say they're moderately more aggressive than we had anticipated and that caused some of the ASP declines. So it wasn't so much a part for part as it was a volume shift.

Q - Charlie Glavin

And are these more for '06 or revenues that you hope to secure '07 designs?

A - Steve Tirado

These are shifts that affected, obviously, the current quarter, right? In other words, the volume shift to some of the lower-priced newer products was a little bit larger than we thought they were going to be. My view kind of going forward is I think we've done most of what we need to do. But again, for me the analysis shows very clearly that it is better for us to sacrifice some unit margin in order to improve total gross margin dollars for the company.

Q - Charlie Glavin

And which merchant guys are giving you the most pressure out there? I can imagine who it is on the PC side, but how about on the CE side?

A - Steve Tirado

Well, I've talked about who -- this is by the way, again it's all on the discrete side. There are companies like Philips and Analog Devices and MStar out there. I think the most aggressive on the price side has been MStar, if I was to name one of them. Philips and ADI tend to be a little less so on the price side. But it's a war out there and we believe it's in our shareholder interest and in our maximization of profit interest to hold our sockets. So we're going to do that.

Q - Charlie Glavin

And then lastly, Steve, in terms of kind of the whole convergence and kind of diluting of boundaries, the Toshiba being a good example of a HD DVD within the laptop. You've also got UDI coming out, DVI. When is it kind of irrelevant in terms of some of the PC versus CE versus storage if you've got a separate attach within a DVR. I mean, how do you kind of approach this? And more importantly, strategically, how do you align the sales guys so as not to have a certain amount of redundancy?

A - Steve Tirado

Well, we're driving the total market to go to HDMI and we're getting a lot of help because there's so much traction in the TV market and all the new PC vendors -- or all the new PC platforms coming out from our big OEMs, especially on the notebook side, they all want to play into the new televisions. The other trend -- you can hear this from a lot of our competitors too is that the broadband market is livening up, and people are going to start getting content via the broadband market and that typically means via some sort of a PC. And then if you want to go play that on a nice television, what are you going to use? It's definitely going to be HDMI. So I think at the end of the day I calculated the total number of -- I talked about how I expect there to be about 100 million HDMI devices at the end of '06. If I'd throw in the DVI devices, it'll be over 200 million.

Q - Charlie Glavin

But, Steve, are those HDMI -- and the reason why I ask is so as not to double count also from a modeling standpoint, but if you look at some of the iSuppli and other forecasts in the hundred million forecasts, does that include PCs? And when you talk PCs?

A - Steve Tirado

Yes, I'm counting everything.

Q - Charlie Glavin

And when you talk a hundred million HDMI, is that including--

A - Steve Tirado

That's year-- that's lifetime, right?

Q - Charlie Glavin

But-- oh, well, let's put it this way. DisplaySearch is forecasting for 50 million. Is that including PC in your mind and how you're viewing it or does that also include some of these convergent devices that are going into the PC?

A - Steve Tirado

So I can't speak to the DisplaySearch. I didn't look at that. The In-Stat numbers show about 60 million devices this year hitting the marketplace. Last year they estimated a little under 20 and then, of course, there were shipments before then. So I think you can get to the 100 million just using their numbers. We know actually we've shipped more than they're even forecasting, so I'm very comfortable with that number.

Q - Charlie Glavin

Okay, got it. Thanks.

A - Steve Tirado

You're welcome.

Operator

Operator Instructions And we'll take our next question from Tayyib Shah from Longbow Research.

Q - Tayyib Shah

Hi, guys. Thank you for taking the question. Can you talk about what's going on with the DVI business in the PC space? And how do you see that in the next quarter?

A - Steve Tirado

Actually, it's been doing quite well. Some of the PC OEMs have really promoted DVI pretty heavily, both on the notebooks and the desktops and so I think it's going to be a very strong year for DVI. Where DVI slows is because HDMI is going to be the preferred answer on the platform. We had about 15 significant wins during the quarter, of which almost a third of those were actually in the PC market itself. So, the PC guys are really, really very much eyeing this whole digital connection, whether it's DVI or HDMI and they continue to put more and more of it on their new platforms.

Q - Tayyib Shah

So we should look at the decline in the first quarter as purely seasonal?

A - Steve Tirado

Yes.

Q - Tayyib Shah

And what's the timeline for this seasonality to work itself through? I mean, are we looking at a weak second quarter and then a ramp in the back-to-school season?

A - Steve Tirado

We're expecting, actually, to be up in all our segments next quarter.

