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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Annual report pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934

For the fiscal year ended December 31, 2002

Commission file number 000-26887

Silicon Image, Inc.
(Exact name of registrant as specified in its charter)

1060 East Arques Avenue
Sunnyvale, CA 94085
(Address of principal executive offices and zip code)

(408) 616-4000
(Registrant's telephone number, including area code)

Securities registered pursuant to section 12(g) of the Act:
Common Stock, $0.001 par value

        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 ý No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 under the Securities Exchange Act of 1934). Yes ý No o

        The aggregate market value of voting and non-voting common equity held by non-affiliates at June 28, 2002 was approximately $371,735,000, based on the last reported sale price of our common shares on the NASDAQ Stock Market on that date of $6.12 per share. We had 65,673,000 common shares outstanding at June 28, 2002.

        Part III incorporates by reference information from our proxy statement for our annual meeting of stockholders' to be held on May 20, 2003.

TABLE OF CONTENTS

        This report contains forward-looking statements within the meaning of Section 21E of the Securities and 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-K entitled "Factors Affecting Future Results," 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-K are identified by words such as "believes," "anticipates," "expects," "intends," "may," "will" 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-K 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.

PART I

Item 1. Business

        Silicon Image designs, develops and markets semiconductor products for applications that require high-bandwidth, cost-effective solutions for high-speed digital data communications. The markets into which we sell our products are personal computer (PC), consumer electronics (CE) and storage.

        Products sold into the PC market generated 58% of our revenue in 2002, 70% of our revenue in 2001 and 96% of our revenue in 2000. Our products for the PC market include:

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Transmitters, which are used in graphic cards or motherboards, for PCs and notebook computers;



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Receivers for use in cathode ray tubes (CRTs), flat panel monitors, flat panels and projectors; and



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Intelligent Panel Controllers, which integrate a receiver with a timing controller, for use in liquid crystal display (LCD) panels.

        Our products in the PC market are based on PanelLink® technology, which is our proprietary implementation of the digital visual interface (DVI) specification that defines a high-speed serial data communication link between computers and digital displays. The majority of the displays in the PC market employ an analog receiver or a dual-interface receiver capable of receiving either an analog or digital signal. We do not offer an analog or dual-interface solution, but do partner with other companies to sell multiple-chip solutions into the dual-interface market. These multiple-chip solutions are typically limited to higher end, larger displays operating at resolutions of SXGA (1280 pixels × 1024 pixels) and above. In addition, we have licensed certain of our technologies to companies for use in making products for the dual-interface market.

        Products sold into the CE market generated 11% of our revenue in 2002, 8% of our revenue in 2001 and 4% of our revenue in 2000. Our products for the CE market include:

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Transmitters for use in set-top boxes, DVD players and D-VHS players;



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Controllers for digital TVs; and



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Digital video processors for use in progressive scan DVD players, DTVs, LCD TVs, projectors and set-top boxes, and video processing systems for use in HDTVs, multimedia TVs, data and video projectors and PC monitors.

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        Semiconductor products sold into the storage market generated 15% of our revenue in 2002, 5% of our revenue in 2001 and none of our revenue in 2000. Our products for the storage market include:

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Fibre Channel SerDes (serializer, deserializer) devices for Host Bus Adapters (HBAs) and Switches that connect PCs and servers to large storage banks;



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Serial ATA (SATA) controllers for PC motherboards, disk controller add-in cards and storage/embedded systems;



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Serial ATA-to-Parallel ATA bridges for use in storage systems and optical and hard disk drives;



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Serial ATA physical layer (PHY) for use in PC motherboards and storage / embedded systems; and



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Parallel and universal serial bus (USB) controllers for use in PC motherboards, add-in cards and embedded systems.

        Sales of storage systems products generated 8% of our revenue in 2002, 17% of our revenue in 2001 and none of our revenue in 2000. During 2002, we decided to phase out our storage systems products and therefore do not expect significant revenue from these products in 2003.

        Development, licensing and royalties represented 8% of our revenue in 2002 and none of our revenue in 2001 and 2000. During 2002, we decided to license our technology to third parties that address market segments in which we do not want to participate directly. Additionally, in conjunction with our decision to phase out our storage systems products and change primarily to a licensing business model, we decided to design products for, and / or license our technology to, third parties in this market segment. We anticipate continuing this business model for our storage systems technology as advancements and developments warrant.

        From our inception in 1995 through the first half of 1997, we were engaged primarily in developing our first generation PanelLink digital transmitter and receiver products, developing our high-speed digital interconnect technology, establishing our digital interface technology as an open standard, and building strategic customer and foundry relationships.

        In the third quarter of 1997, we began volume shipments of our first generation PanelLink digital transmitter and receiver products. Since that time, we have introduced several new generations of transmitter and receiver products providing higher speed and increased functionality. In 1999, we began shipping our first generation digital display controller product.

        In 2000, we began focusing our resources on entering two new markets—CE and storage. We acquired two companies during 2000, one of which was a developer of high-speed transmission technology for data storage applications and the other of which was a provider of digital video processing systems for the CE market.

        In 2001, we focused on accelerating our entry into the CE and storage markets, leveraging our IP into licensing revenue and restructuring the company to improve profitability. We acquired two companies during 2001, one of which was a provider of storage subsystems and semiconductors designed for storage area networks, and the other of which was a provider of mixed-signal and high-speed circuit designs.

        During 2002, we began to see the benefits of our diversification strategy, which resulted in establishing a key presence in the CE and storage markets, both of which we expect to experience significant growth rates during the next several years. Additionally, we were able to successfully leverage our intellectual property to generate licensing revenue. Lastly, we completed the final steps of the restructuring program we began in 2001. As part of this restructuring program, we decided in the second quarter of 2002 to phase out our existing storage subsystem products, to not manufacture new subsystem products, and to license our technology to other companies in this market. Our restructuring

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program has resulted in a more focused market strategy and a more appropriate cost structure for us going forward.

Markets and Customers

        We focus our sales and marketing efforts on achieving design wins with leading original equipment manufacturers (OEMs) of PC, CE and storage products. In most cases, these OEMs outsource manufacturing functions to third parties. Therefore, once our product is designed into an OEMs product, we typically work with the OEMs third party manufacturer to ready the design for production. Once the design is complete, we sell our products to these third party manufacturers either directly or indirectly through distributors.

        Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For instance, our top five customers, including distributors, generated 41%, 51% and 57% of our revenue in 2002, 2001 and 2000, respectively. In 2002, shipments to World Peace International, an Asian distributor, generated 15% of our revenue, and shipments to Weikeng, an Asian distributor, generated 11% of our revenue. In 2001, shipments to Samsung, a Korean customer, and Compaq, a global customer, each generated 12% of our revenue, and shipments to World Peace International generated 11% of our revenue. In 2000, shipments to World Peace International generated 18% of our total revenue, and shipments to Kanematsu, a Japanese distributor, generated 16% of our total revenue. Additionally, the percentage of revenue generated through distributors tends to be significant, since many OEM's rely upon third party manufacturers or distributors to provide purchasing and inventory management functions. In 2002, 42% of our revenue was generated through distributors, versus 40% in 2001 and 66% in 2000.

Products

        Our industry and the markets we serve are characterized by rapid technological advancement. We constantly strive for innovation in our product offerings. We introduce products both to address markets or applications that we previously have not addressed, and to replace our existing products with products that are based on more advanced technology and that incorporate new or enhanced features. We introduced 16 new products in 2002, and expect to introduce 12 to 16 new products in 2003. Although the number of new product introductions may decrease in 2003 from 2002 levels, we expect to continue integrating more functionality into our existing products in order to enhance their performance and capabilities.

        When we introduce replacement products, we notify our customers in advance, work with our customers to qualify and migrate to our newer products and accept final orders for replaced products. This allows us to eventually discontinue production and support for our older, less advanced products. We may decide to phase out products for reasons other than new product introductions. Such reasons could include failure of products to achieve market acceptance, changing market conditions and changes in business strategy.

        In 1999, the Digital Display Working Group (DDWG), of which we are a promoter, published the digital visual interface (DVI) specification, which defines a high-speed serial data communication link between computers and digital displays. Our key PC and CE products are based on our PanelLink technology and our highly-integrated PanelLink controller architecture. PanelLink is our proprietary implementation of the DVI specification. PanelLink architecture is our platform for developing controllers that integrate PanelLink receiver technology with additional functionality to enable intelligent displays. Key features of our solution include a high-speed interface, low cost of system implementation, system-level integration and scalability. Our solution enables customers to introduce digital display products, thereby eliminating the need for analog technology in both the host system and display. We believe this provides a number of benefits to our customers, including lower component

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costs, easy to use "plug and play" products for the end user, better image quality than analog systems, the ability to customize features to differentiate products and shorter design cycles.

