Quarterly Report (10-q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended: March 31, 2013

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 000-26887

 

 

Silicon Image, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		77-0396307
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer I.D. Number)

1140 East Arques Avenue, Sunnyvale, California 94085

(Address of principal executive office)(Zip Code)

[phone]

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨   (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes   ¨     No   x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Shares Outstanding at April 30, 2013
Common Stock, $0.001 par value		77,186,705

 

 

 

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SILICON IMAGE, INC.

FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2013

Table of Contents

 

Part I FINANCIAL INFORMATION
Item 1 Financial Statements (Unaudited)			3
Condensed Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012			3
Condensed Consolidated Statements of Operations for the three months ended March  31, 2013 and 2012			4
Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March  31, 2013 and 2012			5
Condensed Consolidated Statements of Cash Flows for the three months ended March  31, 2013 and 2012			6
Notes to Condensed Consolidated Financial Statements			7
Item  2 Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3 Quantitative and Qualitative Disclosures About Market Risk			24
Item 4 Controls and Procedures			25
Part II OTHER INFORMATION			25
Item 1 Legal Proceedings			25
Item 1A Risk Factors			26
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds			41
Item 3 Defaults Upon Senior Securities			41
Item 4 Mine Safety Disclosures			41
Item 5 Other Information			41
Item 6 Exhibits			41
Signature			42
EXHIBIT 10.01
EXHIBIT 10.02
EXHIBIT 31.01
EXHIBIT 31.02
EXHIBIT 32.01
EXHIBIT 32.02

 

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Part I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS (Unaudited)

SILICON IMAGE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(unaudited)

 

		March 31, 2013				December 31, 2012
ASSETS
Current Assets:
Cash and cash equivalents		$	45,964			$	29,069
Short-term investments			70,522				78,398
Accounts receivable, net of allowances for doubtful accounts of $1,234 at March 31, 2013 and $1,263 at December 31, 2012			40,515				37,936
Inventories			14,281				11,268
Prepaid expenses and other current assets			6,816				8,105
Deferred income taxes			841				841
Total current assets			178,939				165,617
Property and equipment, net			14,125				14,840
Deferred income taxes, non-current			4,144				4,144
Intangible assets, net (Note 6)			10,750				11,452
Goodwill			21,646				21,646
Other assets			10,625				9,043
Total assets		$	240,229			$	226,742
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	19,826			$	10,690
Accrued and other current liabilities			16,605				19,600
Deferred margin on sales to distributors			13,215				10,340
Deferred license revenue			2,310				2,185
Total current liabilities			51,956				42,815
Other long-term liabilities			17,024				16,827
Total liabilities			68,980				59,642
Commitments and contingencies (Note 7)
Stockholders’ Equity:
Convertible preferred stock, par value $0.001; 5,000,000 shares authorized; no shares issued or outstanding			—				—
Common stock, par value $0.001; 150,000,000 shares authorized; shares issued and outstanding: 77,097,490 shares at March 31, 2013 and 77,003,599 shares at December 31, 2012			100				99
Additional paid-in capital			520,618				511,522
Treasury stock, 26,214,339 shares at March 31, 2013 and 25,330,124 shares at December 31, 2012			(148,123	)			(143,912	)
Accumulated deficit			(201,373	)			(200,792	)
Accumulated other comprehensive income			27				183
Total stockholders’ equity			171,249				167,100
Total liabilities and stockholders’ equity		$	240,229			$	226,742

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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SILICON IMAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

		Three Months Ended March 31,
		2013				2012
Revenue:
Product		$	50,341			$	43,024
Licensing			11,698				11,979
Total revenue			62,039				55,003
Cost of revenue and operating expenses:
Cost of product revenue (1)			25,798				23,099
Cost of licensing revenue			267				125
Research and development (2)			18,558				21,707
Selling, general and administrative (3)			16,402				16,137
Amortization of acquisition-related intangible assets			251				496
Restructuring expense			(7	)			5
Total cost of revenue and operating expenses			61,269				61,569
Income (loss) from operations			770				(6,566	)
Interest income and other, net			391				538
Income (loss) before provision for income taxes and equity in net loss of an unconsolidated affiliate			1,161				(6,028	)
Income tax expense			1,742				2,948
Equity in net loss of an unconsolidated affiliate			—				600
Net loss		$	(581	)		$	(9,576	)
Net loss per share – basic and diluted		$	(0.01	)		$	(0.12	)
Weighted average shares – basic and diluted			77,421				82,722
(1) Includes stock-based compensation expense		$	135			$	218
(2) Includes stock-based compensation expense		$	1,018			$	1,160
(3) Includes stock-based compensation expense		$	1,771			$	1,910

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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SILICON IMAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

		Three Months Ended March 31,
		2013				2012
Net loss		$	(581	)		$	(9,576	)
Foreign currency translation adjustments, net of zero tax			(24	)			48
Fair value of effective cashflow hedges, net of zero tax			—				15
Change in unrealized net gain (loss) on available-for-sale securities, net of zero tax			(132	)			174
Other comprehensive income (loss)			(156	)			237
Comprehensive loss		$	(737	)		$	(9,339	)

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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SILICON IMAGE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

		Three Months Ended March 31,
		2013				2012
Cash flows from operating activities:
Net loss		$	(581	)		$	(9,576	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Depreciation			1,573				1,591
Stock-based compensation expense			2,924				3,288
Amortization of investment premium			328				509
Tax benefits from employee stock-based transactions			8				310
Amortization of intangible assets			702				496
Excess tax benefits from employee stock-based transactions			(8	)			(310	)
Realized gain on sale of short-term investments			(9	)			(45	)
Equity in net loss of unconsolidated affiliate			—				600
Others			560				358
Changes in assets and liabilities:
Accounts receivable			(3,138	)			(9,967	)
Inventories			(3,013	)			(2,161	)
Prepaid expenses and other assets			904				969
Accounts payable			8,286				6,483
Accrued and other liabilities			(2,506	)			(1,847	)
Deferred margin on sales to distributors			2,875				3,442
Deferred license revenue			125				858
Cash provided by (used in) operating activities			9,030				(5,002	)
Cash flows from investing activities:
Proceeds from sales of short-term investments			13,027				23,031
Purchases of short-term investments			(5,431	)			(15,797	)
Purchases of property and equipment			(835	)			(2,191	)
Investment in a privately held company			—				(3,500	)
Cash paid for assets purchased from a privately held company			(300	)			—
Advances for intellectual properties			(378	)			—
Other investing activities			—				(500	)
Cash provided by investing activities			6,083				1,043
Cash flows from financing activities:
Proceeds from employee stock program			2,606				2,486
Excess tax benefits from employee stock-based transactions			8				310
Repurchases of restricted stock units for income tax withholding			(653	)			(1,465	)
Cash paid to settle contingent consideration liabilities			(45	)			—
Cash provided by financing activities			1,916				1,331
Effect of exchange rate changes on cash and cash equivalents			(134	)			(26	)
Net increase (decrease) in cash and cash equivalents			16,895				(2,654	)
Cash and cash equivalents – beginning of period			29,069				37,125
Cash and cash equivalents – end of period		$	45,964			$	34,471
Supplemental cash flow information:
Cash payment for income taxes		$	(1,655	)		$	(209	)
Restricted stock units vested		$	1,649			$	3,929
Property and equipment and other assets purchased but not paid for		$	1,418			$	1,150
Unrealized gain (loss) on available-for-sale securities		$	(132	)		$	174

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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SILICON IMAGE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Silicon Image, Inc. (the “Company”, “Silicon Image”, “we” or “our”) included herein have been prepared on a basis consistent with our December 31, 2012 audited financial statements and include all adjustments, consisting of normal recurring adjustments, necessary to fairly state the condensed consolidated balance sheets of Silicon Image and our subsidiaries as of March 31, 2013 and December 31, 2012 and the related condensed consolidated statements of operations for the three months ended March 31, 2013 and 2012, condensed consolidated statements of comprehensive income (loss) for the three months ended March 31, 2013 and 2012, and the related condensed consolidated statements of cash flows for the three months ended March 31, 2013 and 2012. All significant intercompany accounts and transactions have been eliminated. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. Financial results for the three months ended March 31, 2013 are not necessarily indicative of future financial results.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Areas where significant judgment and estimates are applied include revenue recognition, stock-based compensation, valuation, impairment and fair value hierarchy of short-term investments, inventory reserves, impairment of goodwill and long-lived assets, income taxes, deferred tax assets and legal matters. Actual results could differ materially from these estimates.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Silicon Image, Inc. and its subsidiaries after elimination of all intercompany balances and transactions.

Summary of Significant Accounting Policies

There have been no changes to the Company’s significant accounting policies during the three months ended March 31, 2013 as compared to the significant accounting policies described in the Company’s audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

Recently Adopted Accounting Standards

Effective January 1, 2013, the Company adopted Accounting Standard Update (“ASU”) No. 2011-11, “ Disclosures about Offsetting Assets and Liabilities.”  The guidance requires the Company to disclose information about offsetting related arrangements to enable users of the Company financial statements to understand the effect of those arrangements on its financial position. The adoption of ASU 2011-11 did not have a significant impact on the Company’s consolidated financial position or results of operations.

Effective January 1, 2013, the Company prospectively adopted ASU, 2013-02, “ Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This update requires companies to provide information regarding the amounts reclassified out of accumulated other comprehensive income by component. In addition, companies are required to present, either on the face of the statement where net income (loss) is presented or in the accompanying notes, significant amounts reclassified out of accumulated other comprehensive income (loss) by the respective line items of net income (loss). The adoption of ASU 2013-02 did not have a material impact on the Company’s consolidated financial statements.

NOTE 2. NET LOSS PER SHARE

Basic net income (loss) per common share is computed by dividing the net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted income (loss) per common share is computed by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options, shares to be purchased under the employee stock purchase plan and unvested RSUs. The dilutive effect of potentially dilutive securities is reflected in diluted earnings per common share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.

 

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The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share amounts):

 

		Three Months Ended March 31,
		2013				2012
Numerator:
Net loss		$	(581	)		$	(9,576	)
Denominator:
Weighted average outstanding shares used to compute basic and diluted net loss per share			77,421				82,722
Net loss per share – basic and diluted		$	(0.01	)		$	(0.12	)

As a result of the net loss for the three months ended March 31, 2013 and 2012, approximately 5.6 million and 5.1 million, respectively, weighted common stock equivalents were excluded from the computation of diluted net loss per share because their effect would have been anti-dilutive.

NOTE 3. BALANCE SHEET COMPONENTS

The components of inventory, prepaid expenses and other current assets, property and equipment and other assets consisted of the following:

 

		March 31, 2013				December 31, 2012
		(In thousands)
Inventories:
Raw materials		$	4,193			$	4,036
Work in process			2,463				1,874
Finished goods			7,625				5,358
		$	14,281			$	11,268
Prepaid expense and other current assets:
Prepaid software maintenance		$	2,892			$	3,542
Other prepaid expenses			2,006				3,056
Income tax receivable			199				56
Other current assets			1,719				1,451
		$	6,816			$	8,105
Property and equipment:
Computers and software		$	22,503			$	22,272
Equipment			37,367				37,735
Furniture and fixtures			2,506				1,535
			62,376				61,542
Less: accumulated depreciation			(48,251	)			(46,702	)
Total property and equipment, net		$	14,125			$	14,840
Other assets:
Investment in privately-held companies (Note 5, Company A and B)		$	6,000			$	6,000
Warrant to purchase preferred stock of a privately-held company (Note 5, Company C)			1,617				1,690
Advances for intellectual properties			1,892				379
Others			1,116				974
		$	10,625			$	9,043

 

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The components of accrued liabilities and other long-term liabilities were as follows:

 

		March 31, 2013				December 31, 2012
		(In thousands)
Accrued and other current liabilities:
Accrued royalties		$	7,438			$	6,203
Accrued payroll and related expenses			2,867				7,317
Accrued product rebates			1,127				1,063
Accrued payables			3,607				3,080
Others			1,566				1,937
		$	16,605			$	19,600
Other long-term liabilities:
Non-current liability for uncertain tax positions		$	14,616			$	14,410
Others			2,408				2,417
		$	17,024			$	16,827

NOTE 4. FAIR VALUE MEASUREMENTS

The Company records its financial instruments that are accounted for under FASB Accounting Standards Codification (ASC) No. 320-10-25, “ Recognition of Investments in Debt and Equity Securities,” and derivative contracts under FASB ASC No. 815, “ Derivatives and Hedging ,” at fair value. The determination of fair value is based upon the fair value framework established by FASB ASC No. 820-10-35, “ Fair Value Measurements and Disclosures – Subsequent Measurement” (ASC 820-10-35). ASC 820-10-35 provides that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, in the most advantageous market for such asset or liability. The carrying value of the Company’s financial instruments including cash and cash equivalents and short-term investments approximates fair market value due to the relatively short period of time to maturity. The fair value of investments is determined using quoted market prices for those securities or similar financial instruments.

The Company’s cash equivalents and short term investments are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

The Company’s Level 1 assets consist of money market fund securities and U.S. government and agency securities. These instruments are generally classified within Level 1 of the fair value hierarchy because they are valued based on quoted market prices in active markets.

The Company’s Level 2 assets include certificate of deposits, corporate securities and municipal securities and are valued by using a multi-dimensional relational model, the inputs, when available, are primarily benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications.

The Company’s Level 3 assets relate to warrants to purchase 5.3 million shares of a private company’s preferred stock at $0.717 per share (Note 5, Investment in privately-held company C) . The estimated fair value of the warrant as of March 31, 2013, was determined using the Black-Scholes option pricing model with the following assumptions: contractual term of 4.5 years; estimated volatility of 55.45%, risk-free rate of 0.66%, and no expected dividends. The Company recorded an unrealized loss of $73,000 as a component of other comprehensive loss related to the difference between the fair value of this warrant at December 31, 2012 and March 31, 2013. The warrant will continue to be measured at fair value on a recurring basis and any changes in fair value will be recorded as an unrealized gain or loss in other comprehensive income until realized.

The Company’s Level 3 liabilities consist of contingent consideration in connection with a business acquisition. The Company makes estimates regarding the fair value of contingent consideration liabilities on the acquisition date and at the end of each reporting period until the contingency is resolved. The fair value of this arrangement is determined by calculating the net present value of the expected payments using significant inputs that are not observable in the market, including the probability of achieving the milestone, revenue projections and discount rates. The fair value of the contingent consideration will increase or decrease according to the movement of the inputs. The Company does not expect the changes in these inputs to have a material impact on the Company’s consolidated financial statements.

The Company measures certain assets, including its cost and equity method investments, at fair value on a nonrecurring basis when they are deemed to be other-than-temporarily impaired. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections. An impairment charge is recorded when the cost of the investment exceeds its fair value and this condition is determined to be other-than-temporary. Other than as described in Note 5 related to an equity method investment, the Company did not record any other-than-temporary impairments on those financial assets required to be measured at fair value on a nonrecurring basis in any period presented.

 

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For certain of the Company’s financial instruments, including cash held in banks, accounts receivable and accounts payable, the carrying amounts approximate fair value due to their short maturities.

