Silicon Image Q2 2009 Earnings Call Transcript

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Silicon Image, Inc. (NASDAQ:SIMG) Q2 2009 Earnings Call July 23, 2009 5:00 PM ET


Mike Bishop - Investor Relations, The Blueshirt Group

Steve Tirado - President and Chief Executive Officer

Harold Covert - Chief Financial Officer


Richard Shannon - Northland Securities

Rajvindra Gill - Needham and Company


Good day, everyone and welcome to Silicon Image's Second Quarter 2009 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. Mike Bishop. Please go ahead, sir.

Mike Bishop

Thank you. Good afternoon and welcome to Silicon Image's second quarter 2009 financial results conference call. I am Mike Bishop. I'm Silicon Image's Investor Relations.

Joining me today is Steve Tirado, the company's President and CEO; and Hal Covert, the Chief Financial Officer.

The agenda for today's call includes the discussion of second quarter results and company's strategy from Steve, followed by Hal with a more in-depth discussion of financial results in the second quarter of 2009, followed by financial performance estimates for third quarter and comments on the fourth quarter. We will then open the call for Q&A.

Before I turn the call over to Steve, let me remind the listeners that during the call, we will be making forward-looking statements based on our current expectations 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 their anticipated benefits, the timing of new product introductions, average selling prices, design wins, market demand for our products, financial results and performance.

Actual results may differ materially form our forward-looking statements. Moreover, our forward-looking statements and the company's future results are subject to certain risks and uncertainties which we described in today's press release, as well as in our filings with the SEC including but not limited to our most recent periodic reports and 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 non-GAAP financial information to GAAP information in our second quarter 2009 financial results press release, which is available on the Investor Relations section of our website at

And with that, I'll now turn the call over to Steve.

Steve Tirado

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

Q2 was a tough quarter and a turning point for Silicon Image. Our financial results for the second quarter 2009 came in at 37.3 million in revenue, with gross margins coming in at 53.7%.

As we look Q3, it is clear that the mix of legacy compared to new product will start to return to a more normalized levels beginning in the second half of 2009 as we start to ship new products and continue to gain momentum from products such as our DTV port processors with InstaPort. Additionally, with the announcement of HDMI 1.4, we are starting to see customer Silicon innovation not just cost reduction.

While Q2 was difficult, we are entering Q3 with three important differences. Number one, improved visibility; number two, a greater than one book-to-bill ratio; and number three, our more efficient operating infrastructure.

Our decision to cut expenses in December of '08 and then again in June of '09 has kept our cash burn low, and now provides leverage on our expected revenue growth to drive earnings, going into the second half of 2009 where we expect to see over 15% sales growth over the first half of 2009.

As I stated last quarter, we still expect growth in the second half of 2009, based on design wins and several major OEM's in the DTV storage and mobile areas.

More to the point, as we examine our backlog and forecast for Q3 sales, we believe we will see growth across all segments. Significant growth will be seen in DTV with our port processors supplemented by good growth in home theater, storage and mobile with a slight uptick in PC sales as a result of penetration in net books and several Taiwanese PC ODMs.

I'll now cover the key highlights for the quarter. We had a busy quarter for product introductions and standard advancements. We made significant progress within the HDMI 04 memory and MHL standard efforts and continued to make progress on the liquid HD product fronts.

On the standard front, let me start with the release of the HDMI 1.4 certification. The HDMI 1.4 is a significant release for the consumer markets and that it lays the foundation for profound changes in the HD entertainment experience. The addition of Ethernet inside of the HDMI cable acknowledges the importance of continued cable consolidation and connecting the home theater stack.

Even more importantly, that recognizes the trend in IP productivity on over 24% of source devices shipping today in the home theatre stack. From video on demand on your cable or satellite service to Coodoo Voodoo to Apple TV, manufacturers are recognizing that IP based source devices can provide a broader range of entertainment options for consumers.

The HDMI certification has now embraced the trend in IP connectivity necessary for a whole new class of entertainment content, services and applications by including it in into the HDMI standard. At the same time, we're looking forward to future enhancements in picture quality that will come with 3D movies and television. The HDMI standard now incorporates the necessary protocol changes to handle this important improvement in visual quality.