        PanelLink Transmitters    Our PanelLink transmitter products reside on host systems, such as PC motherboards, graphics add-in boards, notebook PCs, set-top boxes, A/V receivers, DVD and D-VHS players. Transmitters take a stream of digital data from a graphics source, convert it to DVI-compliant digital output and transmit that output to a receiver in a display. Our PanelLink transmitter products are:

        Display Products    We have three families of display products: PanelLink receivers, PanelLink controllers and Intelligent Panel Controllers. Our PanelLink receiver products reside in display systems, such as flat panel displays, projectors and digital TVs. Receivers receive DVI-compliant digital input and restore the video data format. Our receivers also contain functionality that simplifies the design of digital displays. Our PanelLink receiver products are:

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        PanelLink Controllers    Our PanelLink controller products are suitable for display systems such as flat panel displays, CRT monitors and digital TVs. Our PanelLink controller products are:

        Intelligent Panel Controllers    Our Intelligent Panel controller products are programmable controllers with integrated timing controllers that reside on the LCD display module. These products receive digital input, restore the video data format and directly interface with the LCD module electronics. Our Intelligent Panel controller products are:

        Digital Video Processors    Our digital video processor products are high-quality digital video format converters that convert any standard-definition interlaced video signal to a non-interlaced signal, resulting in higher-definition images. These products are suitable for display on LCD, digital light processing DTVs or progressive scan. Our digital video processors and processing system products are (* denotes product is being phased out):

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        Fibre Channel SerDes    Our fibre channel serializer / deserializer (SerDes) products are a low-power, high-quality (low-jitter), cost-effective solution for applications such as HBAs and switches that connect PCs and servers to large storage banks. Our Fibre Channel products are:

        Serial ATA Controllers, PHYs and Bridges    The products in our SATALink family include two host controllers, a dual-channel PHY and two bridge ICs that are intended to enable customers to begin to incorporate serial ATA while they transition from parallel ATA. Our serial ATA controller, PHY and bridge devices are based on the SATA 1.0 specification, which is used to transmit and receive data at a rate of 1.5 Gbps, and are:

        Parallel ATA and USB Controllers    Our parallel ATA and USB Controllers serve products incorporating parallel ATA and USB interfaces such as motherboards, add-in cards and embedded systems. Our parallel ATA and USB controller products are (* denotes product is being phased out):

Promotion of Industry Standards

        As technology innovators, a key element of our business strategy is the development and promotion of industry standards in our target markets. Current standards efforts include:

Digital Visual Interface (DVI)

        We, together with Intel, Compaq, IBM, Hewlett-Packard, NEC and Fujitsu, announced the formation of the Digital Display Working Group (DDWG) in 1998. Subsequently, these parties entered into a Promoter's Agreement in which they agreed to:

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define, establish and support the DVI specification, an industry specification for sending video data between a computer and a digital display;



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encourage broad industry adoption of the DVI specification, in part by creating an implementer's forum that others may join in order to receive information and by providing support for the DVI specification; and

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invite third parties to enter into a Participant's Agreement in order to consult on the content, feasibility and other aspects of the DVI specification.

        In 1999, the DDWG published the DVI 1.0 specification, which defines a high-speed serial data communication link between computers and digital displays. Today, over 100 companies, including systems manufacturers, graphics semiconductor companies and monitor manufacturers have participated in DDWG activities, and many are developing hardware and software products designed to be compliant with the DVI specification.

Joint Development of High Definition Content Protection (HDCP)

        In 2000, the High-bandwidth Digital Content Protection (HDCP) specification HDCP 1.0 was released by Intel, with our contributions acknowledged in the specification. The specification was developed to provide a content protected link from host devices, such as set-top boxes and DVD and D-VHS players, to displays such as HDTVs and digital TVs. This technology has support from some members of the Motion Picture Industry Association and aims to prevent high-definition movie content from being copied when transmitted over a digital link.

High Definition Multimedia Interface (HDMI)

        In December 2002, the final specification for High Definition Multimedia Interface (HDMI) was released. The HDMI 1.0 specification is a next-generation digital interface for consumer electronics that enables the secure distribution of uncompressed high-definition video and multi-channel audio in a single cable, providing consumers with a broader array of high-quality digital content while increasing ease of use. This standard was created by Silicon Image, together with Sony, Matsushita Electric (Panasonic), Phillips, Thomson (RCA), Hitachi and Toshiba, and with strong support from Fox and Universal studios, DirecTV and Echostar. The HDMI specification is based on our transition minimized differential signaling (TMDS™) technology, the underlying technology for DVI 1.0. We expect HDMI to become a standard digital interface for consumer electronics products that carry digital audio and video signals.

Serial ATA Working Group

        During 2000, we acquired Zillion Technologies, a developer of high-speed transmission technology for data storage applications. Zillion contributed in drafting the preliminary serial ATA specification (SATA 1.0), which was published in 2001 and is being promoted as a successor to parallel bus technology. We are a contributor to the SATA working group, which includes APT, Dell, Intel, Maxtor and Seagate among its promoters. In February 2002, we joined the SATA II Working Group as a contributor. The SATA II working group released "Extensions to Serial ATA 1.0 Specifications" in October 2002 to enhance the existing SATA 1.0 specification for the server and network storage markets, and is developing a specification for the next-generation SATA speed of 3Gbps. The SATA II working group includes many of the same members as the SATA working group.

Serial-Attached SCSI Working Group

        In January 2002, we joined the Serial-Attached SCSI (SAS) working group as a contributor. The SAS working group is working to develop a specification that will propose serial-attached SCSI as a successor to existing parallel bus SCSI technology. Members of the SAS working group include Adaptec, Agilent, Compaq, Dell, Eurologic, Fujitsu, Hitachi, IBM, LSI Logic, Maxtor, QLogic, Seagate and others.

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Silicon Image Technology

Multi-Layered Systems Approach to Solving High-Speed Interconnect Problems

        We invented technology upon which the DVI and HDMI specifications are based and have substantial experience in the design, manufacture and deployment of semiconductor products incorporating this high-speed data communications technology. The advanced nature of our high-speed digital design allows us to integrate significant functionality with multiple high-speed communication channels using industry-standard, low-cost complementary metal oxide semiconductor (CMOS) manufacturing processes. At the core of our innovation is a multi-layered approach to providing multigigabit semiconductor solutions.

        The three layers of our multi-layer serial link (MSL) architecture include the physical, coding and protocol layers. Serial link technology is the basis for the physical layer, which performs electrical signaling in several data communication protocols, including DVI 1.0, HDMI 1.0, Serial ATA and Fibre Channel. This technology converts parallel data into a serial stream that is transmitted sequentially at a constant rate and then reconstituted into its original form. Our high-speed serial link technology includes a number of proprietary elements designed to address the significant challenge of ensuring that data sent to a display or a storage device can be accurately recovered after it has been separated and transmitted in serial streams over multiple channels. In order to enable a display or a storage device to recognize data at the proper time and rate, our digital serial link technology uses a digital phase-locked loop combined with a unique phase detecting and tracking method to monitor the timing of the data.

        At the coding layer, we have developed substantial intellectual property in data coding technology for high-speed serial communication. Our coding technology simplifies the protocol for high-speed serial communication and allows tradeoffs to be made in physical implementation of the link, which in turn reduces the cost of bandwidth and simplifies the overall system design. In addition, we have ensured direct current (DC) balanced transmission and the ability to use TMDS to keep electromagnetic emissions low and to enable connection to fiber optic interconnects without use of additional components.

PanelLink Cinema

        Our PanelLink Cinema technology sends high-fidelity digital audio and protected video across the HDMI link for use in the consumer electronics market. Combining digital video and digital audio transmissions in a single interconnect system simplifies and reduces the cost of the connection between consumer electronics devices, while maintaining high-quality and protection. PanelLink Cinema technology is fully compliant with the HDMI 1.0 specification.

Research and Development

        We have assembled a team of engineers and technologists with extensive experience in the areas of high-speed interconnect architecture, circuit design, digital imaging processor architecture, LCD panels and storage interconnect, software and systems. Our engineering team includes a group of consultants in Asia that focuses primarily on advanced technology development. The majority of these consultants are students at a university that we utilize for research and design services.

        From our inception until 1998, our internal research and development efforts focused primarily on the development of our core PanelLink technology, our initial transmitter and receiver products, and our first intelligent panel controller product. In 1999, we improved our PanelLink technology and developed new transmitter and receiver products, focusing on providing both higher speeds and improved ease of use. We also began development of our PanelLink architecture for digital displays. In 2000, we focused our internal research and development efforts on integrating our PanelLink receiver

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technology with additional functionality, such as PanelLink A/V and HDCP, for flat panel displays, digital CRTs and the consumer electronics industry. In 2001, we diversified our research and development efforts by increasing our investment in storage semiconductor development and by adding storage system architecture and software development expertise through our acquisition of CMD Technology. In 2002, our research and development efforts focused primarily on technology and applications for the consumer electronics and storage markets, including the development of HDMI technology.

        Our research and development efforts continue to focus on developing higher bandwidth links with different clocking methodologies for use in various PC, CE and storage applications. By utilizing our patented data coding technology and different clocking methodologies, we believe our high-speed link can scale with advances in semiconductor manufacturing process technology and simplify system design.

        We have invested, and expect that we will continue to invest, significant funds for research and development activities. Excluding non-cash stock compensation expense, our research and development expenses were approximately $32.8 million in 2002, $25.5 million in 2001, and $12.8 million in 2000.

Sales and Marketing

        We sell our products to distributors and OEMs throughout the world using a direct sales force with field offices located in North America, Taiwan and Europe, and indirectly through a network of distributors and manufacturer's representatives located throughout North America, Asia and Europe.

        Our sales strategy for all products is to achieve design wins with key industry leaders in order to grow the markets in which we participate and to promote and accelerate the adoption rate for industry standards we support or are developing, such as DVI, HDMI and serial ATA. Our sales personnel and applications engineers provide a high-level of technical support to our customers. Our marketing efforts focus primarily on promoting adoption of the DVI, HDMI and serial ATA specifications, participating in industry trade shows and forums, entering into branding relationships such as PanelLink for DVI, PanelLink Cinema for HDMI, and SATALink for serial ATA to build awareness of our brands, and on bringing new solutions to markets.