The following table presents the fair value of our financial instruments that are measured at fair value on a recurring basis as of March 31, 2013 (in thousands):

 

		Fair value measurements using												Assets (Liabilities)
		Level 1				Level 2				Level 3				at fair value
Assets:
Cash equivalents:
Money market funds		$	31,648			$	—			$	—			$	31,648
Corporate securities			—				2,099				—				2,099
Total cash equivalents		$	31,648			$	2,099			$	—			$	33,747
Short-term investments:
Certificate of deposits		$	—			$	10,592			$	—			$	10,592
Municipal securities			—				48,362				—				48,362
Corporate securities			—				11,568				—				11,568
Total short-term investments		$	—			$	70,522			$	—			$	70,522
Other assets:
Fair value of warrant to purchase preferred stock (Note 5)		$	—			$	—			$	1,617			$	1,617
Liabilities:
Contingent considerations in connection with a business acquisition		$	—			$	—			$	(63	)		$	(63	)

The cash equivalents in the above table exclude $12.2 million in cash held by or on behalf of the Company as of March 31, 2013.

The following table presents the fair value of our financial instruments that are measured at fair value on a recurring basis as of December 31, 2012 (in thousands):

 

		Fair value measurements using												Assets (Liabilities)
		Level 1				Level 2				Level 3				at fair value
Assets:
Cash equivalents:
Money market funds		$	18,878			$	—			$	—			$	18,878
Short-term investments:
Certificate of deposits		$	—			$	10,525			$	—			$	10,525
Municipal securities			—				52,513				—				52,513
Corporate securities			—				15,360				—				15,360
Total short-term investments		$	—			$	78,398			$	—			$	78,398
Other assets:
Fair value of warrant to purchase preferred stock (Note 5)		$	—			$	—			$	1,690			$	1,690
Liabilities:
Contingent considerations in connection with a business acquisition		$	—			$	—			$	(108)			$	(108	)

The cash equivalents in the above table exclude $10.2 million in cash held by the Company or in its accounts or with investment fund managers as of December 31, 2012.

 

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The following table presents the changes in the Company’s Level 3 liabilities, which are measured at fair value on a recurring basis, during the three months ended March 31, 2013 and 2012 (in thousands):

 

		Fair Value Measurement Using Significant Unobservable Inputs
		2013				2012
Assets:
Beginning balance at January 1,		$	1,690			$	—
Adjustment to fair value recorded during the period (Note 5)			(73	)			—
Ending balance at March 31,		$	1,617			$	—
Liabilities:
Beginning balance at January 1,		$	(108	)		$	(1,304)
Payment of contingent consideration			45				—
Ending balance at March 31,		$	(63	)		$	(1,304)

There were no transfers between Level 1, Level 2 and Level 3 fair value hierarchies during the three months ended March 31, 2013.

NOTE 5. INVESTMENTS

Cost Method Investments

Investment in privately-held company A

In February 2012, the Company paid $3.5 million in cash to purchase a minority interest in a privately held company which designs and develops wireless semiconductor chips. This investment is accounted for using the cost method as the Company’s ownership percentage is minor and the Company does not exert significant influence over the investee.

Investment in privately-held company B

On December 21, 2012, the Company agreed to purchase a 17.7% preferred stock equity ownership interest in a privately-held company that designs connectivity related software. The Company accounts for this investment under the cost method as the Company’s ownership percentage is minor and the Company does not have the ability to exert significant influence over the investee. During 2012, the Company paid $2.5 million and an additional $1.0 million is contingent and may be paid over a period of time based on the achievement of various milestones by the investee. Concurrently with the equity investment, the Company entered into the following agreements with the privately-held company: (a) call option agreement whereby the Company can acquire the privately-held company at a purchase price between $14.0 million and $20.0 million by fiscal 2014 plus earn-out payments of up to $10.75 million to be paid by fiscal 2016 subject to certain conditions; (b) a sales representative agreement; and (c) technology and IP license agreement.

This privately-held company is a variable interest entity (“VIE”) and the Company’s 17.7% equity ownership represents a variable interest in the VIE. The Company concluded that it should not consolidate the VIE because it is not the VIE’s primary beneficiary. Significant judgments in this conclusion were based on identification of the activities that most significantly impact the economic performance of the VIE and that the Company is not the party directing such activities. The Company’s risks associated with the involvement with this VIE are limited to the Company’s current and future committed investments in the VIE. At March 31, 2013 the Company’s maximum exposure to the VIE was the balance of its investment in the VIE of $2.5 million. The ongoing impact of involvement with the VIE on the Company’s financial position, financial performance, and cash flows is based on its review for impairment on a quarterly basis.

Investment in privately-held company C

In October 2012, the Company entered into an asset purchase agreement with a privately held entity for the purchase of certain intangible assets for $1.5 million, of which $1.2 million was paid in 2012 and the remaining $300,000 was paid in the first quarter of 2013. The Company may also be required to pay up to an additional $16.5 million of cash consideration if certain revenue levels are achieved and certain financial or operational performance conditions are met, during the two year period starting October 2012. Such additional consideration, if any, would become payable at the end of the measurement period in October 2014. The Company believes that the likelihood that it would be required to pay the additional cash consideration is remote.

Concurrently, the parties also executed a warrant purchase agreement pursuant to which the Company received a warrant which provide the Company with the option to purchase 5.3 million shares of the entity’s preferred stock at $0.717 per share before October 5, 2017. In allocating the purchase price between the warrant and the technology assets, the Company first measured the full value of the warrant and then assigned any residual amount of the price to the other assets (as the warrant was determined to be an available-for-sale security and thus is required to be carried at fair value). Management determined that the full purchase price was allocable to the warrants, and as such none of the initial purchase price was assigned to the intangible assets.

 

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NOTE 6. INTANGIBLE ASSETS

The following table presents the Company’s purchased intangible assets, including those arising from business acquisitions, as of March 31, 2013 (in thousands):

 

				March 31, 2013
		Useful Life (years)		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Intangible assets with finite lives
Intellectual Property		6		$	1,600			$	(578	)		$	1,022
Core Technology		5			1,600				(693	)			907
System Technology		3			400				(289	)			111
Developed Technology		3-5			4,800				(675	)			4,125
Customer Relationship		2-5			1,500				(875	)			625
Acquisition-related intangible assets					9,900				(3,110	)			6,790
Licensed Technology		5			3,867				(507	)			3,360
Total intangible assets with finite lives					13,767				(3,617	)			10,150
Intangible assets with indefinite lives
Trade Name		indefinite			600				—				600
Total intangible assets with indefinite lives					600				—				600
Total purchased intangible assets				$	14,367			$	(3,617	)		$	10,750

There were no impairment charges with respect to the acquisition-related intangible assets during the three months ended March 31, 2013.

Amortization expense of developed technology is recorded to cost of product revenue. Amortization expense of licensed technology is recorded to research and development. Amortization expense of the rest of the intangible assets with finite lives is recorded to amortization of acquisition-related intangible assets.

For intangible assets that are subject to amortization, the Company recorded amortization expense on the consolidated statements of operation as follows (in thousands):

 

		Three Months Ended March 31,
		2013				2012
Cost of product revenue		$	250			$	—
Research and development			201				—
Amortization of acquisition-related intangible assets			251				496
		$	702			$	496

The annual expected amortization expense of intangible assets with finite lives is as follows (in thousands):

 

		Amount
Year ending December 31,
2013 (remaining 9 months)		$	2,045
2014			2,604
2015			2,543
2016			1,868
2017			1,090
Total		$	10,150

 

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NOTE 7. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

In the fourth quarter of 2011, the Company was notified that a customer’s product incorporating one of the Company’s chipsets did not pass compliance testing in connection with certain technology implemented in the Company’s product. The Company is in discussions regarding this matter with the customer and the entity responsible for the licensing and administration (including compliance testing) of the technology at issue. As no claim has been made against the Company, it is premature to form a conclusion as to the potential outcome of such a claim, if made, or the range of possible loss to the Company.

From time to time the Company has been named as a defendant in a number of judicial and administrative proceedings incidental to its business. Moreover, from time to time, the Company receives notices from licensees of its technology and from adopters of the standards for which the Company serves as agent disputing the payment of royalties and sometimes requesting a refund of royalties allegedly overpaid.

Indemnifications

Certain of the Company’s licensing agreements indemnify its customers for any expenses or liabilities resulting from claimed infringements of third party patents, trademarks or copyrights by its products. Certain of these indemnification provisions are perpetual from execution of the agreement and, in some instances the maximum amount of potential future indemnification is not limited. To date, the Company has not paid any such claims or been required to defend any lawsuits with respect to any such claim.

NOTE 8. STOCK-BASED COMPENSATION

The Company has a share-based compensation program that provides its Board of Directors with broad discretion in creating equity incentives for employees, officers and non-employee board members. This program includes incentive and non-statutory stock option grants and restricted stock units (RSUs) for employees, market-based RSUs for the executive officers and an automatic grant program for non-employee board members pursuant to which such individuals will receive grants at designated intervals over their period of board service. These awards are granted under the stockholder approved 2008 Equity Incentive Plan. Grants under the discretionary grant program generally vest as follows: 25% of the shares vest on the first anniversary of the vesting commencement date and the remaining 75% vest proportionately each month over the next 36 months of continued service. Stock option grants to non-employee members of our board vest monthly, over periods not to exceed four years. Some options provide for accelerated vesting if certain identified milestones are achieved, upon a termination of employment or upon a change in control of the Company. RSU grants generally vest over a one to four-year period. These awards are granted under various programs, all of which are approved by the stockholders. In August 2012, the Company granted market-based RSUs to its officers with vesting of these RSUs were based on the performance of the Company’s common stock price over the vesting period. Additionally, our Employee Stock Purchase Plan (ESPP) allows employees to purchase shares of common stock at the lower of 85% of the fair market value on the commencement date of the six-month offering period or on the last day of the six-month offering period.

Valuation and Expense Information under Stock-based Compensation

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:

 

		Three Months Ended March 31,
		2013				2012
Employee stock option plans:
Expected life in years			4.0				4.0
Expected volatility			62.2	%			70.4	%
Risk-free interest rate			0.6	%			0.6	%
Expected dividends			none				none
Weighted average fair value		$	2.28			$	2.43
Employee Stock Purchase Plan:
Expected life in years			0.5				0.5
Expected volatility			40.1	%			68.3	%
Risk-free interest rate			0.1	%			0.1	%
Expected dividends			none				none
Weighted average fair value		$	1.27			$	1.85

Amortization method — The value of options and RSUs are amortized to expense, net of estimated forfeitures, on a straight line basis over the vesting period.

 

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Expected Life — The expected life of the options represents the estimated period of time until exercised and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules, and expectations of future employee behavior. The expected term for the ESPP is based on the term of the purchase period.

Expected Volatility — The volatility rate is based on the Company’s historical common stock volatility derived from historical stock price data for historical periods commensurate with the options’ expected life.

Risk-Free Interest Rate —The risk-free interest rate is based on the implied yield currently available on United States Treasury zero-coupon issues with a term equal to the expected life at the date of grant of the options.

Expected Dividend — The expected dividend is based on our history and expected dividend payouts. The expected dividend yield is zero as the Company has historically paid no dividends and does not anticipate dividends to be paid in the future.

For the three months ended March 31, 2013 and 2012, 566,078 and 517,610 shares of common stock, respectively, were purchased under the ESPP program. At March 31, 2013, the Company had $422,000 of total unrecognized compensation expense, net of estimated forfeitures under the ESPP program. The unamortized compensation expense will be amortized on a straight-line basis over a remaining period of approximately 4.5 months.

Stock Option Activity

The following is a summary of activity under the Company’s stock option plans during the three months ended March 31, 2013, excluding RSUs (in thousands, except weighted average exercise price and contractual term):

 

		Number of Shares				Weighted Average Exercise Price per Share				Weighted Average Remaining Contractual Terms in Years				Aggregate Intrinsic Value
At January 1, 2013			6,434			$	5.78
Granted			109				4.81
Forfeitures and cancellations			(203	)			10.80
Exercised			(73	)			3.87
At March 31, 2013			6,267			$	5.62				4.83			$	3,914
Vested and expected to vest at March 31, 2013			5,766			$	5.69				4.74			$	3,597
Exercisable at March 31, 2013			3,369			$	6.38				4.08			$	1,877

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that option holders would have received had all option holders exercised their options on March 31, 2013. The aggregate intrinsic value is the difference between the Company’s closing stock price on the last trading day of the quarter ended March 31, 2013 and the exercise price, multiplied by the number of outstanding or exercisable in-the-money options. The aggregate intrinsic value excludes the effect of stock options that have a zero intrinsic value. The total pre-tax intrinsic value of options exercised, representing the difference between the fair market value of the Company’s common stock on the date of the exercise and the exercise price of each option, for the three months ended March 31, 2013 and 2012 was $62,000 and $51,000, respectively.

At March 31, 2013, the total unrecognized pre-tax stock-based compensation expense related to stock options, which the Company expects to recognize over the remaining weighted-average vesting period of 2.37 years, was $4.5 million, net of estimated forfeitures.

Restricted Stock Units

The RSUs that the Company grants to its employees typically vest ratably over a certain period of time, subject to the employee’s continuing service to the Company over that period. RSUs granted to executive officers and non-executive employees typically vest over a four-year period.

RSUs are converted into shares of the Company’s common stock upon vesting on a one-for-one basis. The cost of the RSUs is determined using the fair value of the Company’s common stock on the date of the grant. Compensation is recognized on a straight-line basis over the requisite service period of each grant adjusted for estimated forfeitures. Each RSU award granted from the Company’s 2008 Equity Incentive Plan will reduce the number of options available for issuance by 1.5 shares.

 

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A summary of activity with respect to the Company’s RSUs during the three months ended March 31, 2013 is as follows: (in thousands, except weighted average grant date fair value per share):

 

		Number of Units				Weighted- Average Grant Date Fair Value Per Share
Outstanding at January 1, 2013			2,794			$	5.36
Granted			103				4.83
Vested			(339	)			7.03
Forfeitures and cancellations			(23	)			4.80
Outstanding at March 31, 2013			2,535			$	5.12

Of the 2,534,920 RSUs outstanding as of March 31, 2013, approximately 2,021,677 units are expected to vest after considering the applicable forfeiture rate.

The aggregate fair value of awards that vested during the three months ended March 31, 2013 was $1.6 million, which represents the market value of Silicon Image common stock on the date that the RSUs vested. The grant date fair value of awards that vested during the three months ended March 31, 2013 was $2.4 million. The number of RSUs vested includes shares that the Company withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements.

In August 2012, the Company granted 331,500 RSUs with market-based vesting criteria to executives and certain key employees pursuant to 2008 Plan. These market-based awards vest over four years with 25% of the total number of shares vesting on each anniversary of the grant date. Whether or not they vest is determined by a comparison of the price of the Company’s common stock and the price set by the Company, which ranged from $4.52 to $5.39 over the vesting period. The grant-date fair value of these awards was $1.2 million, estimated using a Monte Carlo simulation method which takes into account the probability that the market conditions of these awards will be achieved. Compensation costs related to these awards will be recognized over the vesting period regardless of whether the market conditions are satisfied, provided that the requisite service has been provided. As of March 31, 2013, 316,500 shares of the outstanding restricted stock units were market-based restricted stock units.