We also anticipate to the move to QuadHD where 8 million pixels will become a natural extension of the HD experience; both consumers appreciate today, with only 2 million pixels on the screen.

While, these are some of the bigger highlights in the release that affect bandwidth quality and interoperability, there are a range of other new capabilities we will soon experience on our TVs in the coming years.

In response to the release of the HDMI 1.4 certification, Silicon Image has launched several industry leading products that implement the advantages of HDMI 1.4. We introduced the latest port processor that includes our proprietary InstaPort technology which enables sub-second switching between HDMI devices connected to your HDTV.

The 93, the Silicon Image 9389 core processor, which includes all of the industry leading features from the Silicon Image 9287 adds HDMI 1.4 features including HDMI Internet channel, audio return channel and 3D over HDMI. We also introduced the Silicon Image 9334 products for home theater applications and both are now sampling the customers.

Additionally, we have announced that existing Silicon Image HDMI transmitters and receivers are being upgraded to support 3D over HDMI, providing for the industries broadest portfolio of 3D over HDMI capable port processors, receivers and transmitters. Finally, we announced the new family of HDMI 1.4 IP cores for our growing customer base of licensees.

Let me turn to Serial Port Memory. The Serial Port Memory standard initiatives targeted at the mobile phone market, where low pin count, high performance and low power allow new, more powerful applications possible in a constrained implementation environment has announced the appointment of Jim Venable as the SPMT, LLC President.

The promoters group consisting of Samsung, Hynix, LG and Silicon Image are making progress towards the release of the 1.0 certification, which is targeted for release by year's end.

MHL. The mobile high definition link targeted at mobile devices, especially mobile phones where a micro USB type connector supporting as few as five pins, can support HD quality, digital video and audio, USB, charging and other capabilities, continues to make progress in the recruitment of our promoters group. We believe we are in track for an announcement at this quarter.

In advance of this important milestone, as I said in my last call, we have a design win going to production with this technology starting in Q3 this year, with a major mobile phone OEM. We have also concluded our first licensing deal for this technology.

LiquidHD. LiquidHD are comprehensive protocol suite designed to usher in a new generation of digital devices to enable virtual movie distribution in the home and mobile environment, continues to make progress on the product front with a new revision of our software stack for cable, satellite and IPTV customers.

We believe the advent of Ethernet support on all future HDMI devices is a natural foundation for everything we're doing with LiquidHD. LiquidHD is an IP based solution capable of running on any physical transport from coax to power line to wired and wireless Ethernet, and now HDMI 1.4 connected devices.

We are doing limited sampling and prototyping of our first generation LiquidHD software and micro client or DTV chip hardware this quarter. We continued to receive strong interest in evaluating this new digital content distribution platform from our cable, DTV and PC companies.

And finally on the storage front, we announced our Gen 3 Steel Vine Storage Processor this quarter and expect the initial ramp of this product to drive chip sales growth over last quarter.

In summary, Silicon Image had a tough quarter. But believe we will see significant sequential growth of approximately 20% for Q3 over Q2, driven by design wins. And believe we have trimmed expenses sufficiently to have both earnings growth and cash generation in the second half.

With that, I'll turn the call over to Hal for financial update and guidance before we take your questions. Hal?

Harold Covert

Thanks Steve. Good afternoon. I would like to cover three topics: highlights of our financial results for Q2 '09; our financial goals for Q3 '09 and comments about Q4 '09.

Unless otherwise indicated gross margin, expense and earnings related items are reported on a non-GAAP basis, which excludes stock based compensation expense, amortization of intangible assets and restructuring charges.

Our GAAP financial results and a reconciliation of non-GAAP measures referenced in today's call are available on the Investor Relations page of our website

Revenue for Q2 '09 was 37.3 million compared to 40.5 million for Q1 '09 and 70.1 million for Q2 '08. The sequential and year-over-year drop in revenue for the most part reflects the unfavorable global economic environment. We believe that quarterly revenue generation will begin to improve as we start to rollout our new products in the second half of 2009.