Manufacturing

Wafer Fabrication

        Our semiconductor products are fabricated using standard CMOS processes, which permit us to engage independent wafer foundries to fabricate our semiconductors. By outsourcing our manufacturing requirements, we are able to avoid the high cost of owning and operating a semiconductor wafer fabrication facility. This allows us to focus our resources on the design and quality of our products. Our devices are currently fabricated using 0.5 micron, 0.35 micron, 0.25 micron and 0.18 micron processes. We continuously evaluate the benefits, primarily improved performance, and feasibility of migrating our products to smaller geometry process technologies. We rely almost entirely on Taiwan Semiconductor Manufacturing Company (TSMC), an outside foundry, to produce all of our PC, CE and fibre channel and serial ATA storage products. We also rely on other outside foundries, such as Kawasaki and Atmel, to produce our parallel ATA and USB storage semiconductor products. We do not have long-term supply agreements with any of these foundries and therefore cannot be assured of sufficient capacity availability or future prices. Because of the cyclical nature of the semiconductor industry, capacity availability can change quickly and significantly. We attempt to optimize wafer availability by continuing to use less advanced wafer geometries, such as 0.5 micron, 0.35 micron and 0.25 micron, which generally have more available capacity.

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Assembly and Test

        After wafer fabrication, die (semiconductor devices) are assembled into packages and the finished products are tested. Our products are designed to use low-cost standard packages and to be tested with widely-available semiconductor test equipment. We outsource all of our packaging and the majority of our test requirements to Amkor Technology in Korea, Advanced Semiconductor Engineering in Taiwan, Malaysia and the United States, and Fujitsu and Kawasaki in Japan. We test a small portion of our products in-house.

        The high-speed nature of our products makes it difficult to test our products in a cost-effective manner prior to assembly. Since the fabrication yields of our products have historically been high and the costs of our packaging have historically been low, we test our products after they are assembled. Our operations personnel closely review the process control monitor information provided to us by our foundries. To ensure quality, we have established firm guidelines for rejecting wafers that we consider unacceptable. To date, not testing our products prior to assembly has not caused us to experience higher final test failures or lower yields. However, lack of testing prior to assembly could have adverse effects if there are significant problems with wafer processing. Additionally, for newer products and products for which yield rates have not stabilized, we may conduct bench testing using our personnel and equipment, which is more expensive than fully automated testing.

Quality Assurance

        We focus on product quality through all stages of the design and manufacturing process. Our designs are subjected to in-depth circuit simulation at temperature, voltage and processing extremes before being fabricated. We pre-qualify each of our subcontractors through a series of industry-standard environmental product stress tests, as well as an audit and analysis of the subcontractor's quality system and manufacturing capability. We also participate in quality and reliability monitoring through each stage of the production cycle by reviewing data from our wafer foundries and assembly subcontractors. We closely monitor wafer foundry production to ensure consistent overall quality, reliability and yields. Our independent foundries and assembly and test subcontractors have achieved ISO 9000 certification.

Intellectual Property

        Our success and future revenue growth will depend, in part, on our ability to protect our intellectual property. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods, to protect our proprietary technologies. As of December 31, 2002, we have been issued 31 United States patents and have in excess of 130 United States patent applications pending. Our issued patents expire in 2016 or later, subject to our payment of periodic maintenance fees. We cannot assure you that any valid patent will be issued as a result of any applications or, if issued, that any claims allowed will be sufficiently broad to protect our technology, or that any patent will be upheld in the event of a dispute. In addition, we do not file patent applications on a worldwide basis, meaning we do not have patent protection in some jurisdictions. We also generally control access to and distribution of our documentation and other proprietary information. Despite our precautions, 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. 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, and the relief available may not compensate for the harm caused.

        Our participation in the DDWG requires that we grant others the right to use specific elements of our intellectual property in implementing the DVI specification in their products, at no cost, in exchange for an identical right to use specific elements of their intellectual property for this purpose.

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We agreed to grant rights to the DDWG members and other adopters of the DVI specification in order to promote the adoption of our technology as an industry standard. We thereby limited our ability to rely on intellectual property law to prevent the adopters of the DVI specification from using certain specific elements of our intellectual property for free. This reciprocal free license covers the connection between a computer and digital display. It does not, however, extend to the internal methods by which such performance is created. Although the DVI specification is an open industry standard, we have developed proprietary methods of implementing the DVI specification. The intellectual property that we have agreed to license defines the logical structure of the interface, such as the number of signal wires, the signaling types, and the data encoding method for serial communication. Our implementation of this logical structure in integrated circuits remains proprietary, and includes our techniques to convert data to and from a serial stream, our signal recovery algorithms and our circuits to reduce electromagnetic interference (EMI). Third parties may develop proprietary intellectual property relating to DVI implementations that would prevent us from developing or enhancing our DVI implementation in conflict with those rights. Third parties may also develop equivalent or superior implementations of the DVI specification and we cannot guarantee that we will succeed in protecting our intellectual property rights in our proprietary implementation. Third parties may have infringed or be infringing our intellectual property rights, or may do so in the future, and we may not discover that fact in a timely or cost-effective manner. Moreover, the cost of pursuing an intellectual property infringement may be greater than any benefit we would realize.

        Our participation as a founder of the HDMI specification requires that we grant others the right to use specific elements of our intellectual property in implementing the HDMI specification in their products, in exchange for a license. This license bears an annual fee and royalties that are payable to HDMI Licensing, L.L.C., a wholly-owned subsidiary of ours. There can be no assurance that such license fees and royalties will adequately compensate us for having to license our intellectual property. The license, with restrictions, generally covers the patent claims necessary to implement the specification of an interface for CE devices, and does not extend to the internal methods by which such performance is created. Although the HDMI specification is a proposed industry standard, we have developed proprietary methods of implementing the HDMI specification. The intellectual property that we have agreed to license defines the logical structure of the interface, such as the number of signal wires, the signaling types, and the data encoding method for serial communication. Our implementation of this logical structure in integrated circuits remains proprietary, and includes our techniques to convert data to and from a serial stream, our signal recovery algorithms, our implementation of audio and visual data processing, and our circuits to reduce EMI. Third parties may also develop intellectual property relating to HDMI implementations that would prevent us from developing or enhancing our HDMI specification in conflict with those rights. Third parties may also develop equivalent or superior implementations of the HDMI specification and we cannot guarantee that we will succeed in protecting our intellectual property rights in our proprietary implementation. Third parties may have infringed or be infringing our intellectual property rights, or may do so in the future, and we may not discover that fact in a timely or cost-effective manner. Moreover, the cost of pursuing an intellectual property infringement may be greater than any benefit we would realize. In addition, third parties may not pay the prescribed license fees and royalties, in which case we may become involved in infringement or collection actions, or we may determine that the cost of pursuing such matters may be greater than any benefit we would realize. We agreed to grant rights to the founders and adopters of the HDMI specification in order to promote the adoption of our technology as an industry standard. We thereby limited our ability to rely on intellectual property law to prevent the founders and adopters of the HDMI specification from using certain specific elements of our intellectual property for the specified royalties.

        We entered into a patent cross-license agreement with Intel in which each of us granted the other a license to use the grantor's patents, including certain future patents, with specific exclusions related to the grantor's current and anticipated future products and network devices. Products excluded include

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our digital receivers, discrete digital transmitters and discrete display controllers, and Intel's processors, chipsets, graphics controllers and flash memory products. This cross-license does not require delivery of any masks, designs, software or any other item evidencing or embodying such patent rights, thus making "cloned" products no easier to create. The cross-license agreement expires when the last licensed patent expires, anticipated to be no earlier than 2016, subject to the right of either party to terminate the agreement earlier upon material breach by the other party, or a bankruptcy, insolvency or change of control of the other party. We have forfeited, however, our ability to rely on intellectual property law to prevent Intel from using our patents within the scope of this license. To date, we are not aware of any use by Intel of our patent rights that negatively impacts our business.

        The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights or positions, which can result in significant, protracted litigation. We have brought a patent infringement suit against Genesis Microchip, which is described in further detail below in the section entitled "Legal Proceedings."

Competition

        The markets in which we compete are intensely competitive and are characterized by rapid technological change, evolving standards, short product life cycles and decreasing prices. We believe that some of the key factors affecting competition in our markets are levels of product integration, compliance with industry standards, time-to-market, cost, product capabilities, system design costs, intellectual property, customer support, quality and reputation.

        In the PC market, our products face competition from a number of sources including analog solutions, DVI-compliant solutions, dual-interface solutions and other digital interface solutions.

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Analog Solutions. Display systems still predominantly employ an analog interface. Improvements to analog interface display solutions may slow the adoption of all-digital display systems. We compete with analog solution vendors such as Analog Devices, Genesis Microchip and a number of Taiwan-based companies.



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DVI-Compliant Solutions. We believe that over time, the DVI specification will become widely adopted in the digital display industry and attract additional market entrants. We believe the following companies have developed or announced intentions to develop DVI-compliant solutions: Analog Devices, ATI Technologies, Broadcom, Chrontel, Genesis Microchip, National Semiconductor, nVidia, Pixelworks, SIS, Smart ASIC, ST Microelectronics, Texas Instruments and Thine.



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Dual-Interface Solutions. The following companies have developed, or announced intentions to develop, products that connect to both analog and digital host systems, also known as a dual-interface solution: Genesis Microchip, Macronix, Philips Semiconductor, Pixelworks and a number of Taiwan-based companies.



•

Other Digital Interface Solutions. Texas Instruments, Thine, and National Semiconductor offer proprietary digital interface solutions based on LVDS, or low voltage differential signaling technology. LVDS technology has gained broad market acceptance in notebook PCs, and has gained some adoption with PC and display manufacturers for use outside of the notebook PC market.

        The market for our intelligent panel controller products is also very competitive. Some of our intelligent panel controller products are designed to be functionally interchangeable with similar products sold by National Semiconductor, Texas Instruments and Thine.