Q - Tayyib Shah

Okay. Thank you. And then, in the HDMI space for the consumer side, you talked about deep color coming out with a major OEM. Where do you see the penetration of deep color this year and where do you see it going to in 2007?

A - Steve Tirado

Right now we're really focused on enabling some of the advanced televisions and there are some new source devices in the DVD front that are very excited about this and wanting to move really aggressively. And so we're -- we're basically lining those guys up and making sure that we can satisfy their requirements. It's very possible we'll even see some deep color traction by the end of this year. So we're pretty bullish on that and that represents a positive impact from us from both an ASP and a margin standpoint.

Q - Tayyib Shah

Okay. Then maybe if you could provide some granularity on what do you see is the split between the value segment of the market where MStar can come in and pressurize you a little bit on the margin and the more higher-end stuff where they can't directly compete against you?

A - Steve Tirado

That's a good question. What I would tell you is that right now as we see it, even in the value segment, we've been doing really well in competing for 2007 sockets. I won't have a really solid answer until again as I did last year, it takes me until about early Q4 to really know how well we've done. For 2006 almost all of that was done in 2005. Now I will say this, the cycles are changing and one of the reasons, the cycles are changing. We did have, for example, one of our customers started ramping in Q1 and we're seeing now some of the smaller televisions in that kind of 30 to 32 inch category, we're seeing our customers move to now instead of just one major cycle, actually going to as many as two and some guys are even talking about three product cycles. So the competition is heating up because they're all trying to get market share. And so there's a lot more volume potential, I think, than I thought we were going to see this year. And, of course, that increases the competition in these new platforms coming in. And so our bent, again, our analysis shows that it is much smarter for us to go and take as much market share as we possibly can and position ourselves to migrate those guys to deep color when they're ready for it.

Q - Tayyib Shah

Okay. And I'm sorry if I missed this. Did you guys say how much SteelVine was for the quarter?

A - Steve Tirado

No. We didn't give that number. It was a little under $400,000.

Q - Tayyib Shah

Okay, so what drove the SATA business was other than SteelVine. So how do you see SteelVine coming up through the rest of the year? And the non-SteelVine business, how do you see that progressing through 2006?

A - Steve Tirado

Yeah, I don't see much change. I mean, SteelVine is going to be a bigger contributor in 2007. I'm very excited about this new OEM and I'm excited to make the announcement. You'll see something on this later this quarter because this is our first significant chip win, but by the time they really get into production and get going it'll be towards the end of the year. So again, I'll say what I've said in previous calls that it's really a bring-up year and a design-win year and '07 on the chip side is where we expect to see more significant growth. What contributed to storage doing better than last quarter was really the SATA business itself continues to be good. This is the storage controllers that we sell into the PC market. We had some of our larger OEMs are still wanting to use our products, simply because we've got excellent performance and for some of the platforms they're targeting, they want to also do external SATA and we've got really the best implementation in the market, because then you start caring about signal strength through the cable and those sorts of things and I think we've done a good job, and we also have a very well optimized software stack, whether you just want to use the base drivers or you want to do RAID.

Q - Tayyib Shah

You don't see that changing through the latter part of the year as the market commoditizes?

A - Steve Tirado

Yeah, I mean, I've said this, I think repeatedly that there is integration going on. I was just explaining what happened in the recent quarter.

Q - Tayyib Shah

Okay.

A - Steve Tirado

This is why SteelVine's so important for us. It really represents our way to take the storage market in a way that doesn't really have any strong competition against it.

Q - Tayyib Shah

And one last question if I may. Trident announced good numbers and guided well for the next quarter. Are you seeing more traction on the part of your own licensees this year? Does that change your view a little bit in terms of how much market share they can get this year? Thank you.

A - Steve Tirado

I don't see anything different. I've talked a little bit about Trident and what I expected would happen with them this year from the standpoint of how it impacts the integrated market. My view hasn't changed. I think they're going to do well. I think they outlooked about a 10% to 12% growth. We're outlooking 12% to 15% growth on a larger base, so clearly we're getting pretty strong traction in the marketplace.

Q - Tayyib Shah

Excellent. Thank you so much.

A - Steve Tirado

You're welcome.

Operator

Our next question will come from Aalok Shah from DA Davidson.

Q - Aalok Shah

Hi, guys. A quick question for you, Steve. You talked about the pricing pressure on the discrete side, could you talk about maybe what's going on in the licensing side? Are you seeing that similar type of pressure when you're going out to negotiate new deals?