At March 31, 2013, the total unrecognized pre-tax stock-based compensation expense related to non-vested RSUs, which the Company expects to recognize over the remaining weighted-average vesting period of 2.23 years, was $6.5 million, net of estimated forfeitures.

During the three months ended March 31, 2013 and 2012, the Company repurchased 134,215 and 303,803 shares of stock, respectively, for an aggregate value of $0.7 million and $1.5 million, respectively, from the employees upon the vesting of their RSUs that were granted under the Company’s 2008 Equity Incentive Plan to satisfy the employees’ minimum statutory tax withholding requirement. The Company will continue to repurchase shares of stock from employees as their RSUs vest to satisfy the employees’ minimum statutory tax withholding requirement.

Stock Repurchase Program

In April 2012, the Company’s Board of Directors authorized a $50 million stock repurchase program. The repurchases may occur from time to time in the open market or in privately negotiated transactions. The timing and amount of any repurchase of shares will be determined by the Company’s management, based on its evaluation of market conditions, cash on hand and other factors and may be made under a stock repurchase plan. The authorization will stay in effect until the authorized aggregate amount is expended or the authorization is modified by the Board of Directors. The program does not obligate the Company to acquire any particular amount of stock and purchases under the program may be commenced or suspended at any time, or from time to time, without prior notice. Further, the stock repurchase program may be modified, extended or terminated by the Board at any time.

On November 9, 2012, the Company entered into an accelerated share repurchase (ASR) agreement with Barclays Capital, Inc. (Barclays) to repurchase an aggregate of $30.0 million of its common stock. Pursuant to the ASR agreement, the Company paid $30.0 million in November 2012 and received an initial share delivery of 5,072,463 shares of its common stock. The initial share delivery was valued at $21.0 million and was recorded as treasury stock in the consolidated balance sheet as of December 31, 2012. The remaining balance of $9.0 million was recorded as additional paid-in capital in the consolidated balance sheet as of December 31, 2012. During the three months ended March 31, 2013, the Company received an additional 750,000 shares of its common stock valued at $3.6 million, which was recorded as an addition to treasury stock and a reduction of paid-in capital. The ASR agreement is scheduled to extend for approximately three to seven months from its inception date but may conclude earlier at Barclays’ option and may be terminated early upon the occurrence of certain events. Barclays then may deliver additional shares to the Company at or prior to maturity of the ASR agreement, which is subject to an adjustment based on the average daily volume weighted average price of its common stock during the term of the ASR Agreement. Under certain circumstances, the Company may be required to return to the Barclays a portion of the shares received or, at the Company’s option, make an additional cash payment to Barclays in lieu of delivering shares.

 

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In addition to the shares repurchased under the ASR agreement, the Company had repurchased 2,193,372 shares of its common stock from the open market at a total cost of $9.7 million with an average price per share of $4.42 from May 2012 through March 31, 2013.

NOTE 9. PROVISION FOR INCOME TAXES

The Company recorded an income tax expense of $1.7 million for the three months ended March 31, 2013. The effective tax rate for the three months ended March 31, 2013 was 150%. The difference between the effective tax rate and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to foreign withholding taxes associated with licensing revenue.

The Company continued to maintain a valuation allowance as a result of uncertainties related to the realization of its net deferred tax assets at March 31, 2013. The valuation allowance was established as a result of weighing all positive and negative evidence, including the Company’s cumulative loss over the past three years. The valuation allowance reflects the conclusion of management that it is more likely than not that benefits from certain deferred tax assets will not be realized. If actual results differ from these estimates or these estimates are adjusted in future periods, the valuation allowance may require adjustment which could materially impact the Company’s financial position and results of operations. It is possible that sometime in the next 12 months positive evidence will be sufficient to release a material amount of our valuation allowance; however there is no assurance that this will occur. The required accounting for the potential release would have significant deferred tax consequences and would increase earnings in the quarter in which the allowance is released.

The Company recorded an income tax expense of $2.9 million for the three months ended March 31, 2012. The effective tax rates for the three months ended March 31, 2012 was (48.9%). The difference between the effective tax rate and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to foreign taxes (including foreign withholding taxes), a provision for charges in lieu of income taxes related to employee stock plans where the windfall benefit is charged to tax expense with the benefit to additional paid-in capital, and state taxes.

The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the provision for income taxes. The Company accrued interest and penalties of $33,000 and $53,000 for the three months ended March 31, 2013 and 2012, respectively, The Company conducts business globally and, as a result, the Company and its subsidiaries file income tax returns in various jurisdictions throughout the world including with the U.S. federal and various U.S. state jurisdictions as well as with various foreign jurisdictions. In the normal course of business, the Company is subject to examination by taxing authorities throughout the world.

NOTE 10. CUSTOMER AND GEOGRAPHIC INFORMATION

The Company operates in one reportable operating segment, semiconductors and IP solutions for the secure storage, distribution and presentation of high-definition content. The Company’s Chief Executive Officer, who is considered to be the Company’s chief operating decision maker, reviews financial information presented on one operating segment basis for purposes of making operating decisions and assessing financial performance.

Revenue

Revenue by geographic area based on bill to location was as follows (in thousands):

 

		Three Months Ended March 31,
		2013				2012
United States		$	29,591			$	21,046
Taiwan			9,633				12,173
Japan			8,251				9,462
Europe			5,497				3,975
China			5,349				3,928
Korea			3,417				4,014
Others			301				405
Total revenue		$	62,039			$	55,003

 

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Revenue by geographic area based on customers’ headquarters location was as follows (in thousands):

 

		Three Months Ended March 31,
		2013				2012
Korea		$	27,997			$	22,022
Taiwan			9,178				12,179
Japan			8,252				9,462
Europe			5,487				3,975
China			5,803				3,917
United States			5,038				3,048
Others			284				400
Total revenue		$	62,039			$	55,003

The Company’s revenue by its primary markets was as follows (in thousands):

 

		Three Months Ended March 31,
		2013				2012
Mobile		$	33,603			$	22,256
Consumer Electronics			13,667				16,511
Personal Computers			3,071				4,257
Total product revenue			50,341				43,024
Licensing			11,698				11,979
Total revenue		$	62,039			$	55,003

For the three months ended March 31, 2013 and 2012, one customer represented 40.8% and 34.3% of total revenue, respectively. There were no other customers representing more than 10% of total revenue.

At March 31, 2013, three customers each represented 33.3%, 15.6% and 12.5% of net accounts receivable. At March 31, 2012, four customers each represented 18.3%, 16.0%, 13.2% and 12.1% of net accounts receivable. The Company’s top five customers, including distributors, generated 65.2% and 62.8% of the Company’s revenue for three months ended March 31, 2013 and 2012, respectively.

Property and Equipment

The table below presents the net book value of the property and equipment by their physical location (in thousands):

 

		March 31, 2013				December 31, 2012
United States		$	6,231			$	6,519
China			4,715				4,834
Taiwan			1,462				1,586
India			1,432				1,509
Others			285				392
Net book value		$	14,125			$	14,840

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains forward-looking statements within the meaning of Section 21E of the Exchange Act of 1934 and Section 27A of the Securities Act of 1933. These forward-looking statements involve a number of risks and uncertainties, including those identified in the section of this Form 10-Q entitled “Risk Factors,” that may cause actual results to differ materially from those discussed in, or implied by, such forward-looking statements. Forward-looking statements within this Form 10-Q are identified by words such as “believes,” “anticipates,” “expects,” “intends,” “estimates,” “may,” “will” and variations of such words and other similar expressions. However, these words are not the only means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-Q with the SEC. Our actual results could differ materially from those anticipated in, or implied by, forward-looking statements as a result of various factors, including the risks outlined elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made by Silicon Image, Inc. in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risks and factors that may affect our business.

Silicon Image and the Silicon Image logo are trademarks, registered trademarks or service marks of Silicon Image, Inc. in the United States and other countries. All other trademarks and registered trademarks are the property of their respective owners.

Company Overview

Silicon Image is a leading provider of connectivity solutions that enable the reliable distribution and presentation of high-definition (HD) content for mobile, consumer electronics (CE), and personal computing (PC) markets. We deliver our technology via semiconductor and intellectual property (IP) products that are compliant with global industry standards and feature market leading Silicon Image innovations such as InstaPort™ and InstaPrevue™. Silicon Image’s products are deployed by the world’s leading electronics manufacturers in devices such as smartphones, tablets, digital televisions (DTVs), Blu-ray Disc™ players, audio-video receivers, digital cameras as well as desktop and notebook PCs. Silicon Image has driven the creation of the highly successful High-Definition Multimedia Interface (HDMI ^® ), the latest standard for mobile devices – Mobile High-Definition Link (MHL ^® ), Digital Visual Interface (DVI™) industry standards and the leading 60GHz wireless HD video standard – WirelessHD ^® . Via its wholly-owned subsidiary, Simplay Labs, Silicon Image offers manufacturers comprehensive standards interoperability and compliance testing services.

Silicon Image was founded in 1995. We are a Delaware corporation headquartered in Sunnyvale, California, with regional engineering and sales offices in China, Japan, Korea, Taiwan and India. Our Internet website address is www.siliconimage.com.

Our mission is to be the leader in advanced HD connectivity solutions for mobile, CE, and PC markets to enhance the consumer experience. Our “standards plus” business strategy is to grow the available market for our products and IP solutions through the development, introduction and promotion of market leading products which are based on industry standards but also include Silicon Image innovations that our customers value. We believe that our innovation around our core competencies, establishing industry standards and building strategic relationships, positions us to continue to drive change in the emerging world of high quality digital media storage, distribution and presentation.

Our customers are product manufacturers in each of our target markets—mobile, CE, and PC. Because we leverage our technologies across different markets, certain of our products may be incorporated into our customers’ products used in multiple markets. We sell our products to original product manufacturers (OEMs) throughout the world using a direct sales force and through a network of distributors and manufacturer’s representatives. Our revenue is generated principally by sales of our semiconductor products, with other revenues derived from IP core/design licensing and royalty and adopter fees from our standards licensing activities. We maintain relationships with the eco-system of companies that make the products that drive digital content creation, distribution and consumption, including major Hollywood studios, service providers, consumer electronics companies and retailers. Through these and other relationships, we have formed a strong understanding of the requirements for distributing and presenting HD digital video and audio in the home and mobile environments. We have also developed a substantial IP base for building the standards and products necessary to promote opportunities for our products.

Historically, we have grown our business by introducing and promoting the adoption of new technologies and standards and entering new markets. We collaborated with other companies to jointly develop the DVI and HDMI standards. Our first DVI products addressed the PC market. We then introduced products for a variety of CE market segments, including the set top box (STB), game console and DTV markets. In 2011, we began selling products in the mobile device market using our innovative interconnect core technology. In May 2011, we acquired SiBEAM, Inc., a provider of high-speed wireless communication products for uncompressed HD video in consumer electronics and personal computer applications. With this acquisition, we became a promoter of the WirelessHD standard for transmitting HD content using 60GHz wireless technology.

 

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Concentrations

Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For instance, our largest customer generated 40.8% and 34.3% of our revenues for the three months ended March 31, 2013 and 2012, respectively. In addition, our top five customers, including distributors, generated 65.2% and 62.8% of our revenue for three months ended March 31, 2013 and 2012, respectively. Additionally, the percentage of revenue generated through distributors tends to be significant, since many OEMs rely upon third party manufacturers or distributors to provide purchasing and inventory management services. Revenue generated through distributors was 30.2% of our total revenue for both the three months ended March 31, 2013 and 2012. Our licensing revenue is not generated through distributors, and to the extent licensing revenue increases faster than product revenue, we would expect a decrease in the percentage of our total revenue generated through distributors.

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect amounts reported in our condensed consolidated financial statements and accompanying notes. For a discussion of the critical accounting estimates, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2012.

Results of Operations

REVENUE

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Product revenue
Mobile		$	33,603			$	22,256				51.0	%
Consumer Electronics			13,667				16,511				-17.2	%
Personal Computers			3,071				4,257				-27.9	%
Total product revenue			50,341				43,024				17.0	%
Percentage of total revenue			81.1	%			78.2	%
Licensing revenue			11,698				11,979				-2.3	%
Percentage of total revenue			18.9	%			21.8	%
Total revenue		$	62,039			$	55,003				12.8	%

Product Revenue

The increase in product revenue was primarily due to increased demand for our mobile products offset in part by lower CE and PC revenue. The increase in our mobile products for the three months ended March 31, 2013 when compared to the same period in 2012 was primarily due to the continued success of our MHL product line. We have seen increased shipments of these products quarter after quarter since their introduction in the latter part of fiscal year 2010. Our MHL products represent the majority of our mobile revenue. For the first quarter of fiscal 2013, mobile revenue represented 66.8% of our total product revenue. The decrease in our CE revenue for the three months ended March 31, 2013 when compared to the same period in 2012 was primarily the result of a broad-based market shift to lower-end DTV products that incorporate our HDMI semiconductor products less frequently. We expect products that incorporate both MHL and HDMI to represent a larger portion of our CE revenue going forward. Our PC revenue continued to decline as we are no longer making any investments in these legacy products.

Licensing Revenue

Our licensing activity is complementary to our product sales and helps us to monetize our intellectual property and accelerate market adoption curves associated with our technology and standards. The decrease in licensing revenue for the three months ended March 31, 2013 when compared to the same period in 2012 is primarily the result of lower revenue from settlements being closed in this period as compared to the same period last year, offset by an increase in the HDMI adopter base due to the continued adoption of the HDMI standard. Our licensing revenue may fluctuate quarter to quarter as a result of the timing of completion of IP license arrangements and related settlement of royalty audits.

 

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Revenue by Geography Based on Customers’ Headquarters

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Asia-Pacific		$	51,289			$	47,625				7.7	%
United States			5,038				3,048				65.3	%
Europe			5,487				3,975				38.0	%
Others			225				355				-36.7	%
Total revenue		$	62,039			$	55,003				12.8	%

The increase in revenues in Asia-Pacific or APAC, which includes Japan and Korea, for the three months ended March 31, 2013, compared to the same period in 2012, was primarily due to increased demand for our MHL products by our customers who have their headquarters in APAC. The increase in revenues in the United States for the three months ended March 31, 2013, compared to the same period in 2012, was primarily due to increased demand for our CE transmitter and receiver products and increased licensing revenue. The increase in revenues in Europe for the three months ended March 31, 2013 compared to the same period in 2012 was primarily due to increased demand for our legacy control module business, which is part of our PC category.

For the break-down of the revenue by countries based on customers’ headquarters, please refer to note 10 of Notes to Condensed Consolidated Financial Statements under Part I Item 1 of this Form 10-Q.

COST OF REVENUE AND GROSS PROFIT

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Cost of product revenue (1)		$	25,798			$	23,099				11.7	%
Product gross profit			24,543				19,925				23.2	%
Product gross profit margin			48.8	%			46.3	%
(1) Includes stock-based compensation expense		$	135			$	218
Cost of licensing revenue		$	267			$	125				113.6	%
Licensing gross profit			11,431				11,854				-3.6	%
Licensing gross profit margin			97.7	%			99.0	%
Total cost of revenue		$	26,065			$	23,224				12.2	%
Total gross profit			35,974				31,779				13.2	%
Total gross profit margin			58.0	%			57.8	%

Cost of Product Revenue

Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, and costs to license our technology which involves modification, customization or engineering services, as well as other overhead costs relating to the aforementioned costs including stock-based compensation expense. Total cost of revenue for the three months ended March 31, 2013 increased compared to the same period in 2012 was primarily due to the growth in revenue volume.