        In the consumer electronics market, our digital interface products are used to connect new cable set-top boxes, satellite set-top boxes and DVD players to digital televisions. These products incorporate

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DVI and HDCP, or HDMI with or without HDCP support. Companies that have announced or are shipping competing DVI-HDCP solutions include TI, Thine, Broadcom, and Genesis. In addition, our video processor products face competition from products sold by AV Science, Broadcom, Focus Enhancements, Genesis Microchip, Mediamatics, Micronas Semiconductor, Oplus, Philips Semiconductor, Pixelworks, and Trident. We also compete in some instances against in-house processing solutions designed by large consumer electronics OEMs. We expect competition for HDMI products from the other HDMI founders and adopters, including Hitachi, Matsushita, Philips, Sony, Thomson and Toshiba.

        In the storage market, our fibre channel products face competition from companies selling similar discrete products, including Agilent, Mindspeed, PMC-Sierra, Serverworks and Vitesse, from other Fibre Channel SerDes providers who license their core technology, such as LSI Logic, and from companies that sell HBA controllers with integrated SerDes, such as QLogic and Agilent.

        Our serial ATA products compete with similar products from Marvell, VIA, SIS and Promise. In addition, other companies, such as APT, Intel, LSI Logic, ServerWorks and Vitesse, have developed or announced intentions to develop serial ATA products. We also are likely to compete against Intel and other motherboard chip-set makers that have announced intentions to integrate serial ATA functionality into their chipsets.

        Many of our competitors have longer operating histories and greater presence in key markets, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. As a result, they may be able to adapt more quickly to new or emerging technologies and customer requirements, or devote greater resources to the promotion and sale of their products. In particular, well-established semiconductor companies, such as Analog Devices, Intel, National Semiconductor and Texas Instruments, and consumer electronics manufacturers, such as Hitachi, Matsushita, Philips, Sony, Thomson and Toshiba, may compete against us in the future. We cannot assure you that we can compete successfully against current or potential competitors, or that competition will not seriously harm our business.

Employees

        As of December 31, 2002, we had a total of 249 employees, including 8 located outside of the United States. None of our employees are represented by a collective bargaining agreement, nor have we experienced any work stoppages. We consider our relations with our employees to be good. We depend on the continued service of our key technical, sales and senior management personnel, and our ability to attract and retain additional qualified personnel. If we are unable to hire and retain qualified personnel, our business will be seriously harmed.

Available Information

        Our Internet website address is http://www.siliconimage.com. We make available free of charge through our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

Item 2. Properties

        Our principal operating facility, consisting of approximately 80,000 square feet of space in Sunnyvale, California, is leased through August 1, 2010 and should be adequate to meet our requirements through at least 2003. We also have approximately 91,000 square feet of space in Irvine, California, which is leased through November 2005, and approximately 8,000 square feet of space in

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Milpitas, California, which we currently do not occupy and which is leased through April 2006. We currently sublease to third parties, under two separate arrangements, approximately 24,000 square feet of our space in Irvine, California on conventional terms, and are attempting to sublease additional space at this facility and at our Milpitas facility. Each of our subleases, one of which is on a month-to-month basis and the other of which is through July 2003, is for approximately 12,000 square feet of space.

Item 3. Legal Proceedings

        On April 24, 2001, we filed suit in the U.S. District Court for the Eastern District of Virginia against Genesis Microchip Corp. and Genesis Microchip, Inc. (collectively, Genesis) for infringement of our U.S. patent number 5,905,769 (USDC E.D. Virginia Civil Action No.: CA-01-266-R) (the Federal Suit). On April 24, 2001, we also filed a complaint against Genesis with the International Trade Commission of the United States government (ITC) for unlawful trade practices related to the importation of articles infringing our patent (the ITC investigation). The actions sought injunctions to halt the importation, sale, manufacture and use of Genesis DVI receiver chips that infringe our patent, and monetary damages. We voluntarily moved to dismiss the ITC investigation, with notice that we would proceed directly in the Federal Suit. Our motion to dismiss was granted on February 7, 2002. We filed an amended complaint for the Federal Suit as of February 28, 2002. In April 2002, Genesis answered and made counterclaims against us for non-infringement, license, patent invalidity, fraud, antitrust, unfair competition and patent misuse. Also in April 2002, we filed a motion to dismiss certain of Genesis' counterclaims. In addition, we filed a motion to bifurcate trial of the counterclaims to the extent the court does not dismiss them. In May 2002, the Court granted our motion to dismiss certain of the counterclaims, with leave to amend. Genesis re-filed counterclaims against us for fraud and patent misuse. We filed another motion to dismiss these counterclaims. In August 2002, the Court granted our motion and dismissed Genesis' counterclaims without leave to amend. In September 2002, we filed a motion for summary judgment, upon which the Court has yet to rule. In October 2002, both parties filed several more motions for summary judgment, upon which the Court has yet to rule. Several dispositive motions have subsequently been filed under seal and were heard by the Court in March 2003; the Court has yet to rule on these motions. Depending on the outcome of such motions, a trial date may be set, the case may be dismissed, or other orders may be entered. Management intends to prosecute our position vigorously until this matter is resolved. Through December 31, 2002, we have spent approximately $8.3 million on this matter and expect to continue to incur significant costs through at least the first half of 2003.

        Silicon Image, certain officers and directors, and Silicon Image's underwriters have been named as defendants in a securities class action lawsuit captioned Gonzales v. Silicon Image, et al., No. 01 CV 10903 (SDNY 2001) pending in Federal District Court for the Southern District of New York. The lawsuit alleges that all defendants were part of a scheme to manipulate the price of Silicon Image's stock in the aftermarket following Silicon Image's initial public offering in October 1999. Response to the complaint and discovery in this action on behalf of Silicon Image and individual defendants has been stayed by order of the court. The lawsuit is proceeding as part of a coordinated action of over 300 such cases brought by plaintiffs in the Southern District of New York. Pursuant to a tolling agreement, individual defendants have been dropped from the suit for the time being. In February 2003, the Court denied underwriters' motion to dismiss and ordered that the case may proceed against issuers including against Silicon Image. At this time, we cannot predict the outcome of this lawsuit; however, we intend to defend this matter vigorously.

        Silicon Image, certain officers and directors, and Silicon Image's underwriters have been named as defendants in a securities class action lawsuit captioned Liu v. Credit Suisse First Boston Corp., et al., No. 03-20459 (S.D. Fla. 2003) pending in Federal District Court for the Southern District of Florida. Plaintiff filed an action on behalf of a putative class of shareholders who purchased stock from some or

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all of approximately 50 issuers whose public offerings were underwritten by Credit Suisse First Boston. The lawsuit alleges that Silicon Image and certain officers were part of a scheme by Credit Suisse First Boston to artificially inflate the price of Silicon Image's stock through the dissemination of allegedly false analysts' reports. Silicon Image has not been served with a copy of the complaint. At this time, we cannot predict the outcome of this lawsuit; however, we intend to defend this matter vigorously.

        On August 7, 2002, we filed a demand for arbitration with the American Arbitration Association, file #74 Y 117 01399 02 GAP, against the principal shareholders of CMD Technology (CMD) relating to shares held in escrow in connection with our acquisition of CMD. Pursuant to agreements by which we acquired CMD, a portion of the Silicon Image common stock issued to the principal shareholders of CMD was held in two separate escrow pools as collateral for the indemnification obligations of these shareholders. We previously made indemnification claims against these escrow pools for the release of escrow shares with a value of approximately $5.4 million, which claims were contested by the principal shareholders of CMD. On February 28, 2003, we and the principal shareholders of CMD entered into a settlement agreement and mutual release, pursuant to which our indemnification claims were resolved. As a result of the settlement, we expect to receive 949,780 of the escrowed shares, valued at approximately $4.8 million.

        In addition, we are involved in a number of judicial and administrative proceedings incidental to our business. We intend to prosecute or defend, as appropriate, such matters vigorously, and although adverse decisions or settlements may occur in one or more of such cases, the final resolution of these matters, individually or in the aggregate, is not expected to have a material adverse effect on our results of operations or financial position.

        The amount of legal fees we incur with respect to the litigation matters described above will depend on the duration of our litigation matters, as well as the nature and extent of the litigation activities. We are not able to accurately estimate the amount of legal fees we will incur in 2003 with respect to the litigation matters described above, however, we do expect to incur substantial amounts through at least the first half of 2003.

Item 4. Submission of Matters to a Vote of Securities Holders

        None.

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PART II

Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters

        Our common shares have been traded on the NASDAQ Stock Market under the symbol "SIMG" since our initial public offering on October 6, 1999. Our shares are not listed on any other markets or exchanges. The following table shows the high and low closing prices for our common shares as reported by the NASDAQ Stock Market:

        As of January 31, 2003, we had approximately 227 holders of record of our common shares and a substantially greater number of beneficial owners.

        We filed a Registration Statement on Form S-1 (File No. 333-83665) that was declared effective by the SEC on October 5, 1999. On October 6, 1999, Silicon Image shares commenced trading, and on October 12, 1999, we completed the sale of all 8,970,000 registered shares at a price of $6.00 per share.

        We received net proceeds of $48 million, after deducting underwriting discounts and commissions of approximately $3.8 million and estimated offering expenses of approximately $1.7 million. None of these offering expenses were paid directly or indirectly to any of our directors or officers, any person owning 10% or more of any class of our equity securities, or any of our affiliates. We intend to use the proceeds from this offering for general corporate purposes, including working capital and capital expenditures.

        We have never declared or paid cash dividends on shares of our capital stock. We intend to retain any future earnings to finance growth and do not anticipate paying cash dividends in the future.