Product revenue for Q2 '09 was 29.4 million, for Q1 '09, 34.6 million and Q2 '08, 61.8 million. License revenue for the quarter was 7.9 million versus 5.9 million in Q1 '09 and 8.2 million in Q2 '08.

CE product revenue accounted for 87% of our total product revenue in Q2 '09, while PC product revenue represented 6% and storage product revenue 7%. Historically, over the last two years prior to the 2009, CE product revenue has been in the 70% range.

Average selling prices for product sales of $1.43 per unit during Q2 '09 were inline with our expectations. Historically over the last two years prior to 2009, average selling prices were in the $2 range.

Our overall gross margin for Q2 '09 was 53.7% versus 55% for Q1 '09, and 59.1% for Q2 '08. Product gross margin for Q2 '09 was 42.2% compared to 47.9% in Q1 '09 and 54.4% in Q2 '08, while our license gross margin was 96.5% in Q2 '09, 96.7% in Q1 '09 and 94% in Q2 '08.

Product mix, unfavorable variances and the impact of fixed overhead with lower product revenue volume in Q2 '09 were the primary reasons for the decrease in product gross margin as a percent of revenue when compared to sequential and year-over-year results.

The variances and overhead elements equated to approximately a 3 percentage point impact on our product gross margin percent and 2 percentage point impact on our overall gross margin percent.

We believe that product gross margin will begin to improve as we start to rollout our new products and increase revenue volume in the second half of 2009.

Operating expenses for Q2 '09 were 26.3 million, compared to 28.1 million in Q1 '09 and 35.5 million in Q2 '08. The sequential and year-over-year decrease in operating expenses is a result of restructuring programs and tight expense controls. We believe that operating expenses will continue to sequentially decline in the second half of 2009.

Head count as of June 30, '09 was 574, compared to 597 as of March 31, '09 and 643 as of June 30, '08. We expect head count to be lower by approximately 50 people by the end of 2009.

Our operating loss for Q2 '09 was 6.3 million, compared to an operating loss of 5.8 million in Q1 '09 and operating profit of 5.9 million or 8.4% of revenue for Q2 '08. The decrease in operating profit, both sequentially and year-over-year is primarily due to lower revenue and to a lesser extent a decrease in gross margin as a percent of revenue, both of which were partially offset by lower operating expenses.

For Q2 '09, our other income was 0.6 million, compared to 0.9 million for Q1 '09, and 1.4 million for Q2 '08. The sequential decrease reflects foreign currency charges while the year-over-year decrease is due to lower interest income as a result of using $68 million of cash in the first six months of 2008 for our common stock repurchase program.

In Q2 '09, our non-GAAP effective income tax rate was 25%, while our GAAP tax rate was 28% including discreet items. For Q2 '09, we had a non-GAAP loss of 4.3 million or a $0.06 per share versus the non-GAAP loss for Q1 '09 of 3.6 million or $0.05 per share. In Q2 '08, we have non-GAAP net income of $5 million or $0.07 per diluted share.

Our GAAP net loss of 13.3 million or $0.18 per share for Q2 '09 consisted of a loss of approximately 8.2 million from operations or a $0.11 per share and 5.1 million from restructuring charges or $0.07 per share.

For Q1 '09, our GAAP net loss of 33.3 million or $0.45 per share consisted of a loss of approximately 14.1 million from operations or $0.19 per share and 19.2 million for the write-off of goodwill or $0.26 per share. Our GAAP net loss for Q2 '08 was 0.5 million or $0.01 per share.

Stock base compensation, which is not included in our non-GAAP net income was 4.2 million in Q2 '09 compared to 3.6 million in Q1 '09 and 6.3 million in Q2 '08.

Amortization of intangible assets which is not included in our non-GAAP net income was 1.5 million in Q2 and Q1 '09 and 1.6 million in Q4 '08. We also incurred a restructuring charge which is not included in our non-GAAP net income in Q2 '09 of approximately 7.1 million, primarily due to head count reduction in June 2009 and planned head count reduction during the second half of 2009.