Product Gross Margin

Our product gross margin increased primarily due to average product cost reductions exceeding average selling price reductions. The decrease in product cost is primarily due to a decrease in wafer, assembly, packaging and testing costs, improved freight and warehouse efficiencies, better absorption of fixed and semi-variable overheads as a result of increased revenue and lower depreciation expense due to fully depreciated testers.

 

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Licensing Gross Margin

Licensing gross margin during the three months ended March 31, 2013 was comparable to the licensing gross margin in the same period in 2012.

OPERATING EXPENSES

Research and Development (R&D)

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Research and development (1)		$	18,558			$	21,707				-14.5	%
Percentage of total revenue			29.9	%			39.5	%
(1)    Includes stock-based compensatio n expense		$	1,018			$	1,160

R&D expense consists primarily of employee compensation and benefits, including stock-based compensation, fees for independent contractors, cost of software tools used for designing and testing our products and costs associated with prototype materials. The decrease in R&D expense for the three months ended March 31, 2013 when compared to the same period in 2012 was primarily due to the transition of 75 consultants in India to full time engineers of Silicon Image resulting in lower consultant cost of $2.7 million. Our R&D headcount as of March 31, 2013 was 359 employees as compared to 336 employees as of March 31, 2012 primarily due to the expansion of our R&D capabilities in India.

Selling, General and Administrative (SG&A)

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Selling, general and administrative (1)		$	16,402			$	16,137				1.6	%
Percentage of total revenue			26.4	%			29.3	%
(1)    Includes stock-based compensation expense		$	1,771			$	1,910

SG&A expense consists primarily of compensation and benefits, including stock-based compensation, sales commissions, professional fees, and marketing and promotional expenses. SG&A expense during the three months ended March 31, 2013 increased when compared to the same period in 2012 was primarily due to an increase in compensation related expenses of $1.0 million driven by headcount growth and an increase in consultant expenses, trade show expenses and bad debt expenses of $0.7 million, partially offset by lower personal time-off and stock-based compensation expenses. Our SG&A headcount as of March 31, 2013 was 208 employees as compared to 189 employees as of March 31, 2012.

Amortization of Acquisition-Related Intangible Assets

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Amortization of intangible assets		$	251			$	496				-49.4	%
Percentage of total revenue			0.4	%			0.9	%

The decrease in amortization expense for the three months ended March 31, 2013 when compared to the same period in 2012 was primarily due to the correction of certain errors related to intangible assets that were made in the fourth quarter of 2012. These adjustments reduced the carrying value of intangible assets as of December 31, 2012, and thus resulted in reduced amortization expense in the three months ended March 31, 2013.

 

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Interest Income and Other, net

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Interest income and other, net		$	391			$	538				-27.3	%
Percentage of total revenue			0.6	%			1.0	%

The interest and other income for the three months ended March 31, 2013 decreased as compared to the same period last year primarily due to lower interest income on lower cash invested in short-term investments.

Provision for Income Taxes

 

		Three Months Ended March 31,
		2013				2012				Change
		(dollars in thousands)
Income tax expense		$	1,742			$	2,948				-40.9	%
Percentage of total revenue			2.8	%			5.4	%

The effective tax rate for the three months ended March 31, 2013 was 150%. The difference between the effective tax rate and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to foreign withholding taxes associated with licensing revenue.

The effective tax rates for the three months ended March 31, 2012 was (48.9%). The difference between the effective tax rate and the income tax determined by applying the statutory federal income tax rate of 35% was due primarily to foreign taxes (including foreign withholding taxes), a provision for charges in lieu of income taxes related to employee stock plans where the windfall benefit is charged to tax expense with the benefit to additional paid-in capital, and state taxes.

LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION

The following sections discuss the effects of changes in our balance sheet and cash flows, contractual obligations and other commitments on our liquidity and capital resources.

Cash and Cash Equivalents, Short-term Investments and Working Capital . The table below summarizes our cash and cash equivalents, investments and working capital and the related movements (in thousands).

 

		March 31, 2013				December 31, 2012				Change
Cash and cash equivalents		$	45,964			$	29,069			$	16,895
Short term investments			70,522				78,398				(7,876	)
Total cash, cash equivalents and short term investments		$	116,486			$	107,467			$	9,019
Percentage of total assets			48.5	%			47.4	%
Total current assets		$	178,939			$	165,617			$	13,322
Total current liabilities			(51,956	)			(42,815	)			(9,141	)
Working capital		$	126,983			$	122,802			$	4,181

As of March 31, 2013, $11.6 million of the cash and cash equivalents and short term investments was held by foreign subsidiaries. Local government regulations may restrict our ability to move cash balances from our foreign subsidiaries to meet cash needs under certain circumstances; however, any current restrictions are not material. We do not currently expect such regulations and restrictions to impact our ability to pay vendors and conduct operations. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to indefinitely reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.

The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, inventories and prepaid expenses and other current assets, reduced by accounts payable, accrued and other current liabilities, deferred license revenue and deferred margin on sales to distributors.

 

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The net increase in current assets at March 31, 2013 as compared to December 31, 2012 was primarily due to a $9.0 million increase in total cash and cash equivalents and short-term investments, $3.1 million increase in accounts receivable and $3.0 million increase in inventory, partially offset by a decrease in prepaid expenses and other assets. The increase in accounts receivable was primarily due to revenue growth and timing of invoicing relative to the quarter end over collections during the three months ended March 31, 2013. The increase in inventory was primarily to meet the anticipated revenue levels for the next quarter. The decrease in prepaid expenses and other current assets was primarily due to amortization of prepaid software maintenance and a decrease in prepaid trade show.

The net increase in current liabilities at March 31, 2013 as compared to December 31, 2012 was mainly due to an $8.3 million increase in accounts payable and $2.9 million increase in deferred margin on sales to distributors, partially offset by a $2.5 million decrease in accrued and other current liabilities. The increase in accounts payable was primarily due to the increased payables related to our inventory purchases. The increase in deferred margin on sales to distributors was mainly due to the increasing shipment to our distributors driven by the acceleration of demand for our products while the decrease in accrued and other current liabilities was mainly attributable to a decrease in accrued vacation as we changed the personal time-off policy for U.S exempt salaried employees starting on January 1, 2013 and paid off all previously accrued personal time-off to our employees.

Summary of Cash Flows. The table below summarizes the cash and cash equivalents provided by (used in) in our operating, investing and financing activities (in thousands).

 

		Three Months Ended March 31,
		2013				2012
Cash provided by (used in) operating activities		$	9,030			$	(5,002	)
Cash provided by investing activities			6,083				1,043
Cash provided by financing activities			1,916				1,331
Effect of exchange rate changes on cash and cash equivalents			(134	)			(26	)
Net increase (decrease) in cash and cash equivalents		$	16,895			$	(2,654	)

Operating Activities

Cash provided by operating activities is generated by net loss adjusted for certain non-cash items and changes in assets and liabilities.

During the three months ended March 31, 2013, we incurred a net loss of $581,000 which included non-cash charges of approximately $6.1 million (primarily related to stock based compensation, depreciation and amortization). Changes in assets and liabilities that generated cash were primarily prepaid expenses and other current assets, accounts payable and deferred margin on sales to distributors. These increases were offset by changes in operating assets and liabilities that used cash, primarily accounts receivable, inventories and accrued and other liabilities.

During the three months ended March 31, 2012, we incurred a net loss of $9.6 million which included non-cash charges of approximately $6.8 million (primarily related to stock based compensation, depreciation and amortization). Changes in assets and liabilities that generated cash were primarily prepaid expenses and other current assets, accounts payable and deferred margin on sales to distributors. These increases were offset by changes in operating assets and liabilities that used cash, primarily accounts receivable, inventories and accrued and other liabilities.

Investing Activities

Cash provided by our investing activities during the three months ended March 31, 2013 was primarily a result of the $7.6 million net proceeds from the sales and maturities of short-term investments, partially offset by $0.8 million used for capital expenditures, $300,000 used for strategic business investment and $378,000 used for purchases of intellectual properties.

Cash provided by our investing activities during the three months ended March 31, 2012 was primarily a result of the $7.2 million net proceeds from the sales and maturities of short-term investments, partially offset by $2.2 million used for capital expenditures, $3.5 million used for strategic business investment and $500,000 used for other investing activities.

We are not a capital-intensive business. Our purchases of property and equipment relate mainly to testing equipment, leasehold improvements and information technology infrastructure.

 

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Financing Activities

Cash generated from our financing activities during the three months ended March 31, 2013 was primarily due to the proceeds from stock option exercises and purchases under our employee stock purchase program of approximately $2.6 million, partially offset by $0.6 million used to repurchase restricted stock units for minimum statutory income tax withholding.

Cash generated from our financing activities during the three months ended March 31, 2012 was primarily due to the proceeds from stock option exercises and purchases under our employee stock purchase program of approximately $2.5 million and to the excess tax benefits from employee stock-based transactions of approximately $310,000, partially offset by $1.5 million used to repurchase restricted stock units for minimum statutory income tax withholding.

Contractual Obligations

Our contractual obligations as of March 31, 2013 were as follows (in thousands):

 

		Payments Due In
		Total				Less Than 1 Year				1-3 Years				3-5 Years				More Than 5 Years
Contractual Obligations:
Operating lease obligations		$	12,694			$	2,383			$	5,440			$	3,948			$	923
Contingent payment to acquire additional preferred stock			1,000				1,000				—				—				—
		$	13,694			$	3,383			$	5,440			$	3,948			$	923

On December 21, 2012, we agreed to purchase a 17.7% equity ownership interest in a privately-held company for $3.5 million in cash. We paid $2.5 million in 2012 and the remaining $1.0 million is in the form of contingent payment to acquire additional preferred stock in the privately-held Company, over a period of time based on achievement of certain milestones by the privately-held company.

The amounts above exclude liabilities under FASB ASC 740-10, “Income Taxes – Recognition section” amounting to approximately $27.4 million as of March 31, 2013 as we are unable to reasonably estimate the ultimate amount or timing of settlement. See Note 12, “Income Taxes,” in our notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012.

Liquidity and Capital Resource Requirements

Based on our estimated cash flows, we believe our existing cash and cash equivalents and short-term investments are sufficient to meet our capital and operating requirements for at least the next 12 months.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including government and corporate securities and money market funds. These securities are classified as available for sale and consequently are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss). We also limit our exposure to interest rate and credit risk by establishing and monitoring clear policies and guidelines of our fixed income portfolios. The guidelines also establish credit quality standards, limits on exposure to any one issuer and limits on exposure to the type of instrument. Due to the limited duration and credit risk criteria established in our guidelines, we do not expect the exposure to interest rate risk and credit risk to be material. If interest rates rise, the market value of our investments may decline, which could result in a realized loss if we are forced to sell an investment before its scheduled maturity. As of March 31, 2013, we had an investment portfolio of securities as reported in short-term investments, including those classified as cash equivalents of approximately $104.3 million. A sensitivity analysis was performed on our investment portfolio as of March 31, 2013. This sensitivity analysis was based on a modeling technique that measures the hypothetical market value changes that would result from a parallel shift in the yield curve of plus 50, 100, or 150 basis points over a twelve-month time horizon.

 

0.5%		1.0%				1.5%
$286,000		$	572,000			$	858,000

 

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As of December 31, 2012, we had an investment portfolio of securities as reported in short-term investments, including those classified as cash equivalents of approximately $97.3 million. These securities are subject to interest rate fluctuations. The following represents the potential change to the value of our investments given a shift in the yield curve used in our sensitivity analysis.

 

0.5%		1.0%				1.5%
$284,000		$	568,000			$	852,000

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash equivalents and short-term investments and accounts receivable. A majority of our cash and investments are maintained with a major financial institutions headquartered in the United States. As part of our cash and investment management processes, we perform periodic evaluations of the credit standing of the financial institutions and we have not sustained any credit losses from investments held at these financial institutions. The counterparties to the agreements relating to our investment securities consist of various major corporations and financial institutions of high credit standing.

We perform on-going credit evaluations of our customers’ financial condition and may require collateral, such as letters of credit, to secure accounts receivable if deemed necessary. We maintain an allowance for potentially uncollectible accounts receivable based on our assessment of collectability.

Foreign Currency Exchange Risk

A majority of our revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, certain operating expenditures and capital purchases are incurred in or exposed to other currencies, primarily the Chinese Yuan, Indian Rupee and Japanese Yen. Additionally, many of our foreign distributors price our products in the local currency of the countries in which they sell. Therefore, significant strengthening or weakening of the U.S. dollar relative to those foreign currencies could result in reduced demand or lower U.S. dollar prices or vice versa, for our products, which would negatively affect our operating results. Cash balances held in foreign countries are subject to local banking laws and may bear higher or lower risk than cash deposited in the United States.

We assessed the risk of loss in fair values from the impact of hypothetical changes in foreign currency exchange rates. For foreign currency exchange rate risk, a 10% increase or decrease of foreign currency exchange rates against the U.S. dollar for activities during the three months ended March 31, 2013 with all other variables held constant would have resulted in a $0.6 million change in the value of our foreign currency cash accounts.

As of March  31, 2013, we did not have any material derivative transactions.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our first quarter of fiscal 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

The information set forth under Note 7 of Notes to Condensed Consolidated Financial Statements (Unaudited) under Part I Item 1 of this Form 10-Q, is incorporated herein by reference. For an additional discussion of certain risks associated with legal proceedings, see “Risk Factors” immediately below.

 

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Item 1A. Risk Factors

A description of the risk factors associated with our business is set forth below. You should carefully consider the following risk factors, together with all other information contained or incorporated by reference in this filing, before you decide to purchase shares of our common stock. These factors could cause our future results to differ materially from those expressed in or implied by forward-looking statements made by us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business. The trading price of our common stock could decline due to any of these risks and you may lose all or part of your investment.

Our success depends on our ability to develop and bring to market innovative new technologies and semiconductor products as well as continued growth in consumer and customer demand for these new technologies and semiconductor products. We may not be able to develop and bring to market such technologies and products in a timely manner because the process of developing high-performance semiconductor products is complex and costly.

Our future growth and success depends on the continued growth in market acceptance and the consumer and customer demand for our mobile technologies and semiconductor products, especially our MHL enabled products. Growth in the demand for our MHL enabled products accounted for a significant portion of our revenue growth in 2012. If we cannot continue to increase consumer awareness of and demand for MHL enabled products, our customers’ demand for our MHL enabled semiconductor products may not continue to grow as rapidly as has been the case and may even decrease. This could have a negative impact on our business and results of operations.