        In connection with our acquisition of Zillion Technologies, LLC, we are obligated under an exchange agreement to periodically issue to the two founders of Zillion shares of our common stock as consideration for their membership interests in Zillion which we acquired and services provided pursuant to their employment agreements with us. The Zillion founders were granted registration rights with respect to the shares to be issued under this exchange agreement. These issuances of shares were made in reliance on an exemption from registration under Section 4(2) of the Securities Act. On December 31, 2002, we issued 18,750 shares of our common stock to the Zillion founders pursuant to the exchange agreement. The issuances of shares were made without general solicitation or advertising and were only made to two individuals.

Item 6. Selected Financial Data

        The following selected financial data should be read in connection with our consolidated financial statements and notes thereto and "Management's Discussion and Analysis of Financial Condition and

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Results of Operations" included elsewhere in this Form 10-K. Historical results of operations are not necessarily indicative of future results.

(1)

Excludes non-cash stock compensation and warrant expense of $1.2 million, $279,000, $593,000, and $609,000, for the years ended December 31, 2002, 2001, 2000 and 1999, respectively.

(2)

Excludes non-cash stock compensation and warrant expense of $7.4 million, $9.3 million, $10.2 million, and $2.5 million for the years ended December 31, 2002, 2001, 2000, and 1999, respectively.

(3)

Excludes non-cash stock compensation and warrant expense of $2.5 million, $2.8 million, $2.8 million and $3.5 million for the year ended December 31, 2002, 2001, 2000 and 1999, respectively.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

        Silicon Image designs, develops and markets semiconductor products for applications that require high-bandwidth, cost-effective solutions for high-speed digital data communications. The markets into which we sell our products are personal computer (PC), consumer electronics (CE) and storage.

        Products sold into the PC market generated 58% of our revenue in 2002, 70% of our revenue in 2001 and 96% of our revenue in 2000.

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        Our products in the PC market are based on PanelLink technology, which is our proprietary implementation of the digital visual interface (DVI) specification that defines a high-speed serial data communication link between computers and digital displays. Despite sluggish growth in the host portion of the PC market and a movement among graphic card manufacturers to eliminate the need for discrete transmitters by integrating transmitter functionality into their graphic chips, we expect continued DVI adoption to result in increased overall demand for discrete transmitters. The display portion of the PC market remains predominantly analog or dual-interface, which is capable of receiving either an analog or digital signal. We do not offer an analog or dual-interface solution, but do partner with other companies to sell multiple-chip solutions into the dual-interface market. These multiple-chip solutions are typically limited to higher end, larger displays operating at resolutions of SXGA and above. In addition, we have licensed certain of our technologies to companies for use in making products for the dual-interface market.

        Products sold into the CE market generated 11% of our revenue in 2002, 8% of our revenue in 2001 and 4% of our revenue in 2000. Our CE products offer a secure digital video and audio transmission for consumer devices. Demand for these products will be driven primarily by the adoption rate of new technologies and industry standards, such as DVI with HDCP and HDMI, respectively.

        Semiconductor products sold into the storage market generated 15% of our revenue in 2002, 5% of our revenue in 2001 and none of our revenue in 2000. Demand for our storage products is dependent upon the rate at which technology transitions from parallel to serial, and the extent to which serial ATA and fibre channel functionality are integrated into chip sets and controllers offered by other companies, making our discrete become unnecessary.

        Sales of storage subsystems products generated 8% of our revenue in 2002, 17% of our revenue in 2001 and none of our revenue in 2000. We are phasing out our subsystems products and do not plan on developing, manufacturing and selling new subsystems products in the future. Therefore, we expect sales of such products to represent less than 2% of our revenue in 2003. In conjunction with our decision to phase out our storage systems products and change primarily to a licensing business model, we decided to design products and / or license our technology to third parties in this market segment. We anticipate continuing this business model for our storage systems technology as advancements and developments warrant. In 2002, a large portion of our development, licensing and royalty revenue was related to storage systems technology we acquired in connection with our acquisition of CMD Technology. The majority of this revenue was related to licensing fees associated with one storage systems provider. This licensee paid these license fees pursuant to a development and license agreement under which we have worked with the licensee to provide custom hardware designs and firmware for use in a storage bridge controller board. We are entitled to receive royalties beginning in the second quarter of 2003 based on the unit volume of these controller boards contained in products shipped by the licensee.

        From our inception in 1995 through the first half of 1997, we were engaged primarily in developing our first generation PanelLink digital transmitter and receiver products, developing our high-speed digital interconnect technology, establishing our digital interface technology as an open standard, and building strategic customer and foundry relationships. During that period, we derived substantially all of our revenue from contracts providing for the joint development of technologies for high-speed digital communication and intelligent panel controllers for flat panel displays, as well as from licensing our high-speed digital interconnect technology.

        In the third quarter of 1997, we began volume shipments of our first generation PanelLink digital transmitter and receiver products. Since that time, we have derived most of our revenue from the sale of PanelLink products and we have introduced several new generations of transmitter and receiver products providing higher speed and increased functionality. In 1999, we began shipping our first generation digital display controller product. Our digital display controller products integrate our

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receiver with digital image processing and display controller technology, which enables development of intelligent displays for the mass-market.

        In October 1999, we raised approximately $48 million in our initial public offering. We have incurred losses in each year since our inception and at December 31, 2002, we had an accumulated deficit of $159.8 million.

        In 2000, we began focusing our resources on entering two new markets, storage and CE, which we believed would grow significantly and in which we believed we could apply our technology and expertise in high-speed serial interfaces. During 2000, we acquired Zillion, a developer of high-speed transmission technology for data storage applications, and DVDO, a provider of digital video processing systems for the CE market.

        In 2001, we focused on accelerating our entry into the CE and storage markets, leveraging our IP into licensing revenue and restructuring the company to improve profitability. During 2001, we acquired CMD, a provider of storage subsystems and semiconductors designed for storage area networks, and Silicon Communication Lab, a provider of mixed-signal and high-speed circuit designs.

Year 2002

        During 2002, we achieved double-digit revenue growth in each fiscal quarter, resulting in record annual revenue of $81.5 million, which was a 57% increase from 2001 revenue levels. We also began to see the benefits of our diversification strategy, which resulted in establishing a key presence in the CE and storage markets, both of which we expect to experience significant growth rates during the next several years. Additionally, we were able to successfully leverage our intellectual property to generate $6.7 million of development and licensing revenue.

        In the CE market, the HDMI (High Definition Multimedia Interface) specification was published. HDMI is a new standard for secure digital video and audio transmission for consumer devices. This standard was created by Silicon Image, together with Sony, Matsushita Electric (Panasonic), Philips, Thomson (RCA), Hitachi and Toshiba, and with strong support from Fox and Universal studios, DirecTV and Echostar. We announced our first HDMI products in the fourth quarter and believe every digital TV, DVD and set-top box will include a digital interconnect, whether it is DVI with high definition content protection (HDCP) or HDMI, within the next five years. During the year, DVI with HDCP was embraced by high-end manufacturers of digital TVs, DVDs and set-top boxes.

        In the storage market, we announced our new SATALink family of end-to-end serial ATA solutions for the storage market, including a fully integrated PCI-to-SATA controller. Intel selected our product for inclusion on their next-generation motherboards, and we were able to achieve numerous design wins with our SATALink products. We believe we are well-positioned for the anticipated transition to serial ATA technology, which has been somewhat limited to this point by the availability of serial ATA-enabled hard drives. Additionally, we achieved key design wins with our fibre channel products and are positioned to benefit as we anticipate that 2Gb switches will become the industry standard. Demand declined throughout the year for our parallel ATA and USB 1.0 products as the market began to transition to serial ATA and USB 2.0. We expect demand for these legacy products to continue to decrease throughout 2003.

        In the PC market, Display Search, an independent research firm, estimates that the DVI adoption rate increased to 12% in 2002, from 7% in 2001. We expect the adoption rate to increase significantly during the next two years as quality, cost and content will make an all-digital connection more attractive than an analog solution, and we also expect the prices of digital displays to continue to decrease. Our transmitter products continued to experience competitive pressure, primarily from Thine and Texas Instruments, resulting in lower average selling prices for these products. We are still the market leader for discrete transmitter products, but expect graphic card manufacturers to continue to

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integrate a transmitter into their graphics chip, thus eliminating the need for a discrete transmitter device in many host products. We believe that integration in the next two-to-three years will be limited to lower resolution technology, and that higher resolutions will continue to require a discrete transmitter to achieve high-resolution quality. During 2002, we introduced a low cost add-in card that can be used in conjunction with Intel's 845G chip set to provide an all-digital connection to flat panels. Prior to this introduction, a more expensive, high-end graphics card was needed for high quality digital video and graphics. We continued to lose market share in the receiver market during 2002, as OEMs continued to use dual-interface solutions in flat panels to accommodate both digital and analog signals. We were able to partner with other companies to offer a three-chip discrete solution that we believe is a cost-effective alternative to a dual-interface solution. In addition, we generated licensing revenue by licensing certain technology to companies for use in making products for the dual-interface market.

        During 2002, we also focused on improving the company's profitability and reducing our cash usage rate. Our cash and short-term investments declined by $5.4 million in 2002, versus $19.0 million in 2001.

Outlook

        We expect 2003 revenue to increase from the level achieved in 2002, and believe our revenue in the first quarter of 2003 will be flat to slightly up from the fourth quarter of 2002. We expect to be cash flow positive in 2003.