Weighted average shares outstanding for Q2 '09 were 74.8 million and 74.4 million for Q1 '09. Diluted weighted average shares outstanding for Q2 '08 were 74.8 million.

Moving to the balance sheet, cash and investments as of June 30, '09 were a 163 million, compared to 169 million on March 31, '09 and 185 million on June 30, '08. The sequential decrease in cash and investments is for the most part due to operating loss in Q2 '09.

The decrease on a year-over-year basis primarily reflects the use of cash for accounts receivable during Q1 '09 when our accounts receivable balance return to a normal level as compared to the end of Q4 '08 and the aforementioned loss during Q2 '09.

For Q2 '09, our accounts receivable were 19.1 million, which equates to DSL of 46 days as opposed to 39 days for Q1 '09, 37 days for Q2 '08 and nine days for Q4 '08.

Net inventory as of June 30, '09 was 9.2 million, which represents approximately 7.4 turns on an annualized basis. This compares to net inventory of 12.2 million on March 31, '09 and a 17.7 million on June 30, '08.

Both our channel inventory and in-house inventory were at the low end of historical inventory patterns as of June 30, '09.

Capital expenditures for Q2 '09 were 1.6 million, compared to 0.8 million for Q1 '09 and 1.9 million for Q2 '08.

Now, I'd like to discuss the company's common stock repurchase program. We do not repurchase any of our common stock during Q2 '09 and have not repurchased any of our common stocks since June of 2008, when the Board authorized our current $100 million stock repurchase program. During June of 2008, we repurchased $5 million of our common stock under this program.

Over the last several quarters, as we have experienced the unfavorable impact of the global economic environment on our operations, we elected not to actively pursue our common stock repurchase program.

In the second half of 2009, if our operating performance improves as expected, we will likely remove the self-imposed restriction on repurchasing our common stock.

This completes my summary of our Q2 '09 financial results. Next, I would like to discuss our financial goals for Q3 '09 and provide some comments about Q4 '09.

The following is a summary of our financial goals for Q3 '09. Revenue, 44 million to 46 million; gross margin approximately 54%; GAAP operating expenses approximately 32 million which includes stock based compensation expense; and amortization of intangible assets of approximately 4.5 million and 1.5 million respectively. These expenses are not included in non-GAAP expenses.

Non-GAAP operating expenses approximately 26 million; interest income 0.7 million to 0.8 million; diluted shares outstanding approximately 75 million; and finally use of approximately $5 million of cash for accounts receivable and inventory related to the projected increase in revenue in Q3 '09.

Now turning to Q4 '09. With our new product rollout plans and related projected customer demand, we anticipate that Q4, '09 revenue will be approximately at the same level as Q3 '09 with a similar gross margins and that operating expenses will be lower than Q3 '09 by approximately $1 million.

As we move forward with our new product initiatives and reduced operating expense level, we believe that the company is positioned for profitability in the second half of 2009 as well as in 2010.

In 2010, we anticipate that revenue will be higher than the level projected for 2009. And we plan to continue to put downward pressure on our expenses as we leverage our operating infrastructure and continue to improve efficiency.

This concludes my remarks. Operator, we will now take questions.

Question-and-Answer Session


Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). And we'll hear first from Richard Shannon with Northland Securities.

Richard Shannon - Northland Securities

Hi Steve. How are you?

Steve Tirado


Richard Shannon - Northland Securities

Good. I guess the first question from me is on the product gross margins. If I did my calculations right, I got a 41% for the quarter, which is down a fair amount. Kind of curious if this is kind of a new range here that we should expect or should we see some improvement as you see a more newer products come in? I know you mentioned Steve in your script about several low point in terms of legacy product share. What's your picture understanding of where we think that can go in the third quarter and maybe into the future?

Harold Covert

Yeah, so Richard this is Hal. So I think, in Q2 our product gross was margin was about 42%, pretty close to what you just said. As I indicated in my prepared remarks, we believe that we had about a 3 percentage point hit during the quarter from our negative variances and the overhead volume that we have at the present time.

We believe that the negative variances are behind us now and are going forward; the product margin will improve and head it back up towards the mid-45 to 50% range over the next few quarters.