A - Steve Tirado

Yeah, there's some, there's some competitors out there trying to license. It's hard to say because when we price a deal, it's a function of the process technology, the kind of specials that they may wanted to have. We still do get quite a premium when they wanted to be something in the 90 nanometer or 65 nanometer process geometry. So I wouldn't say that we've had tremendous pressure there. There are alternatives out there, both for SATA and for HDMI but I will say this. Most of the top vendors out there really, really prefer to go with Silicon Image if they're going to go that direction.

Q - Aalok Shah

And Steve, I missed this. Bob, could you just give us the guidance again for the next quarter? What did you guys say about revenue?

A - Robert Freeman

Yeah. In terms of the guidance, we said that for total revenue for the year, year-over-year, we've increased our guidance. Last quarter we said it was 15% to 25%. We've raised that to 20% to 30% for 2006. And then we said the total revenue for the second quarter was going to increase to between 12% and 15%.

Q - Aalok Shah

That's helpful. Steve, one more quick question for you. You guys made the UMC announcement this quarter. Can you give us a little bit of color what led to you guys being giving qualification or getting qualification from UMC and what does this indicate to us? I mean, should it indicate a new big customer or something along those lines?

A - Steve Tirado

Yeah, I mean this was purely driven by customer demand. We had several customers out there who said we'd really like to do, to see something available through UMC. The way this works is, we announce the availability and then what happens is as customers are interested, they come and negotiate the deal with us directly. But I think it's going to be a, it's going to be attractive for some of the licensees.

Q - Aalok Shah

Would you have done this if, I mean, is it multiple customers or one customer that specifically asked for this?

A - Steve Tirado

It’s multiple customers. We wouldn't do something like this unless there was a good reason to do so.

Q - Aalok Shah

Great. Thanks a lot, guys.

A - Steve Tirado

You're welcome.

Operator

We'll take our next question from Jenny Hsu from Thomas Weisel.

Q - Jenny Hsu

Hi. A question for Steve. Could you give us an update on where you see HDMI penetration this year in the non-traditional devices outside of digital TV?

A - Steve Tirado

Yeah I mean, the main ones that we've already talked about are in, I guess the big one is the game consoles with Sony announcing that they're putting HDMI on their PlayStation 3. We've also made announcements on digital camcorders and cameras and those are probably the mainline places where HDMI is going. What else could I say? There is -- we have had some interest on the part of some of these handheld personal media players, especially as they're starting to look at video and that's something for the future. So it's been pretty interesting and I think that in the future it's not hard to imagine that even the telephone market at the high end where you're integrating the media player and your personal information center and all that, it's not hard to imagine that they're going to start to look at some way of connecting to a television to display content, especially as the camera quality in these phones goes up to 5-6 mega pixels. Now you have something that's worth showing on a larger screen.

Q - Jenny Hsu

Okay and then, that's really helpful. What do you see driving HDMI growth the strongest this year? Would it be from the gaming consoles, your traditional TVs or also the newer source devices?

A - Steve Tirado

Now I want to make it clear that on the gaming console side I'm not saying that that's necessarily Silicon Image. I'm just telling you that's a trend in the market towards HDMI that offers an opportunity for growth. This year most of the HDMI growth is really happening, again on the television side. The penetration is getting bigger and the numbers are going up. So I heard that roughly there's a little under 50 million LCDs last year going up to a little under 75 this year. So that's one big driver for growth. The other thing that's happening is that a lot of the source devices are now saying, okay, we want to offer HDMI out. So most of the set-top box and DVD guys are now going to HDMI as their digital connection out, and believe or not there are a lot of interesting high-end DVD players and in that case we are getting sockets there, simply because they want to support the best implementation for HDMI in their high-end products.

Q - Jenny Hsu

Thank you.

A - Steve Tirado

You're welcome.

Operator

Operator Instructions. We'll take a follow up now from Charlie Glavin from Needham & Company.

Q - Ed Marquand

Hi, Steve. This is Ed Marquand (phonetic) for Charlie Glavin. Just to clarify, you were mentioning something about the Sony announcement. Are you saying that you guys are supplying the chips to Sony or are you saying that they have announced an HDMI interface on their PS3?

A - Steve Tirado

Yes, I haven't said anything different than I've said in the past, and that is that Sony has announced the use of HDMI. I'm not saying that we are involved with that. I was just-- the question was: where are the increased new platforms coming from? And that's one area where we're going to see increased HDMI utilization.

Q - Ed Marquand

Right. Okay, great. The other thing is, Bob, can you give us a breakdown of your licensing revenue in terms of PC versus storage versus CE?

A - Robert Freeman

Yes, actually we have we had an increase, a pretty significant increase in terms of our HDMI licensing fees, as well as the beginning of our royalty income off of HDMI as well for this quarter.