        Our expectation of overall revenue growth and positive cash flow in 2003 is based on four assumptions. First, we believe the DVI adoption rate will increase in the PC market as the quality, cost and content capabilities of all-digital solutions become more attractive than those offered by analog solutions and as prices of digital displays become lower. Display Search forecasts the adoption rate to increase from approximately 12% in the fourth quarter of 2002 to approximately 17% by the end of 2003. Second, we achieved numerous design wins in the CE market for DVI with HDCP and HDMI products, and expect these designs to go into production in the middle of the year. Although it is difficult to predict exactly when and how aggressively revenue from these products will ramp during 2003, our expectation is that we will generate significant revenue from these designs in the second quarter and that revenue will grow quarter-over-quarter throughout the remainder of 2003. Third, we believe that the storage market will continue its transitions to 2 Gb fibre channel switches and serial ATA technology, which should result in increasing revenue from our fibre channel and SATALink products. We expect the availability of serial ATA-enabled hard drives and other peripherals to improve, which should enable acceleration of the transition to serial ATA technology. Fourth, we expect licensing and royalty revenue to nearly double during 2003 as we continue to implement our strategy of licensing our technology to companies that address market segments in which we have chosen not to directly participate, and expect to begin receiving royalties from licenses entered into during 2001 and 2002.

        Among the factors that may cause our actual results to differ materially from those anticipated by our assumptions include the rate at which the PC market adopts DVI, CE market acceptance of our DVI with HDCP and HDMI products, the rate at which the storage market transitions to 2 Gb fibre channel switches and serial ATA technology, consumer demand in the PC and CE markets, the availability of serial ATA-enabled hard drives and other peripherals, whether and how quickly OEMs are able to integrate transmitters in their graphics chips, our ability to leverage our intellectual property into licensing revenue and the ability of our semiconductor foundries to manufacture our products in commercial volumes at an acceptable cost and in a timely manner. In addition, our revenue remains dependent on competition and general economic and market conditions, none of which can be accurately predicted.

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        We expect our gross margin percentage to increase slightly from 2002 levels as a result of higher licensing revenue, for which there is no associated cost of sales, manufacturing cost reductions on certain of our higher volume products, higher unit volume and shifts in product mix whereby higher margin CE products will generate a higher percentage of our total revenue and lower margin storage board products will generate nominal revenue. These positive effects will be offset by declining average selling prices (ASPs), especially for products in the PC market, and higher manufacturing overhead spending to support increased production levels for products in the CE and Storage markets.

        Excluding non-cash charges for stock compensation expense, we expect the dollar amount of our R&D expense to increase approximately 14% in 2003. R&D expense will be incurred for enhancements to existing products and for further development of technology related to consumer electronics and storage applications. Excluding non-cash charges for stock compensation expense, we expect SG&A expense for 2003 to increase approximately 7% over 2002, primarily as a result of our scheduled implementation of a new ERP system in 2003 and increased headcount levels necessary to support our revenue growth. Our plan is to control R&D and SG&A expenses such that these expenses, exclusive of non-cash charges for stock compensation expense, in the fourth quarter of 2003 represent approximately 36% of our fourth quarter revenue.

        We expect to incur substantial non-cash stock compensation expense in 2003 and future periods as a result of previous stock option repricings, stock options assumed in connection with our acquisitions in 2000 and 2001, the issuance of stock options to consultants, and modifications to stock options. We may also incur non-cash stock compensation expense in connection with future acquisitions. The amount of stock compensation expense in each period will fluctuate with changes in our stock price and volatility.

        During 2003 and future periods, we may also incur non-cash expenses for the impairment or amortization of intangible assets.

        We will also incur legal fees in 2003 in conjunction with our patent infringement lawsuit against Genesis. The amount of legal fees incurred will depend on the duration of the litigation, as well as the nature and extent of the litigation activities. We are not able to accurately estimate the amount of legal fees we will incur with respect to this matter, however, we do expect to incur substantial amounts through at least the first half of 2003.

        In March 2003, we exercised an option to acquire TransWarp Networks (TransWarp), a privately-held storage networking company. In connection with this acquisition, we anticipate issuing approximately 2.4 million shares of our common stock in exchange for all outstanding shares of TransWarp capital stock, and converting all outstanding TransWarp stock options into options to purchase approximately 700,000 shares of our common stock. We also anticipate assuming TransWarp's stock option plan and having a remaining reserve of approximately 75,000 shares available for issuance under such plan following the acquisition. We anticipate adding approximately 10 employees as a result of this acquisition. Subject to the satisfaction of customary closing conditions, including due diligence and no material adverse changes, we anticipate that the acquisition will close in April 2003.

        In March 2003, we reorganized our business to better enable customer focus, strategic alignment and operational excellence. As part of this reorganization, we will reduce our workforce by approximately 35 people, or 15%. These reductions will be primarily in engineering and operations functions. As a result of our workforce reduction, we expect to record a restructuring expense consisting of severance costs and non-cash expenses for stock option modifications in the first quarter of 2003.

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Commitments, Contingencies and Concentrations

        In September 1998, we entered into an agreement with Intel to develop and promote the adoption of a digital display interface specification. In connection with this agreement, we granted Intel a warrant to purchase 285,714 shares of our common stock at $1.75 per share. Under the same agreement, we granted Intel a warrant to purchase 285,714 shares of our common stock at $0.18 per share upon achievement of a specified milestone that was reached during the first quarter of 1999. Both of these warrants were exercised in May 2001. Additionally, if a second specified milestone is achieved, which we do not believe is likely, we would be required to grant Intel a third warrant to purchase 285,714 shares of our common stock at $0.18 per share. The estimated fair value of the warrant at December 31, 2002 was $1.7 million.

        Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For instance, our top five customers, including distributors, generated 41%, 51%, and 57% of our revenue in 2002, 2001 and 2000, respectively. The decrease in 2002 from prior year levels can be attributed to our market diversification. Additionally, the percentage of revenue generated through distributors tends to be significant, since many OEM's rely upon third party manufacturers or distributors to provide purchasing and inventory management functions. In 2002, 42% of revenue was generated through distributors, compared to 40% in 2001 and 66% in 2000. Our licensing revenue is not generated through distributors, and to the extent licensing revenue increases, we would expect a decrease in the percentage of our revenue generated through distributors.

        A significant portion of our revenue is generated from products sold overseas. Sales to customers in Asia, including distributors, generated 64%, 64%, and 71% of our revenue in 2002, 2001, and 2000, respectively. The reason for our geographical concentration in Asia is that most of our products are part of flat panel displays, graphic cards and motherboards, the majority of which are manufactured in Asia. The percentage of our revenue derived from any country is dependent upon where our end customers choose to manufacture their products. Accordingly, variability in our geographic revenue is not necessarily indicative of any geographic trends, but rather is the combined effect of new design wins and changes in customer manufacturing locations. All revenue to date has been denominated in U.S. dollars.

Critical Accounting Policies

        The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and all known facts and circumstances that we believe are relevant. Actual results may differ materially from our estimates. We believe the following accounting policies are critical, either because they relate to financial statement line items that are key indicators of our financial performance (such as revenue) and/or because their application requires significant management judgment.

Revenue recognition

        For products sold directly to end-users, or to distributors that do not receive price concessions and do not have rights of return, we recognize revenue upon shipment and title transfer if we believe collection is reasonably assured. Reserves for sales returns and allowances are estimated based primarily on historical experience and are provided at the time of shipment. The amount of sales returns and allowances has not been, and is not expected to be, material.

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        For sales to distributors with agreements allowing for price concessions and product returns, we recognize revenue based on our best estimate of when the distributor sold the product to its end customer. Our estimate of distributor sell-through to end customers is based on point of sales reports received from our distributors. Due to the timing of receipt of these reports, we recognize distributor sell-through using information that lags quarter end by one month. Revenue is not recognized upon shipment since, due to various forms of price concessions, the sales price is not substantially fixed or determinable at that time. Additionally, these distributors have contractual rights to return products, up to a specified amount for a given period of time. Revenue is earned when the distributor sells the product to an end-user, at which time our sales price to the distributor becomes fixed. Pursuant to our distributor agreements, older or end-of-life products are sold with no right of return and are not eligible for price concessions. For these products, revenue is recognized upon shipment and title transfer if we believe collection is reasonably assured.

        At the time of shipment to distributors, we record a trade receivable for the selling price since there is a legally enforceable right to payment, relieve inventory for the carrying value of goods shipped since legal title has passed to the distributor, and record the gross margin in "deferred margin on sales to distributors", a component of current liabilities on the balance sheet. Deferred margin represents the gross margin on the sale to the distributor; however, the amount of gross margin we recognize in future periods could be less than the deferred margin as a result of price concessions. We do not reduce deferred margin by estimated future price concessions; instead, price concessions are recorded when incurred, which is generally at the time the distributor sells the product to an end-user. The difference between deferred margin and the margin actually recognized has not been material in the past; however, since price concessions are highly dependent upon market conditions, there can be no assurance that the difference will not be material in the future. Price concessions are not granted for amounts in excess of the deferred margin.

        License revenue is recognized when an agreement with a licensee exists, the price is fixed or determinable, delivery or performance has occurred, and collection is reasonably assured. Generally, we expect to meet these criteria and recognize revenue at the time we deliver the agreed-upon items. However, we may defer recognition of revenue until cash is received if collection is not reasonably assured at the time of delivery, and we may enter into agreements requiring customer acceptance of deliverables, in which case we would defer recognition of revenue until the licensee has accepted the deliverables. Development revenue is recognized when project milestones have been completed and acknowledged by the other party to the development agreement, and collection is reasonably assured.