With all those impacts we actually would have been a little bit above 55% gross margin for the quarter on a total basis. So we do believe that as we move forward, the product gross margins will improve in the back half of the year. And then as we get into 2010 when we were in kind of the full rollout of our new products, we should push back towards our targeted range.

Richard Shannon - Northland Securities

Okay. Okay. The comments, Steve correct me if I am wrong, I had to moving up out of some calls here, I've got a couple going. But in terms of the legacy between products, was there... are you experiencing some market share losses in their pricing that's creating a difficulty here in near term?

Steve Tirado

You mean in terms of the gross margins?

Richard Shannon - Northland Securities


Steve Tirado

The gross margin was really just what Hal said, if we look at our ASP decline is within normal parameters and we experience a 4 to 5% decline on a quarterly basis, just that our business, it really was the variance and the volume that drove the product margin down. And what we expect is that as we roll the new products out which have better characteristics in terms of gross margin, you'll see our margins improve.

Harold Covert

Yeah, so we should push right back into the 55 to 57% overall gross margin range.

Steve Tirado

Right. And that's we're really trying to... that's a model we're always driving the business towards.

Richard Shannon - Northland Securities

Okay. Any thoughts on what kind of contribution from your consumer electronics products specifically that you'll get from either 1.4 or perhaps 1.3 and 1.4 together, any sense that you can give us for that?

Steve Tirado

Yeah. I'm hesitant to the break it out, but I will say that we will shift some percentage of 1.4 product out in Q4 of this year. We have customers lined up and we'll see what the volumes eventually turn out to be. But we are expecting to shift some percentage of our product on 1.4 based step in Q4.

Richard Shannon - Northland Securities

Okay. And did you make any statements about your expectations of MHL product revenues during the third quarter or the second half of this year?

Steve Tirado

Yeah, I'd actually mention this last quarter. We have a design win in not a very high volume but in a kind of high end phone with one of the big mobile phone OEMs that will start shipping this quarter. And it's using the MHL technology inside.

Richard Shannon - Northland Securities

Okay. Any sense of how big that can be? Is that something to get over the million dollar mark in the quarter?

Steve Tirado

Over the million dollar mark in the quarter?

Richard Shannon - Northland Securities

In any quarter that it starts join revenues I guess?

Steve Tirado

Let me look here. It's probably... it's in the low millions and that's going to get spread out over like six quarters or something like that. So it's not a big revenue driver. What's significant is that the use of the technology and we think this is a good indicator about what the market thinks about the technology.

Richard Shannon - Northland Securities

Okay. And then one last quick question from me and I'll jump out of the line. For MHL, you mentioned you also have signed up a NOM for licensing. Is that the same one which you'd expect to generate product revenues from?

Steve Tirado

No, they are different.

Richard Shannon - Northland Securities

Different ones.

Steve Tirado

Yeah, two different GOs.

Richard Shannon - Northland Securities

Great. I will jump out of the line. Thank you.

Steve Tirado

Thank you.


And now, I'll open the call to Rajvindra Gill with Needham and Company.

Rajvindra Gill - Needham and Company

Yeah, thanks for taking my question. If you could kind of talk a little bit about the dynamic that's going on in the digital TV landscape this quarter. Your revenue came in at about 4 million below which you're guided to and it seems a lot of that was a much little product gross margin, product revenue, because the license revenue seemed to be better than expected. So can you give us a little bit in a sense of what's going on in the end demand market, end demand for digital TVs, especially in the high end of the market, number one.

And then number two, going to the second half of '09, what gives you confidence that the legacy issues, the legacy mix issue that you see in the second quarter are going to similarly dramatically improve in the back half of the year where you're going to get nearly 50% growth in the second half?

Harold Covert

Yeah. So let me start and then I'm going to pass it over to Steve. In regard to the Q2 revenue, we actually were in a position where we could have shipped more products if we were to have the product.

We tightened down pretty effectively on our inventories and we did have orders in-house that we could have shipped. We simply didn't have the product. So, I would characterize the Q2 missing revenue if you want to say it that way, as related more to supply chain issues as opposed to demand. And with that I'll pass it over to Steve.