A - Steve Tirado

But you're asking overall. It's roughly a 70:30 split.

A - Robert Freeman

Yeah.

A - Steve Tirado

Storage to - I'm sorry, CE being the big one and storage being the smaller one and it's been pretty consistent, 65:35, 70:30. Usually that's about the split there is on the licensing. We don't really do much of anything in the PC anymore.

Q - Ed Marquand

I see. Just thanks for clarifying that. One last thing is about the PC. You mentioned that there was one customer who started to ramp first quarter. I believe you were talking about a TV customer, right? And are they ramping for additional TV with HDMI or are you just talking about them deciding to start procuring parts earlier on then what you expected for Q2?

A - Steve Tirado

I was talking about the first quarter, right?

Q - Ed Marquand

Yes.

A - Steve Tirado

So we actually got into a big OEM and won 100% of their product line, and in order to do that we were a little bit more aggressive on pricing, but we thought it was well worth it, because it was a huge win for us. And so that volume really kicked in to high gear in the first quarter and that is what promoted some of the volume mix and put some pressure on the ASPs overall and a little bit on the margin side. But it was such a large opportunity we really couldn't walk away and the pricing was reasonable for us, and certainly within a reasonable margin with respect to our products. I mean, typically we'll get somewhere around 50 to 55 points on margin and the reason we've been up in the 60 percentile has been somewhat promoted by the licensing that we've done. But again, when you look at the market and the opportunity, it's far better for us to take some of the unit margin hit in order to maximize total margin for the company.

Q - Ed Marquand

Right. So, are you saying that the 58% gross margin guidance that you are giving, is that for second quarter or are you saying that more for a year?

A - Robert Freeman

We said that that's for the second quarter.

Q - Ed Marquand

That was for the second quarter. I see.

A - Robert Freeman

And then also, related to that large OEM, too, a lot of the sales to that OEM went through their distributor. So -- which kind of drove or changed our DSO because a portion of the revenue has been deferred till the second quarter, but the receivables still there.

Q - Ed Marquand

Great. Thanks for clarifying that.

Operator

And we'll take a follow-up from Tayyib Shah from Longbow Research.

Q - Tayyib Shah

Hi guys, can you talk about the margin downtrend that you're guiding towards in the second quarter? Should we expect you to continue to be aggressive on pricing and maybe this trend to continue in the third quarter as well as you go to production with new designs?

A - Steve Tirado

Tayyib, I don't want you to over-steer on this. So we've had the last two quarters, we've averaged about 58% and so we're out looking that for the next quarter and I think that's about all we're going to say at this point.

Q - Tayyib Shah

Fair enough. And then in the PC side, I mean, could you give us some idea of how that's split between HDMI and DVI now?

A - Steve Tirado

It's still dominated by DVI, however, if I look at the preponderance of new design wins, a lot of them are HDMI. But the volumes aren’t that big yet. I think we probably won't see a bigger impact from HDMI as a percentage of PC business until the latter half of this year. I think that some of the new notebooks and desktops going into the Christmas and back-to-school selling season could have some good impact with respect to the mix of HDMI to DVI. But right now, the preponderance of what we're seeing is DVI.

Q - Tayyib Shah

Okay. And then you talked about the HDMI really taking hold in the flat panel TV side. Are you finding HDMI penetration into CRT TVs also increasing? Or is that-- is that a segment that--?

A - Steve Tirado

There's a little bit there but, but it's not really anything significant. And what's happening is everybody's going flat, so it's not a market that we're focused on either.

Q - Tayyib Shah

Okay. And then it looks like your design portfolio is pretty strong for the back half of 2006. What's your main risk here that would prevent your designs from going to production between now and, let's say in the third quarter?

A - Steve Tirado

I don't see anything outside of the normal risks that we would run with respect to managing our supply chain and making sure that our forecasts are reasonably accurate so we don't wind up with surprises on the upside. I don't if you're asking me do I see any design risk with respect to getting our products out on time or being supplied by our supply chain, I don't see anything out of the normal. I mean we always have risk every quarter with respect to all those variables, but I don't see anything that's going to increase that as we look ahead.

Q - Tayyib Shah

Okay. Thank you.

A - Steve Tirado

You're welcome.

Operator

We'll take our next question from Brian Alger from Pacific Growth Equities.

Q - Erik Rasmussen

Hi, this is Erik Rasmussen for Brian. I just wanted to follow up. You talked about SteelVine being down to about 400,000 or slightly below 400,000, this quarter, this year being a design win year with next year more of a growth year. In the past, you talked about maybe an $8 million to $10 million ramp or revenue opportunity. Where do you see this in 2007?