Allowance for Doubtful Accounts

        We review collectibility of accounts receivable on an on-going basis and provide an allowance for amounts we estimate will not be collectible. During our review, we consider our historical experience, the age of the receivable balance, the credit-worthiness of the customer, and the reason for the delinquency. Write-offs to date have not been material. At December 31, 2002, we had $12.1 million of gross accounts receivable and an allowance for doubtful accounts of $519,000.

Inventories and Related Reserves

        We record inventories at the lower of standard cost, determined on a first-in first-out basis, or market. Standard cost approximates actual cost. Standard costs are determined based on our estimate of material costs, manufacturing yields, costs to assemble, test and package our products, and allocable indirect costs. We review differences between standard and actual costs, and, based on the nature of the difference, determine whether to record the amount on our balance sheet or in our statement of operations. Standard costs are evaluated at least twice each year.

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        Reserves are provided for excess and obsolete inventory, and are estimated based on a comparison of the quantity and cost of inventory on hand to management's forecast of customer demand. Customer demand is dependent on many factors and requires us to use significant judgment in our forecasting process. We must also make assumptions regarding the rate at which new products will be accepted in the marketplace and at which customers will transition from older products to newer products. Generally, inventories in excess of six months demand are fully reserved and the related charge is recorded as a cost of revenue. Once a reserve is established, it is maintained until the product to which it relates is sold or otherwise disposed of, even if in subsequent periods we forecast demand for the product. This treatment is in accordance with Accounting Research Bulletin 43 and Staff Accounting Bulletin 100. At December 31, 2002 and 2001, we had gross inventories of $13.1 million and $10.7 million, respectively, and reserves for excess and obsolete inventory of $5.8 million and $4.2 million, respectively.

Long-Lived Assets

        Consideration paid in connection with acquisitions is required to be allocated to the assets, including identifiable intangible assets, and liabilities acquired. Acquired assets and liabilities are recorded based on our estimate of fair value, which requires significant judgment with respect to future cash flows and discount rates.

        For certain long-lived assets, primarily fixed assets and intangible assets, we are required to estimate the useful life of the asset and recognize its cost as an expense over the useful life. We use the straight-line method to depreciate long-lived assets. Additionally, pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", we periodically assess whether long-lived assets have been impaired. We deem an asset to be impaired if its estimated fair value is less than the cost at which it is recorded on our balance sheet. Our estimate of fair value is based on the net present value of expected future cash flows attributable to the asset. Predicting future cash flows attributable to a particular asset is difficult, and requires the use of significant judgment. At December 31, 2002, we had $19.7 million of long-lived assets recorded on our balance sheet.

Deferred Tax Assets

        We account for income taxes using an asset and liability approach, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements, but have not been reflected in our taxable income. A valuation allowance is established to reduce deferred tax assets to their estimated realizable value. Therefore, we provide a valuation allowance to the extent we do not believe it is more likely than not that we will generate sufficient taxable income in future periods to realize the benefit of our deferred tax assets. Predicting future taxable income is difficult, and requires the use of significant judgment. At December 31, 2002, we had a net operating loss carryforward for federal income tax purposes of approximately $63.0 million, against which a full valuation allowance has been provided.

Accrued Liabilities

        Certain of our accrued liabilities are based largely on estimates. For instance, we record a liability on our balance sheet each period for the estimated cost of goods and services rendered to us, for which we have not received an invoice. Additionally, a component of our restructuring reserve related to a loss we expect to incur for excess leased facility space is based on numerous assumptions and estimates, such as the market value of the space and the time it will take to sublease the space. Our estimates are based on historical experience, input from sources outside the company, and other relevant facts and circumstances. Actual amounts could differ materially from these estimates.

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Stock-Based Compensation Expense

        We are required to determine the fair value of stock option grants to non-employees, and to record the amount as an expense over the period during which services are provided to us. Management calculates the fair value of these stock option grants using the Black-Scholes model, which requires us to estimate the life of the stock option, the volatility of our stock, an appropriate risk-free interest rate, and our dividend yield. The calculation of fair value is highly sensitive to the expected life of the stock option and the volatility of our stock, both of which we estimate based primarily on historical experience.

Recent Accounting Pronouncements

        In June 2002, the Financial Accounting Standards Board (FASB) issued Statement No. 146 (SFAS No. 146), Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses issues regarding the recognition, measurement and reporting of costs associated with exit and disposal activities, including restructuring activities, costs related to terminating a contract that is not a capital lease and termination benefits provided under a one-time benefit arrangement to involuntarily terminated employees. SFAS No. 146 requires that an expense associated with an exit or disposal activity be recognized when a liability is incurred, and that fair value be used for the initial measurement of the liability. SFAS No. 146 is effective for all exit or disposal activities that are initiated after December 31, 2002.

        In November 2002, the FASB issued Interpretation No. 45 (Interpretation 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Guarantees of Indebtedness of Others". Interpretation 45 clarifies disclosure, recognition and measurement requirements related to certain guarantees. The disclosure requirements are effective for financial statements issued after December 15, 2002 and the recognition and measurement requirements are effective for guarantees issued or modified after December 31, 2002. The Company does not expect the adoption of Interpretation 45 to have a significant effect on its results of operations or financial condition.

        In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 (SFAS No. 148), "Accounting for Stock-Based Compensation—Transition and Disclosure". SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions of SFAS No. 148 are effective for interim periods beginning after December 15, 2002. We have adopted the disclosure requirements of SFAS No. 148 as of December 31, 2002.

Annual Results of Operations

        Revenue.    Revenue was $81.5 million for 2002, an increase of 56.9% from $52.0 million for 2001. This increase was the result of several factors:

•

The DVI adoption rate in the PC market increased to 12% in 2002, from 7% in 2001;



•

A full year's worth of revenue in 2002 from fibre channel products that were introduced late in 2001, which contributed $3.2 million of incremental revenue in 2002;



•

Increased sales of parallel ATA and USB controllers acquired in connection with our acquisition of CMD in June 2001. Revenue from these products increased by $4.1 million in 2002, primarily

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as a result of 2002 including a full year's worth of revenue, versus only 7 months worth of revenue in 2001;

•

The introduction of serial ATA products in 2002, which contributed $2.4 million of revenue;



•

Our ability to leverage our intellectual property to generate $6.7 million of licensing revenue in 2002, versus no licensing revenue in 2001; and



•

Adoption of DVI with HDCP in 2002 for high-end consumer products in the CE market.

        These positive factors were partially offset by the effect of our decision as part of our strategic restructuring program to de-emphasize our storage subsystems board business in 2002, which resulted in 2002 revenue from such products being $2.7 million less than the 2001 amount, and the effect of declining ASPs during 2002.

        Revenue by market was as follows (in thousands):

        Revenue was $52.0 million for 2001, an increase of 3.9% from $50.0 million for 2000. This increase was primarily the result of our acquisition of CMD in June 2001, which contributed $10.6 million of revenue in 2001. Without CMD, our revenue would have been $41.4 million in 2001, a decrease of 17.4% from 2000. This decrease was primarily the result of a 7% decrease in unit demand and to a lesser extent, to lower average selling prices. Weaker demand was largely attributable to a downturn in the semiconductor industry that began in the fourth quarter of 2000. To a lesser extent, increased competition in the PC market from companies offering dual-interface solutions reduced demand and average selling prices for our digital receiver products.

        Cost of revenue.    Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as related overhead costs. Gross margin (revenue minus cost of revenue, as a percentage of revenue), excluding non-cash stock compensation expense, was 53.3% for 2002, 51.8% for 2001 and 62.4% for 2000. The increase in gross margin from 2001 to 2002 was due to our ability to generate $6.7 million of licensing revenue in 2002, which has low cost of revenue associated with it and contributed 4.2% to our gross margin, offset by the effect of declining ASPs and increased revenue from serial ATA products, which have lower margins relative to our other volume products. The decrease in gross margin from 2000 to 2001 was primarily due to the effect of lower volume and average selling prices during 2001 and, to a lesser extent, our acquisition of CMD in 2001, which had lower margin board products. Cost of revenue excludes non-cash stock compensation expense of $1.2 million, $279,000 and $593,000 for 2002, 2001 and 2000, respectively. Including stock compensation expense, our product gross margin would have been 51.8%, 51.2% and 61.2% for 2002, 2001 and 2000, respectively.

        Research and Development.    R&D expense consists primarily of compensation and related costs for employees, fees for independent contractors, the cost of software tools used for designing and testing our products, and costs associated with prototype materials. R&D expense, excluding non-cash stock compensation expense, was $32.8 million, or 40.2% of revenue, for 2002, compared to $25.5 million, or 49.0% of revenue, for 2001, and $12.8 million, or 25.6% of revenue, for 2000. The increase in absolute

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dollars for 2002 can be attributed primarily to our acquisition of CMD in June 2001, which increased spending by $4.7 million in 2002 due to the inclusion of 12 months of CMD related expense in 2002, versus only 7 months of expense in 2001. Additionally, we increased our product development efforts in 2002 in order to accelerate our entrance into the storage and CE markets. We introduced 16 new products in 2002, versus 12 in 2001. These increases were partially offset by an additional one-week shutdown in 2002. The increase in absolute dollars in 2001 was primarily due to additional personnel and acquisitions of CMD and SCL. These acquisitions accounted for $5.1 million of the $12.7 million expense increase from 2000. Increased R&D expense as a percentage of revenue in 2001 reflected our intentional investment to gain initial penetration into the CE and storage markets. R&D excludes non-cash stock compensation expense of $7.4 million, $9.3 million, and $10.2 million for 2002, 2001, and 2000, respectively. Including stock compensation expense, R&D expense would have been $40.2 million, $34.8 million, and $23.0 million, or 49.3%, 67.0%, and 46.0%, of revenue for 2002, 2001, and 2000, respectively.