Steve Tirado

Yeah, the other issue I'll add is that we also saw a tightening of capacity in the test houses in packaging. And so we had some stuff that came in towards the end and we just couldn't get it out. So that was part of what explains the down, the mix on the product side.

What gives us confidence about Q3 is really backlog visibility. It's much higher than we've had in the first and the last two quarters both Q4, coming out of Q4 and coming out of Q1. So, we've got much better visibility.

And then, there is one of our new products we had a glitch with it, we had determinant chip which we did do. And so that stuff we wanted to match shipping Q2 that will we'll ship in Q3. So, that gives you a little bit of extra boost. The Q2, Q3 delta is roughly 20%. The second half delta over first is 15.

Harold Covert

The other thing I would add I think Steve mentioned this in his prepared remarks, but Q2 was the first quarter and a number of quarters we actually had our book-to-bill ratio above one. So, we're starting to see a pickup in demand and in particular as I think customers are now certain to focus on innovation again as well as cost reduction.

Steve Tirado


Rajvindra Gill - Needham and Company

Right. And can you give us a sense though in terms of what's going on with the sale through forecast, what's going on with order rates? Are you going to continue to see kind of legacy HDMI products begin to continue to ramp or to continue in the second half and how do you look at the competition that competitive landscape? Are they begin to integrate more of this functionality into the SOC for this seems like from the TV manufacturer and some of the data points that I get from the channel is that outside Samsung and maybe one of the major TV manufacturer, no one is coming out with new 2009 models and 2010 models are even going to be halted?

Steve Tirado

Yeah. So, for us we definitely are in a bunch of 2009 models. They may not be changing the DTV processor. But I can tell you they are absolutely are changing the port processor. And that's because they want more HDMI port.

It's a smaller; it's a more incremental change that's easier to do. When you're doing a full system upgrade of your software and your chip that's a big deal. And so lot of folks to say cost and because they have got reduced R&D resources, they are not doing it as much, but they absolutely are changing port processors or at least the front-end shift. And there is a tremendous amount of interest in 1.4, there is a lot of buzz about 3D.

Then so, if you think about it, we're in this $1.50 to $2 range and some parts we have our pricing lower than that. It's not a hard economic decision and it's an easy system decision to implement the changes that we're promoting versus the whole DTV SOC.

Harold Covert

So most of the revenue upside or most of revenue growth coming in second half is not going to really come from 1.4. It's going to be continuation of the change of the processors switching them out.

Steve Tirado

Well, it's the... our port processors was InstaPort, which was the feature we brought in last year; that was really successful. And so a lot of companies wanted more ports and they wanted InstaPort. And so that is what's driving a lot of growth coming in the Q3 and Q4.

Now in Q4, we do have some customers who are interested because we have... we're sampling 1.4 technology, we have got looking... and remember to do a port processor change is a whole different deal than doing an SOC change in your TV, in your software. It's just a whole different algorithm. So, they can get some differentiated value added to in the port processor change without a huge incremental investment on the R&D side. So it's... we haven't had the same issues you might be hearing about from the SOC guys.

Rajvindra Gill - Needham and Company

And then the other driver going to the September as well as in December is the storage business. I mean based on what I am hearing that you can have outside a real big uptake in storage, either 2 million, 2.1 million or so in the second quarter if I do the maths correctly. For going to the third quarter, you got to do 6 million of revenue in the storage business and 7 million in the fourth quarter roughly for you to get to that 45 million of third quarter and 45 million in December. Maybe you can kind of help me walk through some of the key drivers that's in your --

Steve Tirado

That's not how we see the business. The mix that Hal laid out for you for Q2 is going to moderate some because we are getting some growth in storage. But it's still primarily carried by CE. I mean the port processors are big driver and then the seasonality of the consumer sector is also some of our home theater business. So we're still going to be largely dominated by CE revenue, still at around 85%.

Rajvindra Gill - Needham and Company

All right. Now going into kind of the second half, it just seems difficult that you'll be able to be profitable. And first of all you had mentioned you'll be profitable in the third quarter, which is not going to happen based on from the guided. And then year into the fourth quarter, you have mentioned your OpEx is going to be a million less than your, what you had in the third quarter, is that right?