Our future growth and success also depends on our ability to continuously develop and bring to market new and innovative semiconductor products on a timely basis—such as semiconductor products supporting the MHL and WirelessHD standards. There can be no assurance that we will be successful in developing and marketing these new or other future products. Moreover, there is no assurance that our new or future products will incorporate the innovations, features or functionality at the price points necessary to achieve a desired level of market acceptance in the anticipated timeframes. There is no way to make certain that any such new or future products will contribute significantly to our revenue. We face significant competition from startups having the resources, flexibility and ability to innovate faster than we can. We also face competition from established companies with more significant financial resources and greater breadth of product line than we have, providing them with a competitive advantage in the marketplace. If we cannot continue to innovate and to develop and market new products could negatively affect our business and results of operations could be negatively affected.

The development of new semiconductor products is highly complex. On several occasions in the past, we have experienced delays, some of which exceeded one year, in the development and introduction of our new semiconductor products. As our products integrate new, more advanced functions and transition to smaller geometries, they become more complex and increasingly difficult to design, manufacture and debug.

Our ability to successfully develop and introduce new products also depends on a number of factors, including, but not limited to:

 

•

our ability to accurately predict market trends and requirements, the establishment and adoption of new standards in the market and the evolution of existing standards and connectivity technologies, including enhancements or modifications to existing standards such as HDMI, MHL and WirelessHD;

 

•

our ability to identify customer and consumer market needs where we can apply our innovation and skills to create new standards or areas for product differentiation that improve our overall competitiveness either in an existing market or in a new market;

 

•

our ability to develop advanced technologies and capabilities and new products and solutions that satisfy customer and consumer market demands;

 

•

how quickly our competitors and customers integrate the innovation and functionality of our new products into their semiconductor products, putting pressure on us to continue to develop and introduce innovative products with new features and functionality;

 

•

our ability to complete and introduce new product designs on a timely basis, while accurately anticipating the market windows for our products and bringing them to market within the required time frames;

 

•

our ability to manage product life cycles;

 

•

our ability to transition our product designs to leading-edge foundry processes in response to market demands, while achieving and maintaining of high manufacturing yields and low testing costs;

 

•

the consumer electronics market’s acceptance of our new technologies, architectures products and other connectivity solutions; and

 

•

consumers’ shifting preferences for how they purchase and consume HD content, which may not be met by our products.

Accomplishing what we need to do to be successful is extremely challenging, time-consuming, and expensive; and there is no assurance that we will succeed. We may experience product development delays from unanticipated engineering complexities, commercial deployment of new connectivity standards changing market or competitive product requirements or specifications, difficulties in overcoming resource constraints, our inability to license third-party technology and other factors. Also our competitors and customers may integrate the innovation and functionality of our products into their own products, thereby reducing demand for our products. If we are not able to develop and introduce new and innovative products and solutions successfully and in a timely manner, our costs could increase or our revenue could decrease, both of which would adversely affect our operating results. Even if we are successful in our product development efforts, it is possible that failures in our commercialization may result in delays or failure in generating revenue from these new products.

 

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In addition, we must work with semiconductor foundries and potential customers to complete new product development and to validate manufacturing methods and processes to support volume production and potential re-work. These steps may involve unanticipated difficulties, which could delay product introductions and reduce market acceptance of our products. These difficulties and the increasing complexity of our products may further result in the introduction of products that contain defects or that do not perform as expected, which would harm our relationships with customers and market acceptance of our new products. There can be no assurance that we will be able to achieve design wins for our new products, that we will be able to complete development of these products when anticipated, or that these products can be manufactured in commercial volumes at acceptable yields, or that any design wins will produce any revenue. Failure to develop and introduce new products, successfully and in a timely manner, may adversely affect our results of operations.

We have made acquisitions of companies and intangible assets in the past and expect to continue to make such acquisitions in the future as we look to develop and bring to market new and innovative semiconductor and products and technologies on a timely basis. Acquisitions of companies or intangible assets involve numerous risks and uncertainties.

Our growth depends on the growth of the markets we serve and our ability to enter new markets. We are also dependent on our ability to enhance our existing products and technologies and to introduce new products and technologies for existing and new markets on a timely basis. The acquisition of companies or intangible assets is a strategy we have used in the past and will continue to use to develop new technologies and products enhance our existing products portfolio and to enter new markets. Acquisitions involve numerous risks, including, but not limited to, the following:

 

•

the inability to find acquisition opportunities that are suitable to our needs available in the time frame necessary for us to take advantage of market opportunities or available at a price that we can afford;

 

•

the difficulty and increased costs of integrating the operations and employees of the acquired business, including our possible inability to keep and retain key employees of the acquired business;

 

•

the disruption to our ongoing business of the acquisition process itself and subsequent integration;

 

•

the risk of undisclosed liabilities of the acquired businesses and potential legal disputes with founders or stockholders of acquired companies;

 

•

the inability to successfully commercialize acquired products and technologies;

 

•

the inability to retain the customers and suppliers of the acquired business;

 

•

the need to take impairment charges or write-downs with respect to acquired assets and technologies; and

 

•

the risk that the future business potential as projected may not be realized and as a result, we that we may be required to take a charge to earnings that would impact our profitability.

We cannot assure you that our prior acquisitions or our future acquisitions, if any, will be successful or provide the anticipated benefits, or that they will not adversely affect our business, operating results or financial condition. Our failure to manage growth effectively and to successfully integrate acquisitions made by us could materially harm our business and operating results.

In January 2007, for example we completed the acquisition of Sci-worx, now Silicon Image, GmbH. In 2009, because of our decision to focus on discrete semiconductor products and related intellectual property, we decided to restructure our research and development operations resulting in the closure of our two sites in Germany.

We have made and continue to make strategic investments in and enter into strategic partnerships with third parties. The anticipated benefits of these investments and partnerships may never materialize.

We have made and will continue to make strategic investments in and enter into strategic partnerships with third parties with the goal of acquiring or gaining access to new and innovative semiconductor products and technologies on a timely basis. Negotiating and performing under these arrangements involves significant time and expense, and we cannot assure you that the anticipated benefits of these arrangements will ever materialize or that the products or technologies involved will ever be commercialized or that, as a result, we will not have write down a portion or all of our investment.

For example, on July 13, 2011, we purchased a 17.5% equity ownership interest in a U.S. based privately-held company for $7.5 million in cash. In July 2012, we invested an additional $2.75 million in the form of convertible secured promissory notes. As of September 30, 2012, we concluded that these investments are impaired, and that such impairment is other than temporary. In reaching this conclusion, we considered all available evidence, including that (i) the privately-held company had not achieved forecasted revenue or operating results, (ii) the privately-held company had limited liquidity or capital resources as of September 30, 2012, and (iii) the overall progress the privately-held company has made towards its business objectives, including the acquisition of home theater wireless speaker customers, has not progressed as previously expected. As a result of our analysis of these factors, we believed that the possibility was remote that we would exercise our call option on the investments or that we would realize any other value from these investments. As a result, we recorded a non-cash impairment charge of $7.5 million representing the carrying value of the investments in the quarter ended September 30, 2012.

 

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In 2011, we converted $8.5 million of secured promissory notes from a third-party company into advances for intellectual properties. In the fourth quarter of 2011 and again subsequent to our year ended December 31, 2011, we assessed our advances for intellectual properties for impairment. We concluded that the intangible assets related to these advances were fully impaired as of December 31, 2011, and have written them off. This conclusion was based on our determination that certain of the technologies was no longer aligned with our product roadmap due to a change in strategic focus and therefore, would not be used. The remaining technologies were impaired due to an adverse change in the extent and manner in which the technology was expected to be utilized by a strategic customer, as well as the competitive environment in which the technology was intended for use. In connection with this assessment, we recognized an impairment charge of $8.5 million in our 2011 consolidated statement of operations.

Negotiation and integration of acquisitions or strategic investments could divert management’s attention and other company resources. Any of the following risks associated with past or future acquisitions or investments could impair our ability to grow our business, develop new products and sell our products and ultimately could harm our growth or financial results:

 

•

difficulty in combining the technology, products, operations or workforce of the acquired business with our business;

 

•

difficulties in entering into new markets in which we have limited or no experience and where competitors have stronger positions;

 

•

loss of, or impairment of relationships with, any of our key employees, vendors or customers;

 

•

difficulty in operating in new and potentially disperse locations;

 

•

disruption of our ongoing businesses or the ongoing business of the company we invest in or acquire;

 

•

failure to realize the potential financial or strategic benefits of the transaction;

 

•

difficulty integrating the accounting, management information, human resources and other administrative systems of the acquired business;

 

•

disruption of or delays in ongoing research and development efforts and release of new products to market;

 

•

diversion of capital and other resources;

 

•

assumption of liabilities;

 

•

issuance of equity securities that may be dilutive to our existing stockholders;

 

•

diversion of resources and unanticipated expenses resulting from litigation arising from potential or actual business acquisitions or investments;

 

•

failure of the due diligence processes to identify significant issues with product quality, technology and development, or legal and financial issues, among other things;

 

•

incurring one-time charges, increased contingent liabilities, adverse tax consequences, depreciation or deferred compensation charges, amortization of intangible assets or impairment of goodwill, which could harm our results of operations; and

 

•

potential delay in customer purchasing decisions due to uncertainty about the direction of our product offerings or those of the acquired business.

Mergers and acquisitions of high-technology companies are inherently risky and subject to many factors outside of our control and no assurance can be given that our previous or future acquisitions will be successful, will deliver the intended benefits of such acquisition, and will not materially harm our business, operating results or financial condition. Failure to manage and successfully integrate acquisitions could materially harm our business and operating results.

Our annual and quarterly operating results are highly dependent upon how well we manage our business.

Our annual and quarterly operating results are highly dependent upon and may fluctuate based on how well we manage our business, including without limitation:

 

•

our ability to manage product introductions and transitions, develop necessary sales and marketing channels and manage our entry into new market segments;

 

•

our ability to manage sales into multiple markets such as mobile, CE and PC, which may involve additional research and development, marketing or other costs and expenses;

 

•

our ability to enter into licensing transactions when expected and make timely deliverables and milestones on which recognition of revenue often depends;

 

•

our ability to develop customer solutions that adhere to industry standards in a timely and cost-effective manner;

 

•

our ability to achieve acceptable manufacturing yields and develop automated test programs within a reasonable time frame for our new products;

 

•

our ability to manage joint ventures and projects, design services and our supply chain partners;

 

•

our ability to monitor the activities of our licensees to ensure compliance with license restrictions and remittance of royalties;

 

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•

our ability to structure our organization to enable achievement of our operating objectives and to meet the needs of our customers and markets;

 

•

the success of the distribution and partner channels through which we choose to sell our products and our ability to manage expenses and inventory levels;

 

•

our ability to successfully maintain certain structural and various compliance activities in support of our global structure which is designed to result in certain operational benefits as well as an overall lower tax rate and which, if not maintained, may result in us losing these operational and tax benefits; and

 

•

Our ability to effectively manage our business.

Our annual and quarterly operating results may fluctuate significantly and are difficult to predict, particularly given adverse domestic and global economic conditions.

Our annual and quarterly operating results are likely to fluctuate significantly in the future based on a number of factors many of which we have little or no control over. These factors include, but are not limited to:

 

•

the growth, evolution and rate of adoption of industry standards in our key markets, including mobile, CE and PCs;

 

•

the completion of a few key licensing transactions in any given period on which our anticipated licensing revenue and profits are highly dependent, and the timing of which is not always predictable and is especially susceptible to delay beyond the period in which completion is expected and we depend on a few licensees in any period for substantial portions of our anticipated licensing revenue and profits;

 

•

our licensing revenue has been uneven and unpredictable over time and is expected to continue to be uneven and unpredictable in the future, resulting in considerable fluctuation in the amount of revenue recognized in a particular quarter;

 

•

the impact on our operating results of the results of the royalty compliance audits which we regularly perform;

 

•

competitive pressures, such as the ability of our competitors to offer or introduce products that are more cost-effective or that offer greater functionality than our products;

 

•

average selling prices and gross margins of our products, which are influenced by competition and technological advancements, among other factors;

 

•

government regulations impacting the industry standards in our key markets or our products;

 

•

the availability or continued viability of other semiconductors or key components required for a customer solution where we supply one or more of the necessary components;

 

•

the cost to manufacture our products, including the cost of gold, and prices charged by the third parties who manufacture, assemble and test our products; and

 

•

fluctuations in market demand, one-time sales opportunities and sales goals, which sometimes result in heightened sales efforts during a given period that may adversely affect our sales in future periods.

Because we have little or no control over these factors and/or their magnitude, our operating results are difficult to predict. Any substantial adverse change in any of these factors could negatively affect our business and results of operations. For example, in January 2013, we announced a reduction in our revenue guidance for the fourth quarter of 2012 as a result of the rescheduling of certain orders by a large customer.

Our business has in the past and may in the future be significantly impacted by a deterioration in worldwide economic conditions and any uncertainty in the outlook for the global economy could make it more likely that our actual results will differ materially from expectations.

Global credit and financial markets have experienced disruptions, and may experience disruptions in the future, including national debt and fiscal concerns, diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and continued uncertainty about economic stability. These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. Any tightening of credit in financial markets may lead consumers and businesses to postpone spending, which may cause our customers to cancel, decrease or delay their existing and future orders with us. In addition, financial difficulties experienced by our suppliers or distributors could result in product delays, increased accounts receivable defaults and inventory challenges. Our mobile and CE product revenue, which comprised approximately 76.2% and 70.5% of total revenue for the three months ended March 31, 2013 and 2012, respectively, is dependent on continued demand for consumer electronics, including but not limited to, DTVs, STBs, AV receivers, tablets, digital still cameras, and smartphones. Demand for consumer electronics is a function of the health of the economies in the United States, Japan and around the world. As a result, the demand for our mobile, CE and PC products and our operating results have in the past and may in the future be adversely affected as well. We cannot predict the timing, strength or duration of any economic disruption or subsequent economic recovery, worldwide, in the United States, in our industry, or in the consumer electronics market. These and other economic factors have had and may in the future have a material adverse effect on demand for our mobile, CE and PC products and on our financial condition and operating results.

 

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Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate debt securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates. We may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. Any adverse events in the global economy and in the credit markets could negatively impact our return on investment for these debt securities and thereby reduce the amount of cash and cash equivalents and investments on our balance sheet.

The licensing component of our business strategy increases our business risk and market volatility.

Our business strategy includes licensing our IP to companies that incorporate it into their respective technologies that address markets in which we do not directly participate or compete and we license into markets where we do participate and to compete. There can be no assurance that these customers will continue to be interested in licensing our technology on commercially favorable terms or at all. Our licensing revenue can be impacted by the introduction of new technologies by customers in place of the technologies used by them based on our IP. There also can be no assurance that our licensing customers will introduce and sell products incorporating our technology, will accurately report royalties owed to us, will pay agreed upon royalties, will honor agreed upon market restrictions, will not infringe upon or misappropriate our intellectual property or will maintain the confidentiality of our proprietary information. Our IP licensing agreements are complex and depend upon many factors including completion of milestones, allocation of values to delivered items and customer acceptances. Many of these require significant judgments.