A - Steve Tirado

So, I guess you haven't been listening to many calls. So, we decided to wind down the systems business quite a while ago, okay? So, the $8 million to $10 million number run rate was predicated on us really going after the systems market and we decided not to do that quite some time ago. One of the things I will say, however, is we may see some interesting things happen. We've just gotten on to the Dell website through our relationship with LaCie and that has not kicked in yet. So we're anxious to see how much of an impact that has on the system boxes as it relates to next quarter. The 400,000 a little under 400,000 for this quarter and I think last year we did last quarter we did about $0.5 million, those are those system boxes that we're selling primarily through LaCie and what we did was we decided that it really represented too much of a departure in our business model to go after those system customers and we decided to really focus on consumer applications and home applications for SteelVine. And so, as you know, to get a design win into production you're in sort of a 12 to 18 month cycle. Exciting news on this quarter was that we have garnered a really good OEM and we're going to do that announcement this quarter or I should say in Q2 and we hope to just keep that going.

Q - Erik Rasmussen

Great. So you right now I guess it's too early to give us an idea of what we might expect for '07? You're still kind of trying to win more designs and--?

A - Steve Tirado

Yes. I mean, we're not going to give you any outlook on '07, probably, until Q4. We're really trying to make sure that, again, that we're very consistent and predictable, we either meet or beat our guidance on an ongoing basis and so we've kind of taken the tack that we'll give you a core outlook at a time. Now we did, we did adjust our annual outlook because if you look at where the Street was for Q2, they were expecting on a consensus basis about an 8% growth and we're going to be quite a bit better than that in Q2. And so we obviously had to adjust the annual number.

Q - Erik Rasmussen

Got you. Okay. Maybe I missed this earlier, but the 1.3 million, the non-tax, non-cash benefit, it seems like you're kind of carving that out to get to your non-GAAP. Can you just kind of go through that again, help me understand that?

A - Robert Freeman

Yeah. Okay, so what we've put in is basically for the year a 38% tax provision. However, a portion -- a significant portion of that provision is based upon are not being able to utilize stock compensation benefits from stock option exercises. So instead of being able to take those benefits and apply them against the provision, we take them to capital. But effectively, we'll still be able to utilize them for purposes of our 2006 tax liability, and so we don't really have a tax liability, per se, and so we essentially take that to capital. And being a non-cash item and also being an item that we really can't control because they're based upon stock option exercises, we exclude that portion for purposes of non-GAAP reporting.

Q - Erik Rasmussen

Okay. Well, I guess we'll expect to see this going forward, last quarter, as well?

A - Robert Freeman

Yes. The big change will be in at the end of the year you saw that adjustment go into the cash flow statement as part of operating cash flow. Going forward, that adjustment will actually be in cash flow from financing versus operations.

Q - Erik Rasmussen

Great. Okay, thank you.

A - Robert Freeman

You'll be able to see it in the cash flow statement.

Q - Erik Rasmussen

Great.

Operator

And we'll take another follow-up from Charlie Glavin from Needham & Company.

Q - Ed Marquand

Hi, this is Ed again. I just want to clarify one thing. You had some supply constraints back in – well actually in fourth quarter. Can you make some comments on that?

A - Robert Freeman

Yes. In fact, we talked about that a little bit in my comments. Essentially what we've done is we've kind of relaxed, within prudent guidelines, our inventory targets to allow us to do a better job of essentially our production of products but also to make sure that we've got, either in a wafer bank or somewhere within the work in process, sufficient materials and product to meet our customer demands. So—

A - Steve Tirado

The other thing that we've done is on the test side, we had some risk there in Q4, so we've actually shifted our strategy a little bit in that, we are acquiring some testers in order to guarantee that we've got capacity, especially as we get into the Q2 Q3 timeframe. We found out from an operational cost standpoint it's actually more cost effective for us, based on the arrangement we can set up with our suppliers. So, we as a result of that Q4 incident, we have made some adjustments going forward to make sure we've both got supply and actually as it turns out, it's going to be a better cost scenario for us that we hope will start to kick in towards the end of this year.

Q - Ed Marquand

Great. Thanks for clarifying that.

A - Steve Tirado

Okay, we'll take one more call. Hello?

Operator

At this time, sir, we'll conclude the question and answer session then. I'll turn the conference back over to Mr. Freeman for any additional or closing remarks.

Robert Freeman, Chief Financial officer

Thank you. We don't have any additional remarks at this point in time so I think we'll conclude the call at this time.

Operator

Thank you. That will conclude today's conference. At this time, all participants may now disconnect.

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