Harold Covert

Yeah, I think what we said was that we believe we would be profitable in the second half of 2009. We didn't specify anything about Q3. If you want the numbers on the high end of the guidance that we provided for Q3, I think it would come out fairly close to breakeven. And then if you look into Q4 with about the same revenue level and margin structure with $1 million less in operating expenses, then you would be profitable in Q4.

Rajvindra Gill - Needham and Company


Harold Covert

And we did say we were going to drop our expenses roughly by about $1 million a quarter in the back half of the year.

Rajvindra Gill - Needham and Company

And so how should we look at the OpEx run rate going to 2010? There is... I'm assuming a pretty healthy revenue level based on '09 to '10. I'm assuming that you guys have got growth 20%, 22% and gross margins getting back to 55, 56%. What OpEx, what was revenue assuming?

Harold Covert

Yeah, so I think as I indicated in my prepared remarks on 2010, we said that we were going to continue to put downward pressure on our operating expenses and really getting to specify a level of this point.

So I think what you can take from that is that our expenses are not going to go up from the run-rate that we have in Q4. And we haven't really locked in on our full plan for the year yet. But, again there is going to be a lot of pressure on our expenses. We do not believe that they will go up in 2010 as we leverage the operating infrastructure.

Rajvindra Gill - Needham and Company

Okay. And if you could just I think it will stretch a little bit before, can you give us a sense of what's going on in MHL in 2010? We talked to some of the context in the channel. It seems like MHL's still a very distant products. Just one idea when you'll start to see some real tangible MHL revenue coming in?

Steve Tirado

So we have a little bit. But to your point, tangible it's going to require certain events to take place. So if you look at HDMI, it wasn't until the spec went up on the website that all of a sudden we had a tremendous amount of interest in those parts and in moving to those parts. I think it will be a similar phenomenon for MHL. You'll have to watch for the working group announcement. I know I have been promising this. I think it's going to come pretty soon. And we actually have the full promoters group assembled already.

So we're just kind of cranking through the LOY to compare across invitees and down in the eyes (ph). But it will take until the spec comes up. We'd like to see the spec come out before the end of the year. And so we expect to see, we hope to see I should say meaningful revenues in 2010 and then growing thereafter.

Rajvindra Gill - Needham and Company

All right guys. Thank you.


(Operator Instructions). And now we'll hear from Adam Benjamin with Jefferies.

Unidentified Analyst

Good afternoon, guys. It's Blinker (ph) for Adam. Steve, I had a question on your Q4 flat. It's hard to tell given typical seasonality. This is not quite a typical year, but it's typically a down quarter particularly in the TV market. Just curious what you baking into your assumptions for flat?

Harold Covert

Yeah, I'll start and then I'll pass it to Steve. What we're trying to do is to take a look at our revenue forecast procured by our sales guys and the backlog. And I think the thing it's a little bit different this year than past years is that the new product rollouts that we have going on right now and then some of the design wins we have. So with that I'll pass it to Steve.

Steve Tirado

Yeah, what we have for the reason we think we'll be flat in Q4 is we have some customers who are doing an early ramp. They are excited about the 1.4 features and they are asking us for products sooner than kind of the normal ramp.

And this has happened in other years. And if you look at Silicon Image's history, when we're on the adoption curve for a new standard release, it tends to drive our Q4 higher than normal. So this is one of those years.

Unidentified Analyst

Okay. And then just continuing on your comments that you expect 2010 to be a growth year; the PC market has declined and I think you expect that to continue to decline from assuming that product line would be down, storage I think similarly. So I guess when were you baking in as far as the CE business for that growth and with 1.4 just kind of starting with some of these products in Q4, but I am assuming smaller volumes. It sounds like it's probably not until kind of the back half for the year that you would get material tractions.

So I am just trying to figure out what kind of percent are you thinking baking into the assumptions for 1.4 adoption or is it some of your other products MHL or if you could just elaborate on what kind of drivers you look at CE and then kind of what your kind of outlook is for the PCM storage?