Our licensing revenue fluctuates, sometimes significantly, from period to period because it is heavily dependent on a few key transactions being completed in a given period, the timing of which is difficult to predict and may not match our expectations. Because of its high margin, the licensing revenue portion of our overall revenue can have a disproportionate impact on gross profit and profitability. Generating revenue from IP licenses is a lengthy and complex process that may last beyond the period in which our efforts begin and, once an agreement is in place, the timing of revenue recognition may be dependent on the customer acceptance of deliverables, achievement of milestones, our ability to track and report progress on contracts, customer commercialization of the licensed technology and other factors. The accounting rules governing the recognition of revenue from IP licensing transactions are increasingly complex and subject to interpretation. As a result, the amount of license revenue recognized in any period may differ significantly from our expectations.

We face intense competition in our markets, which may lead to reduced revenue and gross margins from sales of our products and losses.

The markets in which we operate are intensely competitive and characterized by rapid technological change, evolving standards, short product life cycles and declining selling prices. We expect competition to increase, as industry standards become more widely adopted, new industry standards are introduced, competitors reduce prices and offer products with greater levels of integration, and new competitors enter the markets we serve.

Our products face competition from companies selling similar discrete products and from companies selling products such as chipsets and system-on-a-chip (SoC) solutions with integrated functionality. Our competitors include semiconductor companies that focus on the mobile, CE and PC markets, as well as major diversified semiconductor companies and we expect that new competitors will enter our markets.

Some of our current or potential customers, including our own licensees, have their own internal semiconductor capabilities or other semiconductor suppliers or relationships, and may also develop solutions integrating the innovations, features and functionality of our products for use in their own products rather than purchasing products from us. Some of our competitors have already established supplier or joint development relationships with some of our current or potential customers and may be able to leverage these relationships to discourage these customers from purchasing products from us or to persuade them to replace our products with theirs. Many of our competitors have longer operating histories, greater presence in key markets, better name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do and therefore may be able to adapt more quickly to new or emerging technologies and customer requirements, or to devote greater resources to the promotion and sale of their products. Our competitors in the CE market include Analog Devices, Analogix Semiconductor, Parade Technologies, Explore, Broadcom, Intel, MediaTek, Mstar, Sigma and Marvell and our competitors in the Mobile market include Analogix, Parade, Explore, Broadcom, Intel, Qualcomm, Texas Instrument, NVIDIA, Marvell and MediaTek. Mergers and acquisitions are very common in our industry and some of our competitors could merge, which may enhance their market presence. Existing or new competitors may also develop technologies that more effectively address our markets with products that offer enhanced features and functionality, lower power requirements, greater levels of integration or lower cost. Increased competition has resulted in and is likely to continue to result in price reductions and loss of market share in certain markets. We cannot assure you that we can compete successfully against current or potential competitors, or that competition will not reduce our revenue and gross margins.

We operate in rapidly evolving markets, which makes it difficult to evaluate our future prospects.

The markets in which we compete are characterized by rapid technological change, evolving customer needs and frequent introductions of new products, technologies and standards. As we adjust to evolving customer requirements and technological advances, we may be required to further reposition our existing offerings and to introduce new products and services. We may not be successful in developing and marketing such new offerings, or we may experience difficulties that could delay or prevent the development and marketing of new products. In addition, new standards that compete with standards that we promote have been and likely will continue to be introduced, which could impact our success. Accordingly, we face risks and difficulties frequently encountered by companies in new and rapidly evolving markets. If we do not successfully address these risks and challenges, our results of operations could be negatively affected.

 

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We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration, which may result in reduced manufacturing yields, delays in product deliveries and increased expenses.

To remain competitive, we expect to continue to transition our semiconductor products to increasingly smaller geometries. This requires us to change the manufacturing processes for our products and to redesign some products as well as standard cells and other integrated circuit designs that we may use in multiple products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs. Currently most of our products are manufactured in 180 nanometer, 130 nanometer, 65 nanometer and 55 nanometer geometry processes. We are now designing new products in 40 nanometer process technologies. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, resulting in reduced manufacturing yields, delays in product deliveries and increased expenses. The transition to 40 nanometer geometry process technologies has and will continue to result in significantly higher mask and prototyping costs, as well as additional expenditures for engineering design tools and related computer hardware. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes.

We are dependent on our relationship with our foundry to transition to smaller geometry processes successfully. We cannot assure you that the foundries that we use will be able to effectively manage the transition in a timely manner, or at all, or that we will be able to maintain our existing foundry relationships or develop new ones. If any of our foundry subcontractors or we experience significant delays in this transition or fail to efficiently implement this transition, we could experience reduced manufacturing yields, delays in product deliveries and increased expenses, all of which could harm our relationships with our customers and our results of operations.

We will have difficulty selling our products if customers do not design our products into their product offerings or if our customers’ products are not commercially successful.

Our products are generally incorporated into our customers’ products at the customers’ design stage. We rely on OEMs in the markets we serve to select our products to be designed into their products. Without having our products designed into our customers’ products (we refer to such design integration as “design wins”), it is very difficult to sell our products. We often incur significant expenditures on the development of a new product under the hope for such “design wins” without any assurance that a manufacturer will select our product for design into its own product. Additionally, in some instances, we are dependent on third parties to obtain or provide information that we need to achieve a design win. Some of these third parties may be competitors and, accordingly, may not supply this information to us on a timely basis, if at all. Once a manufacturer designs a competitor’s product into its product offering, it becomes significantly more difficult for us to sell our products to that customer because changing suppliers involves significant cost, time, effort and risk for the customer. Furthermore, even if a manufacturer designs one of our products into its product offering, we cannot be assured that its product will be commercially successful or that we will receive any revenue from sales of that product. Sales of our products largely depend on the commercial success of our customers’ products. Our customers generally can choose at any time to stop using our products if their own products are not commercially successful or for any other reason. We cannot assure you that we will continue to achieve design wins or that our customers’ products incorporating our products will ever be commercially successful.

Our products typically have lengthy sales cycles. A customer may decide to cancel or change its product plans, which could cause us to lose anticipated sales. In addition, our average product life cycles tend to be short and, as a result, we may hold excess or obsolete inventory that could adversely affect our operating results.

Our customers typically test and evaluate our products prior to deciding to design our product into their own products. This evaluation period generally lasts from three to over six months to test, followed by an additional three to over nine months to begin volume production of products incorporating our products. This lengthy sales cycle may cause us to experience significant delays and to incur additional inventory costs until we generate revenue from our products. It is possible that we may never generate any revenue from products after incurring significant expenditures. Even if we achieve a design win with a customer, there is no assurance that the customer will successfully market and sell its products with our integrated components. The length of our sales cycle increases the risk that a customer will decide to cancel or change its product plans, which would cause us to lose sales that we had anticipated. In addition, anticipated sales could be materially and adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle or chooses not to release equipment that contains our products. Further, the combination of our lengthy sales cycles coupled with worldwide economic conditions could have a compounding negative impact on the results of our operations.

While our sales cycles are typically long, our average product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, from time to time, our product sales and marketing efforts may not generate sufficient revenue requiring that we write off excess and obsolete inventory. If we incur significant marketing expenses and investments in inventory in the future that we are not able to recover or otherwise compensate for our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions but still hold higher-cost products in our inventory, our operating results would be harmed.

Our customers may not purchase anticipated levels of products, which can result in excess inventories.

We generally do not obtain firm, long-term purchase commitments from our customers and, in order to accommodate the requirements of certain customers, we may from time to time build inventory that is specific to that customer in advance of receiving firm purchase orders. The short-term nature of our customers’ commitments and the rapid changes in demand for their products reduce our ability to accurately estimate the future requirements of those customers. Should the customer’s need shift so that they no longer require such inventory, we may be left with excessive inventories, which could adversely affect our operating results.

 

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We depend on a few key customers and the loss of any of them could significantly reduce our revenue and gross margins and adversely affect our results of operations.

Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue and we may not be able to diversify our customer and/or distributor base. For the three months ended March 31, 2013, revenue from Samsung Electronics and our distributors Weikeng and Edom Technology accounted for 40.8%, 8.0% and 6.8% of our total revenue, respectively. For the three months ended March 31, 2012, revenue from Samsung Electronics and our distributors Edom Technology and Weikeng accounted for 34.3%, 8.9% and 7.3% of our total revenue, respectively. In addition, an OEM customer of ours may buy our products through multiple distributors, contract manufacturers and /or directly from us, which could mean an even greater concentration of revenue in such a customer. We cannot be certain that customers and key distributors that have accounted for significant revenue in past periods, individually or as a group, will continue to sell our products or products incorporating our products and generate revenue for us. As a result of this concentration of revenue in few customers, our results of operations could be adversely affected if any of the following occurs:

 

•

one or more of our customers or distributors becomes insolvent or goes out of business;

 

•

one or more of our key customers or distributors significantly reduces, delays or cancels orders; and/or

 

•

one or more significant customers selects products manufactured by one of our competitors for inclusion in their future product generations.

While our participation in multiple markets has broadened our customer base, we remain dependent on a small number of customers or, in some cases, a single customer for a significant portion of our revenue in any given quarter, the loss of which could adversely affect our operating results.

We sell our products through distributors, which limits our direct interaction with our end customers, therefore reducing our ability to forecast sales and increasing the complexity of our business.

Many OEMs rely on third-party manufacturers or distributors to provide inventory management and purchasing functions. Distributors generated 30.2% of our total revenue for both the three months ended March 31, 2013 and 2012. Selling through distributors reduces our ability to forecast sales and increases the complexity of our business, requiring us to:

 

•

manage a more complex supply chain;

 

•

monitor the level of inventory of our products at each distributor;

 

•

estimate the impact of credits, return rights, price protection and unsold inventory at distributors; and

 

•

monitor the financial condition and credit-worthiness of our distributors, many of which are located outside of the United States and not publicly traded.

Since we have limited ability to forecast inventory levels at our end customers, it is possible that there may be significant build-up of inventories in the distributor channel, with the OEM or the OEM’s contract manufacturer. Such a buildup could result in a slowdown in orders, requests for returns from customers, or requests to move out planned shipments. This could adversely impact our revenues and profits. Any failure to manage these challenges could disrupt or reduce sales of our products and unfavorably impact our financial results.

We are dependent upon suppliers for a portion of raw materials used in the manufacturing of our products and new regulations related to conflict free minerals could require us to incur additional expenses in connection with procuring these raw materials.

The Securities and Exchange Commission has recently adopted additional disclosure requirements related to certain minerals, so called “conflict minerals”, sourced from the Democratic Republic of Congo and adjoining countries for which such conflict minerals are necessary to the functionality of a product manufactured, or contracted to be manufactured. These regulations also require a reporting company to disclose efforts to prevent the use of such minerals.

In our industry, such conflict minerals are most commonly found in metals. Some of our products use certain metals, such as gold, silicon and copper, as part of the manufacturing process. Although we have not yet determined whether the gold, silicon or copper used in the manufacture of our products would be considered conflict minerals, if such a determination is made, we may not be able to obtain alternative supplies for such metals due to the limited number of sources of non conflict metals. If we are required to use alternative supplies, the price we pay for such metals may increase. Additionally, our reputation with our customers could be harmed if we cannot certify that our products do not contain conflict metals.

Governmental action against companies located in offshore jurisdictions may lead to a reduction in the demand for our common shares.

Federal and state legislation have been proposed in the past, and similar legislation may be proposed in the future which, if enacted, could have an adverse tax impact on both us and our stockholders. For example, the ability to defer taxes as a result of permanent investments offshore could be limited, thus raising our effective tax rate.

 

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The cyclical nature of the semiconductor industry may create constraints in our foundry, test and assembly capacities and strain our management and resources.

The semiconductor industry is characterized by significant downturns and wide fluctuations in supply and demand. This cyclicality has led to significant fluctuations in product demand and in the foundry, test and assembly capacity of third-party suppliers. During periods of increased demand and constraints in manufacturing capacity, production capacity for our semiconductors may be subject to allocation, in which case not all of our production requirements may be met. This may impact our ability to meet demand and could also increase our production costs and inventory levels. Cyclicality has also accelerated decreases in average selling prices per unit. We may experience fluctuations in our future financial results because of changes in industry-wide conditions. Our financial performance has been and may in the future be, negatively impacted by downturns in the semiconductor industry. In a downturn situation, we may incur substantial losses if there is excess production capacity or excess inventory levels in the distribution channel.

The cyclicality of the semiconductor industry may also strain our management and resources. To manage these industry cycles effectively, we must:

 

•

improve operational and financial systems;

 

•

train and manage our employee base;

 

•

successfully integrate operations and employees of businesses we acquire or have acquired;

 

•

attract, develop, motivate and retain qualified personnel with relevant experience; and

 

•

adjust spending levels according to prevailing market conditions.

If we cannot manage industry cycles effectively, our business could be seriously harmed.

We depend on third-party sub-contractors to manufacture, assemble and test nearly all of our products, which reduce our control over the production process.

We do not own or operate a semiconductor fabrication facility. We rely on one third party semiconductor foundry overseas to produce substantially all of our semiconductor products. We also rely on outside assembly and test services to test all of our semiconductor products. Our reliance on an independent foundry and assembly and test facilities involves a number of significant risks, including, but not limited to:

 

•

reduced control over delivery schedules, quality assurance, manufacturing yields and production costs;

 

•

lack of guaranteed production capacity or product supply, potentially resulting in higher inventory levels; and

 

•

lack of availability of, or delayed access to, next-generation or key process technologies.

For example, in the fourth quarter of fiscal 2012, we recorded the write down of certain unsalable inventory amounting to $6.2 million due to defects in the material used by one of our assembly vendors in the packaging process.

We do not have a long-term supply agreement with our third party semiconductor foundry or many of our other subcontractors and instead obtain these services on a purchase order basis. Our outside sub-contractors have no obligation to manufacture our products or supply products to us for any specific period of time, in any specific quantity or at any specific price, except as set forth in a particular purchase order or multi month quote. Our requirements represent a small portion of the total production capacity of our outside foundry, assembly and test facilities and our sub-contractors may reallocate capacity on short notice to other customers who may be larger and better financed than we are, or who have long-term agreements with our sub-contractors, even during periods of high demand for our products. We may elect to have our suppliers move or expand production of our products to different facilities under their control, even in different locations, which may be time consuming, costly and difficult, have an adverse effect on quality, yields and costs and require us and/or our customers to re-qualify our products, which could open up design wins to competition and result in the loss of design wins. If our subcontractors are unable or unwilling to continue manufacturing, assembling or testing our products in the required volumes, at acceptable quality, yields and costs and in a timely manner, our business will be substantially harmed. In this event, we would have to identify and qualify substitute sub-contractors, which would be time-consuming, costly and difficult; and we cannot guarantee that we would be able to identify and qualify such substitute sub-contractors on a timely basis or obtain commercially reasonable terms from them. This qualification process may also require significant effort by our customers and may lead to re-qualification of parts, opening up design wins to competition and loss of design wins. Any of these circumstances could substantially harm our business. In addition, if competition for foundry, assembly and test capacity increases, our product costs may increase and we may be required to pay significant amounts or make significant purchase commitments to secure access to production services.

The complex nature of our production process can reduce yields and prevent identification of problems until well into the production cycle or, in some cases, until after the product has been shipped.

The manufacture of semiconductors is a complex process and it is often difficult for semiconductor foundries to achieve acceptable product yields. Product yields depend on both our product design and the manufacturing process technology unique to the semiconductor foundry. Since low yields may result from either design or process difficulties, identifying problems can often only occur well into the production cycle, when an actual product exists that can be analyzed and tested.

Further, we only test our products after they are assembled, as their high-speed nature makes earlier testing difficult and expensive. As a result, defects often are not discovered until after assembly. This could result in a substantial number of defective products being assembled and tested or shipped, thus lowering our yields and increasing our costs. These risks could result in product shortages or increased costs of assembling, testing or even replacing our products.

 

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Although we test our products before shipment, they are complex and may contain defects and errors. For example, in January 2013, we announced that we took a charge to reflect the write down of certain unsalable inventory due to defects in the material used by one of our assembly vendors in the packaging process. In the past we have encountered defects and errors in our products. Because our products are sometimes integrated with products from other vendors, it can be difficult to identify the source of any particular problem. Delivery of products with defects or reliability, quality or compatibility problems, may damage our reputation and our ability to retain existing customers and attract new customers. In addition, product defects and errors could result in additional development costs, diversion of technical resources, delayed product shipments and replacement costs, increased product returns, warranty and product liability claims against us that may not be fully covered by insurance. Any of these circumstances could substantially harm our business.

We face foreign business, political and economic risks because a majority of our products and our customers’ products are manufactured and sold outside of the United States and because we have employees in research and development centers and sales offices throughout the world.

A substantial portion of our business is conducted outside of the United States and we have a significant portion of our workforce in research and development centers and sales offices throughout the world. As a result, we are subject to foreign business, political and economic risks. Nearly all of our products are manufactured in Taiwan or elsewhere in Asia. For the three months ended March 31, 2013 and 2012, approximately 51.9% and 61.2% of our total revenue respectively, was generated from customers and distributors located outside of North America, primarily in Asia. We anticipate that sales outside of the United States will continue to account for a substantial portion of our revenue in future periods.

In addition to our headquarters in Sunnyvale, California, we maintain research and development centers in Shanghai, China, and Hyderabad, India, and undertake sales and marketing activities through regional offices in several other countries. As we grow, we intend to continue to expand our international business activities.

Accordingly, we are subject to a variety of risks associated with the conduct of business outside the United States. These risks include, but are not limited to:

 

•

political, social and economic instability;

 

•

the operational challenges of conducting our business in several geographic regions around the world, especially in the face of different business practices, social norms and legal standards that differ from those to which we are accustomed and held to as a publicly traded company in the United States, particularly with respect to the protection and enforcement of intellectual property rights and the conduct of business generally;

 

•

policies, laws, regulations and social pressures in foreign countries that favor and promote their own local, domestic companies over non-domestic companies, and additional trade and travel restrictions;

 

•

natural disasters and public health emergencies;

 

•

nationalization of business and blocking of cash flows;

 

•

changing raw material, energy and shipping costs;

 

•

the imposition of governmental controls and restrictions;

 

•

burdens of complying with a variety of foreign laws;

 

•

import and export license requirements and restrictions of the United States and each other country in which we operate;

 

•

unexpected changes in regulatory requirements;

 

•

foreign technical standards;

 

•

changes in taxation and tariffs, including potentially adverse tax consequences;

 

•

difficulties in staffing and managing international operations;

 

•

fluctuations in currency exchange rates;

 

•

cultural and language differences;

 

•

difficulties in collecting receivables from foreign entities or delayed revenue recognition;

 

•

expense and difficulties in protecting our intellectual property in foreign jurisdictions;

 

•

exposure to possible litigation or claims in foreign jurisdictions; and

 

•

potentially adverse tax consequences.

Any of the factors described above may have a material adverse effect on our ability to increase or maintain our foreign sales or conduct our business generally.

 

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Also OEMs that design our semiconductors into their products sell them outside of the United States. This exposes us indirectly to foreign risks. Because sales of our products are denominated exclusively in United States dollars, relative increases in the value of the United States dollar will increase the foreign currency price equivalent of our products, which could lead to a change in their competitiveness in the marketplace. This in turn could lead to a reduction in our sales and profits.

Our success depends on our investment of significant amount of resources in research and development. We may have to invest more resources in research and development than anticipated, which could increase our operating expenses and negatively impact our operating results.

Our success depends on us investing significant amounts of resources into research and development. Our research and development expenses as a percent of our total revenue were 29.9% and 39.5% for the three months ended March 31, 2013 and 2012, respectively. We expect to have to continue to invest heavily in research and development in the future in order to continue to innovate and come to market with new products in a timely manner and increase our revenue and profitability. If we have to invest more resources in research and development than we anticipate, we could see an increase in our operating expenses which may negatively impact our operating results. Also, if we are unable to properly manage and effectively utilize our research and development resources, we could see adverse effects on our business, financial condition and operating results.

In addition, if new competitors, technological advances by existing competitors, our entry into new markets, or other competitive factors require us to invest significantly greater resources than anticipated in our research and development efforts, our operating expenses would increase. If we are required to invest significantly greater resources than anticipated in research and development efforts without a corresponding increase in revenue, our operating results could decline. Research and development expenses are likely to fluctuate from time to time to the extent we make periodic incremental investments in research and development and these investments may be independent of our level of revenue which could negatively impact our financial results. In order to remain competitive, we anticipate that we will continue to devote substantial resources to research and development, and we expect these expenses to increase in absolute dollars in the foreseeable future due to the increased complexity and the greater number of products under development.

The success of our business depends upon our ability to adequately protect our intellectual property.

We rely on a combination of patent, copyright, trademark, mask work and trade secret laws, as well as nondisclosure agreements and other methods, to protect our confidential and proprietary technologies and information. Our success depends on our ability to adequately protect such intellectual property. With respect to our patents, we have been issued patents and have a number of pending patent applications. However, we cannot assume that any pending patents applications will be issued or, if issued, that any claims allowed will protect our technology. Recent and proposed changes to U.S. patent laws and rules may also affect our ability to protect and enforce our intellectual property rights. For example, the recently passed Leahy-Smith America Invents Act would transition the manner in which patents are issued and change the way in which issued patents are challenged. The long-term impact of these changes are unknown, but this law could cause a certain degree of uncertainty surrounding the enforcement and defense of our issued patents, as well as greater costs concerning new and existing patent applications. In addition, we do not file patent applications on a worldwide basis, meaning we do not have patent protection in some jurisdictions. Furthermore, it is possible that our existing or future patents may be challenged, invalidated or circumvented.

With respect to our copyright and trademark intellectual property, it may be possible for a third-party, including our licensees, to misappropriate such proprietary technology. It is possible that copyright, trademark and trade secret protection and enforcement effective in the US may be unavailable or limited in foreign countries. Additionally, with respect to all of our intellectual property, it may be possible for a third-party to copy or otherwise obtain and use our products or technology without authorization, develop similar technology independently or design around our patents in the United States and in other jurisdictions. It is also possible that some of our existing or new licensing relationships will enable other parties to use our intellectual property to compete against us. Legal actions to enforce intellectual property rights tend to be lengthy and expensive and the outcome often is not predictable.

Despite our efforts and expenses, for the foregoing reasons and others, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business. In addition, practicality also limits our assertion of intellectual property rights. Assertion of intellectual property rights often results in counterclaims for perceived violations of the defendant’s intellectual property rights and/or antitrust claims. Certain parties after receipt of an assertion of infringement will cut off all commercial relationships with the party making the assertion, thus making assertions against suppliers, customers and key business partners risky. If we forgo making such claims, we may run the risk of creating legal and equitable defenses for an infringer .

We generally enter into confidentiality agreements with our employees, consultants and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, internal or external parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. Also, current or former employees may seek employment with our business partners, customers or competitors, and we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, current, departing or former employees or third parties could attempt to penetrate our computer systems and networks to misappropriate our proprietary information and technology or interrupt our business. Because the techniques used by computer hackers and others to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate, counter or ameliorate these techniques. As a result, our technologies and processes may be misappropriated, particularly in countries where laws may not protect our proprietary rights as fully as in the United States.

 

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Our products may contain technology provided to us by other parties such as contractors, suppliers or customers. We may have little or no ability to determine in advance whether such technology infringes the intellectual property rights of a third party. Our contractors, suppliers and licensors may not be required to indemnify us in the event that a claim of infringement is asserted against us, or they may be required to indemnify us only up to a maximum amount, above which we would be responsible for any further costs or damages. In addition, we may have little or no ability to correct errors in the technology provided by such contractors, suppliers and licensors, or to continue to develop new generations of such technology. Accordingly, we may be dependent on their ability and willingness to do so. In the event of a problem with such technology, or in the event that our rights to use such technology become impaired, we may be unable to ship our products containing such technology, and may be unable to replace the technology with a suitable alternative within the time frame needed by our customers.

Our participation in consortiums for the development and promotion of industry standards in our target markets, including the HDMI, MHL and WirelessHD standards, requires us to license some of our intellectual property for free or under specified terms and conditions, which makes it easier for others to compete with us in such markets.

A key element of our business strategy includes participating in consortiums to establish industry standards in our target markets, promoting and enhancing specifications and developing and marketing products based on such specifications and future enhancements. We have in the past and will continue to participate in consortiums that develop and promote the HDMI, MHL and WirelessHD specifications. In connection with our participation in these consortiums, we make certain commitments regarding our intellectual property, in each case with the effect of making our intellectual property available to others, including our competitors, desiring to implement the specification in question. For example, as a founder of the HDMI Consortium, we must license specific elements of our intellectual property to others for use in implementing the HDMI specification, including enhancements thereof, as long as we remain part of the consortium. Also, as a promoter of the MHL specification, we must agree not to assert certain necessary patent claims against other members of the MHL Consortium, even if such members may infringed upon such claims in implementing the MHL specification.

Accordingly, certain companies that implement these specifications in their products can use specific elements of our intellectual property to compete with us. Although in the case of the HDMI and MHL Consortiums, there are annual fees and royalties associated with the adopters’ use of the technology, there can be no assurance that our shares of such annual fees and royalties will adequately compensate us for having to license or refrain from asserting our intellectual property.

Through our wholly-owned subsidiary, HDMI Licensing, LLC, we act as agent of the HDMI specification and are responsible for promoting and administering the specification. We receive all the license fees paid by adopters of the HDMI specification to cover the costs we incur to promote and administer the HDMI specification. There can be no assurance that, going forward, we will continue to act as agent of the HDMI specification and/or receive or to continue to oversee the management of all the license fees paid by HDMI adopters. After an initial period during which we received all of the royalties paid by HDMI adopters, in 2007, the HDMI founders reallocated the royalties to reflect each founder’s relative contribution of intellectual property to the HDMI specification, and following this reallocation, our portion of HDMI royalties was reduced to approximately 62%. In 2010, HDMI founders again reviewed the allocation of HDMI royalties and agreed on an allocation formula that reduced the portion of HDMI royalties received by us in 2012 to approximately 40% to 50%. We expect the HDMI founders to continue to review the allocation of HDMI royalties from time to time and we cannot provide any assurance regarding the portion of HDMI royalties received by us in the future.

Through our wholly-owned subsidiary, MHL, LLC, we act as agent of the MHL specification and are responsible for promoting and administering the specification. As agent, we are entitled to receive license fees paid by adopters of the MHL specification sufficient to reimburse us for the costs we incur to promote and administer the specification. Given the limited number of MHL adopters to date, we do not believe that the license fees paid by such adopters will be sufficient to reimburse us for these costs and there can be no assurance that the license fees paid by MHL adopters will ever be sufficient to reimburse us the cost we incur as agent of the specification.

We intend to promote and continue to be involved and actively participate in other standard setting initiatives. For example, through our acquisition of SiBEAM, Inc. in May 2011, we achieved SiBEAM’s prior position as founder and chair of the WirelessHD Consortium. Accordingly, we may likely license additional elements of our intellectual property to others for use in implementing, developing, promoting or adopting standards in our target markets, in certain circumstances at little or no cost. This may make it easier for others to compete with us in such markets. In addition, even if we receive license fees and/or royalties in connection with the licensing of our intellectual property, there can be no assurance that such license fees and/or royalties will compensate us adequately.

Our business may be adversely impacted as a result of the adoption of competing standards and technologies by the broader market.

The success of our business to date has depended on our participation in standard setting organizations, such as the HDMI and MHL Consortiums, and the widespread adoption and success of those standards. From time to time, competing standards have been established which negatively impact the success of existing standards or jeopardize the creation of new standards. DisplayPort is an example of a competing standard on a different technology base which has been created as an alternative high definition connectivity solution in the PC space. The DisplayPort standard has been adopted by many large PC manufacturers. While currently not as widely recognized as the HDMI standard, DisplayPort does represent a viable alternative to the HDMI or MHL technologies. If DisplayPort should gain broader adoption, especially with non-PC consumer electronics, our HDMI or MHL businesses could be negatively impacted and our revenues could be reduced. WiGig is an example of a competing 60GHz standard which has been created as an alternative high-bandwidth wireless connectivity solution for the PC industry. While the WiGig standard has not been in the market as long as the WirelessHD standard, it does represent a viable alternative to WirelessHD for 60GHz connectivity. If WiGig should gain broader adoption before WirelessHD is adopted, it could negatively impact us.

 

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Our current and future business is dependent on the continued adoption and widespread implementation of the HDMI and MHL specifications and the new implementation and adoption of the WirelessHD specifications.

Our future success is largely dependent upon the continued adoption and widespread implementation of the HDMI, MHL and WirelessHD specifications. For the three months ended March 31, 2013, more than 90% of our total revenue was derived from the sale of HDMI and MHL enabled products and the licensing of our HDMI and MHL technology. Our leadership in the market for HDMI and MHL-enabled products and intellectual property has been based on our ability to introduce first-to-market semiconductor and IP solutions to our customers and to continue to innovate within the standard. Therefore, our inability to be first to market with our HDMI and MHL-enabled products and intellectual property or to continue to drive innovation in the HDMI and MHL specifications could have an adverse impact on our business going forward.

With our acquisition of SiBEAM, Inc. in May 2011, we acquired 60GHz wireless technology that we hope will be made widely available and adopted by the marketplace through the efforts of the WirelessHD Consortium and incorporated into certain of our future products. As was and is the case with our HDMI and MHL products and intellectual property, our success with this technology will depend on our ability to introduce first-to-market, WirelessHD-enabled semiconductor and IP solutions to our customers and to continue to innovate within the WirelessHD standard. There can be no guarantee that this wireless technology will be adopted by the marketplace and our inability to do this could have an adverse impact on our business going forward.

Additionally, if competing digital interconnect technologies are developed, our ability to sell our products and license our intellectual property could be adversely affected and our revenues could decrease.

As the agent for the HDMI specification, we derive revenue from the license fees paid by adopters, and as a founder we derive revenue from the royalties paid by the adopters of the HDMI technology. Any development that has the effect of lowering the number of adopters of the HDMI standard will negatively impact these license fees and royalties. The allocation of license fees and royalty revenue among the HDMI founders is reviewed and discussed by the founders from time to time. There can be no assurance that going forward we will continue to act as agent of the HDMI specification or to receive the share of HDMI license fees and royalties that we currently receive. If our share of these license fees and royalties is reduced, this decision will have a negative impact on our revenues. Refer to the previously discussed risk factor above which also discusses the sharing of HDMI royalty revenues among various founders.