Steve Tirado

Sure, I think on the PC front you got that correct. We took the big hit this year for PC because the HDMI technology has being integrated into South Bridge. The little uptick we're seeing over the next quarters, really driven by net books because Intel has yet to integrated near South Bridge for the net book chips that they add on the HDMI capability. But eventually they will do that.

So, we are not counting on much as it relates to PC. There is always some amount you get, but it will be very small. We are expecting growth in storage, driven largely by the Steel Vine Storage Processor that we announced just this quarter.

And then on the CE front, there is... it kind of goes back to what I was saying before. The decision to do a new port processor is a very different decision process than doing a new SOC. Doing a new SOC is a big deal. It's a lot of software, it's a lot of validation and call time in several months of bring up.

Bringing a port processor in is a lot easier and a lot less expensive. And we've made it a lot easier as time has gone on. So that the drivers going into 2010 are HDMI 1.4 momentum. Bear in mind we're already out sampling parts today. So we are well positioned to get design wins for 2010. So, HDMI 1.4 is a factor.

The InstaPort technology we introduced last year we're on our second generation and we're adding some new delta and vessels to that. That's another driver for why we want our port processors.

The home theater side of the stack is looking very seriously at 1.4. As I mentioned in my prepared remarks, about 24% of source devices now have Ethernet integrated. And we think that number is driven do nothing but go higher. Because people are looking for new application, services and entertainment concept, they want to be able to offer and the internet connection allows them to do some pretty cool, pretty interesting things on the platform.

And then last things I think that's important is MHL. And I know for you guys you got to wait and see what's going on, but there is... we think we are going to make substantial progress in terms of the announcement of the working group and getting the spec out. We're hoping before the end of 2009 and that's going to give us some real momentum for 2010.

Bear in mind that we have MHL parts in the market already. And that was how we got that one design wins just wanted the OEMs.

Unidentified Analyst

Okay, helpful. And then just one final question for Hal. The licensing tick-up in Q2 which you elaborate on what drove that whether it's licensing deals or just high royalties? And then kind of, I think you indicated that you expect to be up again in Q3. Just trying to figure out what the kind of run-rate on that business is going forward?

Harold Covert

Yeah. Again, our belief is that licensing will continue to be about 15% of our overall revenue. It was up in Q2 primarily because product was down. So it was up as a percent.

Heading into the back half, we expect that it continue to stay in about the same range now. And that as we've indicated in the past that has somewhat of a lumpiness characteristic depending on when we sign the deals. But we believe for the full year that will be around 15% of total revenue.

Unidentified Analyst

Okay. So that actually would be a decline from the Q2 levels?

Harold Covert

Well, again I think if you look at Q3 and Q4, depending on when we close the deal, one quarter could be up the other one could be down a little bit. It just depends on when we close out; but if you look at for the full year overall, it should be right around the 15% range.

Unidentified Analyst

Okay. So what does that imply for product gross margins? You had indicated them being up or with you're licensing falling off it seems to indicate?

Harold Covert

Yeah. I think what will happen in the back half of the year is that some of the influence that we have in Q2, the negative influences won't be there. And we should push very close to our overall goal of 55 to 57. It would be closer to low end of 55 number. And then as we push in the next year, as we get in the full blown roll out of our new product, we should then start pushing above the 55%. But we're going to be bouncing right around the lower end of our overall target for gross margin.

Unidentified Analyst

But you can't bring up the product gross margin in the back half to offset that?

Harold Covert

The product gross margins in the back half will come up. Because again we don't believe we'll have the variances that we had in Q2. And with the revenue pickup that we're talking about, it moderates the overhead issue that impacted us in Q2.

Unidentified Analyst

Okay. Great, thanks.


And ladies and gentlemen, that does conclude our question-and-answer session. At this time, I'd like to turn it back to Mr. Mike Bishop for any closing or additional remarks.

Mike Bishop

Thanks. I would like to thank everyone for their continued support of Silicon Image and for participating today. And with that, that concludes today's call. Thank you.


Ladies and gentlemen, that does conclude our conference for today. Again, thank you for your participation.

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