We act as agent of the MHL specification and are responsible for promoting and administering the specification. As agent, we are entitled to receive license fees paid by adopters of the MHL specification sufficient to reimburse us the costs we incur to promote and administer the specification. Given the limited number of MHL adopters to date, we do not believe that the license fees paid by such adopters will be sufficient to reimburse us for these costs and there can be no assurance that the license fees paid by MHL adopters will ever be sufficient to reimburse us the cost we incur as agent of the specification.

We have granted Intel Corporation certain rights with respect to our intellectual property, which could allow Intel to develop products that compete with ours or otherwise reduce the value of our intellectual property.

We entered into a patent cross-license agreement with Intel in which each of us granted the other a license to use the patents filed by the grantor prior to a specified date, except for identified types of products. We believe that the scope of our license to Intel excludes our current products and anticipated future products. Intel could, however, exercise its rights under this agreement to use our patents to develop and market other products that compete with ours, without payment to us. Additionally, Intel’s rights to our patents could reduce the value of our patents to any third-party who otherwise might be interested in acquiring rights to use our patents in such products. Finally, Intel could endorse competing products, including a competing digital interface, or develop its own proprietary digital interface. Any of these actions could substantially harm our business and results of operations.

New Releases of Microsoft Windows ^® , Apple Mac OS ^® , Apple iOS and Google Android operating systems may render our chips inoperable.

ICs targeted to PC or mobile designs, laptop, or notebook designs often require device driver software to operate. This software is difficult to produce and may require various certifications such as Microsoft’s Windows Hardware Quality Labs (WHQL) before being released. Each new revision of an operating system may require a new software driver and associated testing/certification. Failure to produce this software can have a negative impact on our relation with OS providers and may damage our reputation as a quality supplier of products in the eyes of end consumers.

We may become engaged in intellectual property litigation that could be time-consuming, may be expensive to prosecute or defend and could adversely affect our ability to sell our product.

In recent years, there has been significant litigation in the United States and in other jurisdictions involving patents and other intellectual property rights. This litigation is particularly prevalent in the semiconductor industry, in which a number of companies aggressively use their patent portfolios to bring infringement claims. In addition, in recent years, there has been an increase in the filing of so-called “nuisance suits,” alleging infringement of intellectual property rights. These claims may be asserted as counterclaims in response to claims made by a company alleging infringement of intellectual property rights. These suits pressure defendants into entering settlement arrangements to quickly dispose of such suits, regardless of merit. In addition, as is common in the semiconductor industry, from time to time we have been notified that we may be infringing certain patents or other intellectual property rights of others. Responding to such claims, regardless of their merit, can be time consuming, result in costly litigation, divert management’s attention and resources and cause us to incur significant expenses. As each claim is evaluated, we may consider the desirability of entering into settlement or licensing agreements. No assurance can be given that settlements will

 

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occur or that licenses can be obtained on acceptable terms or that litigation will not occur. In the event there is a temporary or permanent injunction entered prohibiting us from marketing or selling certain of our products, or a successful claim of infringement against us requiring us to pay damages or royalties to a third-party and we fail to develop or license a substitute technology, our business, results of operations or financial condition could be materially adversely affected.

Any potential intellectual property litigation against us or in which we become involved may be expensive and time-consuming and may divert our resources and the attention of our executives. It could also force us to do one or more of the following:

 

•

stop selling products or using technology that contains the allegedly infringing intellectual property;

 

•

attempt to obtain a license to the relevant intellectual property, which license may not be available on reasonable terms or at all; and

 

•

attempt to redesign products that contain the allegedly infringing intellectual property.

If we take any of these actions, we may be unable to manufacture and sell our products. We may be exposed to liability for monetary damages, the extent of which would be very difficult to accurately predict. In addition, we may be exposed to customer claims, for potential indemnity obligations and to customer dissatisfaction and a discontinuance of purchases of our products while the litigation is pending. Any of these consequences could substantially harm our business and results of operations.

We have entered into and may again be required to enter into, patent or other intellectual property cross-licenses.

Many companies have significant patent portfolios or key specific patents, or other intellectual property in areas in which we compete. Many of these companies appear to have policies of imposing cross-licenses on other participants in their markets, which may include areas in which we compete. As a result, we have been required, either under pressure of litigation or by significant vendors or customers, to enter into cross licenses or non-assertion agreements relating to patents or other intellectual property. This permits the cross-licensee, or beneficiary of a non-assertion agreement, to use certain or all of our patents and/or certain other intellectual property for free to compete with us. Our results of operations could be adversely affected by the use of cross-license or beneficiary of a non-assertion agreement of all our patents and/or certain other intellectual property.

We indemnify certain of our customers against infringement.

We indemnify certain of our customers for any expenses or liabilities resulting from third-party claims of infringements of patent, trademark, trade secret, or copyright rights by the technology we license. Certain of these indemnification provisions are perpetual from execution of the agreement and, in some instances; the maximum amount of potential future indemnification is not limited. To date, we have not paid any such claims or been required to defend any lawsuits with respect to any claim. In the event that we were required to defend any lawsuits with respect to our indemnification obligations, or to pay any claim, our results of operations could be materially adversely affected.

We must attract and retain qualified personnel to be successful and competition for qualified personnel is increasing in our market.

Our success depends to a significant extent upon the continued contributions of our key management, technical and sales personnel, many of who would be difficult to replace. The loss of one or more of these employees could harm our business. We generally do not have employment contracts with our key employees. Our success also depends on our ability to identify, attract and retain qualified technical, sales, marketing, finance and managerial personnel. Competition for qualified personnel is particularly intense in our industry and in our locations throughout the world. This makes it difficult to retain our key personnel and to recruit highly qualified personnel. We have experienced and may continue to experience, difficulty in hiring and retaining candidates with appropriate qualifications. To be successful, we need to hire candidates with appropriate qualifications and retain our key executives and employees. Replacing departing executive officers and key employees can involve organizational disruption and uncertain timing.

The volatility of our stock price has had an impact on our ability to offer competitive equity-based incentives to current and prospective employees, thereby affecting our ability to attract and retain highly qualified technical personnel. If these adverse conditions continue, we may not be able to hire or retain highly qualified employees in the future and this could harm our business. New regulations could make it more difficult or expensive to grant options to employees, we may incur increased cash compensation costs or find it difficult to attract, retain and motivate employees, either of which could harm our business.

We have experienced transitions in our management team and our board of directors in the past and we may continue to do so in the future, which could result in disruptions in our operations and require additional costs.

We have experienced a number of transitions with respect to our board of directors and executive officers in the past and we may experience additional transitions in our board of directors and management in the future. Any such future transitions could result in disruptions in our operations and require additional costs.

 

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If our internal control over financial reporting or disclosure controls and procedures are not effective, there may be errors in our financial statements that could require restatement or our filings may not be timely and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price. While we have not identified any material weaknesses in the past three years, we cannot assure you that a material weakness will not be identified in the future.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each year and to include a management report assessing the effectiveness of our internal control over financial reporting in each Annual Report on Form 10-K. Section 404 also requires our independent registered public accounting firm to report on, our internal control over financial reporting.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because changes in conditions or deterioration in the degree of compliance with policies or procedures may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

As a result, we cannot assure you that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding disclosure controls and the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause us to fail to timely meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

We have been and may continue to become the target of securities class action suits and derivative suits which could result in substantial costs and divert management attention and resources.

Securities class action suits and derivative suits are often brought against companies, particularly technology companies, following periods of volatility in the market price of their securities. Defending against these suits, even if meritless, can result in substantial costs to us and could divert the attention of our management.

Our operations and the operations of our significant customers, third-party wafer foundry and third-party assembly and test subcontractors are located in areas susceptible to natural disasters, the occurrence of which could adversely impact our supply of product, revenues, gross margins and results of operations.

Our operations are headquartered in the San Francisco Bay Area, which is susceptible to earthquakes. TSMC, our outside foundry that manufactures almost all of our semiconductor products, is located in Taiwan. Siliconware Precision Industries Co. Ltd., or SPIL, Advanced Semiconductor Engineering, or ASE, and Amkor Taiwan are subcontractors located in Taiwan that assemble and test our semiconductor products.

In addition, the operations of certain of our significant customers are located in Japan and Taiwan. For the three months ended March 31, 2013 and 2012 customers and distributors located in Japan generated 13.3% and 17.2% of our total revenue, respectively, and customers and distributors located in Taiwan generated 15.5% and 22.1% of our total revenue, respectively.

Taiwan and Japan are susceptible to earthquakes, typhoons and other natural disasters.

Our supply of product and our revenues, gross margins and results of operations generally would be adversely affected if any of the following were to occur:

 

•

an earthquake or other disaster in the San Francisco Bay area were to damage our facilities or disrupt the supply of water or electricity to our headquarters;

 

•

an earthquake, typhoon or other natural disaster in Taiwan were to damage the facilities or equipment of TSMC, SPIL, ASE or Amkor or were to result in shortages of water, electricity or transportation, which occurrences would limit the production capacity of our outside foundry and/or the ability of our third party contractors to provide assembly and test services;

 

•

an earthquake, typhoon or other natural disaster in Taiwan or Japan were to damage the facilities or equipment of our customers or distributors or were to result in shortages of water, electricity or transportation, which occurrences would result in reduced purchases of our products, adversely affecting our revenues, gross margins and results of operations; or

 

•

an earthquake, typhoon or other disaster in Taiwan or Japan were to disrupt the operations of suppliers to our Taiwanese or Japanese customers, outside foundries or our third party contractors providing assembly and test services, which in turn disrupted the operations of these customers, foundries or third party contractors, resulting in reduced purchases of our products or shortages in our product supply.

In March 2011, Japan experienced a 9.0-magnitude earthquake which triggered extremely destructive tsunami waves. The earthquake and tsunami significantly impacted the Japanese people and the overall economy of Japan resulting to reduced consumer spending in Japan and supply chain issues, which adversely affected our revenues and results of operations in 2011.

 

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Terrorist attacks or war could lead to economic instability and adversely affect our operations, results of operations and stock price.

The United States has taken and continues to take, military action against terrorism and currently has troops in Afghanistan. In addition, the current tensions regarding nuclear arms in North Korea and Iran could escalate into armed hostilities or war. Acts of terrorism or armed hostilities may disrupt or result in instability in the general economy and financial markets and in consumer demand for the OEM’s products that incorporate our products. Disruptions and instability in the general economy could reduce demand for our products or disrupt the operations of our customers, suppliers, distributors and contractors, many of whom are located in Asia, which would in turn adversely affect our operations and results of operations. Disruptions and instability in financial markets could adversely affect our stock price. Armed hostilities or war in South Korea could disrupt the operations of the research and development contractors we utilize there, which would adversely affect our research and development capabilities and ability to timely develop and introduce new products and product improvements.

Changes in environmental rules and regulations could increase our costs and reduce our revenue.

Several jurisdictions have implemented rules that would require that certain products, including semiconductors, be made “green,” which means that the products need to be lead free and be free of certain banned substances. All of our products are available to customers in a green format. While we believe that we are generally in compliance with existing regulations, such environmental regulations are subject to change and the jurisdictions may impose additional regulations which could require us to incur additional costs to develop replacement products. These changes will require us to incur cost or may take time or may not always be economically or technically feasible, or may require disposal of non-compliant inventory. In addition, any requirement to dispose or abate previously sold products would require us to incur the costs of setting up and implementing such a program.

Provisions of our charter documents and Delaware law could prevent or delay a change in control and may reduce the market price of our common stock.

Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These provisions include:

 

•

authorizing the issuance of preferred stock without stockholder approval;

 

•

providing for a classified board of directors with staggered, three-year terms;

 

•

requiring advance notice of stockholder nominations for the board of directors;

 

•

providing the board of directors the opportunity to expand the number of directors without notice to stockholders;

 

•

prohibiting cumulative voting in the election of directors;

 

•

limiting the persons who may call special meetings of stockholders; and

 

•

prohibiting stockholder actions by written consent.

Provisions of Delaware law also may discourage delay or prevent someone from acquiring or merging with us.

The price of our stock fluctuates substantially and may continue to do so.

The stock market has experienced extreme price and volume fluctuations that have affected the market valuation of many technology companies, including Silicon Image. These factors, as well as general economic and political conditions, may materially and adversely affect the market price of our common stock in the future. The market price of our common stock has fluctuated significantly and may continue to fluctuate in response to a number of factors, including, but not limited to:

 

•

actual or anticipated changes in our operating results;

 

•

changes in expectations of our future financial performance;

 

•

changes in market valuations of comparable companies in our markets;

 

•

changes in market valuations or expectations of future financial performance of our vendors or customers;

 

•

changes in our key executives and technical personnel; and

 

•

announcements by us or our competitors of significant technical innovations, design wins, contracts, standards or acquisitions.

Due to these factors, the price of our stock may decline. In addition, the stock market experiences volatility that is often unrelated to the performance of particular companies. These market fluctuations may cause our stock price to decline regardless of our performance.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities. The table below summarizes information about our purchases of equity securities registered pursuant to Section 12 of the Exchange Act during the three months ended March 31, 2013.

 

Period		Total Number of Shares Purchased (1)				Average Price Paid per Share (2)				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)				Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (2)
January 1, 2013 to January 31, 2013			—			$	—				—			$	19,349,123
February 1, 2013 to February 28, 2013			—				—				—				19,349,123
March 1, 2013 to March 31, 2013			750,000				4.74				750,000				15,791,066
Total			750,000				4.74				750,000

 

(1)

In the Quarterly Report of Silicon Image, Inc. on Form 10-Q for the quarter ended March 31, 2012, we announced a board-approved plan authorizing us to repurchase up to $50.0 million of our common stock in the open market or in privately negotiated transactions. The stock repurchase program may be modified, extended or terminated by the Board at any time.

(2)	Does not include amounts paid for commissions.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The information required by this item is set forth on the exhibit index which follows the signature page of this report.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Dated: May 9, 2013				Silicon Image, Inc.
						/s/ Noland Granberry
						Noland Granberry
						Chief Financial Officer
						(Principal Financial Officer)

 

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Exhibit Index

 

Filing

Filed

Form

File No.

Exhibit

Date

Herewith

10.01*

Silicon Image, Inc. Executive Incentive Compensation Plan for Fiscal Year 2013

X

10.02*

Silicon Image, Inc. Sales Compensation Plan for Vice President of Worldwide Sales for Fiscal Year 2013

X

31.01

Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

X

31.02

Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

X

32.01**

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

X

32.02**

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

X

101.INS***

XBRL Instance Document

X

101.SCH***

XBRL Taxonomy Extension Schema Document

X

101.CAL***

XBRL Taxonomy Extension Calculation Linkbase Document

X

101.DEF***

XBRL Taxonomy Extension Definition Linkbase Document

X

101.LAB***

XBRL Taxonomy Extension Label Linkbase Document

X

101.PRE***

XBRL Taxonomy Extension Presentation Linkbase Document

X

 

*	This exhibit is a management contract or compensatory plan or arrangement.

**	This exhibit is being furnished, rather than filed, and shall not be deemed incorporated by reference into any filing of the registrant, in accordance with Item 601 of Regulation S-K.

***

In accordance with Rule 406T of Regulation S-T, these interactive data files are furnished and deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and otherwise are not subject to liability under these sections.

 

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