        Selling, General and Administrative.    SG&A expense consists primarily of employee compensation and benefits, sales commissions, and marketing and promotional expenses. Excluding non-cash stock compensation expense, SG&A expense was $17.5 million, or 21.4% of revenue for 2002, $18.8 million, or 36.1% of revenue, for 2001, and $18.9 million, or 37.8% of revenue, for 2000. The decrease in spending for 2002 can be attributed primarily to a reduction in SG&A headcount from 88 at December 31, 2001 to 69 at December 31, 2002. Additionally, as part of our expense management efforts in 2002, we implemented an additional one-week shutdown in 2002 and reduced spending on discretionary items such as advertising, travel and professional fees. Lastly, we were able to reduce spending in 2002 by consolidating space in our facilities. The change from 2000 to 2001 can be attributed to the acquisitions of CMD and SCL, which contributed $3.3 million of additional SG&A expense in 2001, offset by the effects of our headcount reduction in 2001 and lower advertising expenses. SG&A excludes non-cash stock compensation expense of $2.5 million for 2002 and $2.8 million for both 2001 and 2000. Including stock compensation expense, SG&A expense would have been $20.0 million, $21.6 million and $21.7 million, or 24.5%, 41.5% and 43.4% of revenue for 2002, 2001, and 2000, respectively.

        Stock Compensation.    Stock compensation expense was $11.1 million, or 13.6% of revenue, for 2002, $12.4 million, or 23.8% of revenue, for 2001, and $13.6 million, or 27.2% of revenue, for 2000. The decrease from 2001 to 2002 can be attributed to use of the accelerated method for recognizing expense for stock options granted to employees and for stock options assumed in connection with acquisitions, which results in a higher proportion of the expense being recognized in earlier periods. These decreases are partially offset by expense recognized in 2002 for options repriced in 2001 and 2000, as our average stock price in 2002 exceeded the strike price of the repriced options. We did not recognize expense in 2001 or 2000 in conjunction with our stock option repricings since our average stock price in those periods was less than the exercise price of the repriced options. The decrease in expense from 2000 to 2001 can be attributed primarily to our use of the accelerated method for recognizing expense for certain grants to employees, which results in a higher proportion of the expense being recognized in the initial year of grant. Additionally, our average stock price was lower during 2001, which also affected the amount of expense we recognized for certain options. Those decreases were partially offset by expense of $4.2 million associated with our acquisitions of CMD and

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SCL. The following table summarizes the components of our stock compensation expense for 2002, 2001 and 2000 (in thousands).

        We will incur substantial non-cash stock compensation expense in future periods as a result of (1) the issuance of, or modifications to, restricted stock awards and stock option grants to employees and consultants, (2) the stock option repricing programs we implemented in 2000 and 2001, and (3) amortization of our existing unearned compensation balance. Since the expense associated with our stock option repricings and stock options issued to consultants is dependent on our stock price and volatility, stock compensation expense may fluctuate significantly from period to period. Although to date we have recognized only $2.9 million of expense in connection with our stock option repricings, this may become a significant component of our stock compensation expense in future periods if our weighted average stock price exceeds $5.63, the exercise price of these repriced stock options. Approximately 4.2 million of our 19.9 million stock options outstanding as of December 31, 2002 were repriced in 2000 and 2001.

        Amortization of Goodwill and Intangible Assets.    For 2002, we recorded $3.5 million of expense for the amortization of goodwill and intangible assets, compared to $14.1 million for 2001 and $4.4 million for 2000. The decrease from 2001 to 2002 can be attributed to adoption of a new accounting standard that required companies to no longer amortize goodwill to expense beginning January 1, 2002, and to the impairment charges recorded against intangible assets in 2001 and 2002 that reduced the carrying value of the assets subject to amortization. The increase in 2001 can be attributed to additional acquisitions in 2001, and to a full year of expense recorded in 2001, versus a partial year in 2000, for the acquisitions we completed in 2000.

        In-process Research and Development    In-process research and development represents technology that has not reached technological feasibility and that has no alternative future use as of the acquisition date.

CMD

        During the quarter ended June 30, 2001, we recorded a one-time operating expense of $1.5 million for in-process research and development incurred in connection with the acquisition of CMD. As of the acquisition date, there were four identified development projects that met the necessary criteria—Titan 2U, Titan.next, SANBox and IDE Ultra-680. The value of these projects was determined by estimating their future cash flows from the time they were expected to become commercially feasible, discounting the net cash flows to their present value, and applying a percentage of completion to the calculated values. The net cash flows from the identified projects were based on estimates of revenue, cost of revenue, research and development expenses, selling general and administrative expenses, and applicable income taxes. These estimates did not take into account any potential synergies that could be realized as a result of the acquisition, and were in line with industry averages and growth estimates for the storage and semiconductor industries.

        Revenue for Titan 2U was expected to commence in the fourth quarter of 2001 and to extend through 2003. Revenue for IDE Ultra-680 was expected to commence in the fourth quarter of 2001 and

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extend through 2004, and revenue for both Titan.next and SANBox was expected to commence in 2002 and extend through 2005. We based our revenue projections on estimates of market size and growth, expected trends in technology and the expected timing of new product introductions by our competitors and us. The discount rate used for all projects was 25%, a rate that is consistent with the estimated rates of return on our intangible assets. This rate is higher than the industry weighted average cost of capital because of the risks associated with the inherent uncertainties of the successful development of the in-process research and development, market acceptance of the technology, the useful life of the technology, the profitability level of such technology and the uncertainty of technological advances.

        The percentage of completion for each project was determined based on research and development expenses incurred immediately prior to the acquisition as a percentage of total estimated research and development expenses to bring each project to technological feasibility. As of June 30, 2001, we estimated that Titan 2U was 25% complete with total projected costs of $164,000, that Titan.next was 15% complete with total projected costs of $200,000, that SANBox was 10% complete with total projected costs of $150,000 and that IDE Ultra-680 was 85% complete with total projected costs of $500,000. Consistent with our projections, revenue related to Titan 2U and IDE Ultra-680 commenced in the fourth of quarter of 2001. Development of Titan.next and SANBox was not completed.

DVDO

        During the quarter ended September 30, 2000, a one time in-process research and development expense related to the acquisition of DVDO was recorded in the amount of $8.4 million. As of the date of our acquisition of DVDO, there was one identified project that met the necessary criteria, the 201 Image Enhancement Chip. The value of this project was determined by estimating its future cash flows from the time it was expected to become commercially feasible, discounting the net cash flows to their present value, and applying a percentage of completion to the calculated value. The net cash flows from the identified project were based on estimates of revenue, cost of revenue, research and development expenses, selling general and administrative expenses, and applicable income taxes for the project. These estimates did not take into account any potential synergies that could be realized as a result of the acquisition, and were in line with industry averages and growth estimates for the semiconductor industry.

        Revenue for the project was expected to begin in the first quarter of 2001 and extend through 2004. We based our revenue projection on estimates of market size and growth, expected trends in technology and the expected timing of new product introductions by our competitors and us. The discount rate used was 25%, a rate that is consistent with the estimated rates of return on our intangible assets. This rate is higher than the industry weighted average cost of capital because of the risks associated with the inherent uncertainties of the successful development of the in-process research and development, market acceptance of the technology, the useful life of the technology, the profitability level of such technology and the uncertainty of technological advances.

        The percentage of completion for the project was determined based on research and development expenses incurred immediately prior to the acquisition as a percentage of total research and development expenses to bring the project to technological feasibility. As of June 30, 2000, we estimated the project to be approximately 86% complete with remaining costs to be incurred on portions of logic, flow, layout, coding and testing. These costs were expected to be incurred over a six month period and were not expected to be material. The project began shipping to customers in the second quarter of 2001 and is still offered for sale.

        We expect to make future acquisitions if advisable and may record additional expenses for in-process research and development in connection with those acquisitions.

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        Impairment of Goodwill and Intangible Assets.    In 2002, we recorded $5.2 million of expense for the impairment of goodwill and intangible assets recorded in connection with the acquisition of CMD in 2001. These assets became impaired as a result of our decision in the second quarter of 2002 to transition to a licensing model for our storage subsystem board products, whereby instead of developing, manufacturing and selling board products, we will develop and license board designs in exchange for license fees and royalties. For 2001, we recorded $29.9 million of expense for the impairment of goodwill and intangible assets recorded in connection with the acquisitions of DVDO and CMD. DVDO goodwill and intangible assets became impaired primarily as a result of our decision to phase out or de-emphasize certain existing digital video processing products and to cease funding of certain digital video processing development projects. Additionally, prevailing economic and industry conditions and the departure of certain key DVDO employees during the quarter ended September 30, 2001 also contributed to the impairment expense of $13.9 million. We recorded impairment expense of $16.0 million in the fourth quarter of 2001 related to goodwill and intangible assets recorded in connection with our CMD acquisition. This impairment resulted from a decrease in our initial estimate of future revenue from CMD's products.

        Restructuring.    During the third quarter of 2001, we began a program to focus our business on products and technology, including those obtained through acquisitions, in which we have, or believe we can achieve, a leadership position. As part of this program, we decided to cancel numerous products under development and to remove certain projects from our development plan, to phase out or de-emphasize certain existing products and to integrate the operations of our two recently acquired companies, CMD and SCL. During the quarter ended December 31, 2001, we reduced our workforce by approximately 60 people in connection with our plan to focus on products and technology in which we have, or believe we can achieve, a leadership position, and as a result of the continued integration of recently acquired companies. In connection with these actions, we recorded a restructuring expense of $1.5 million, consisting of severance related costs of $902,000, including $303,000 for the intrinsic value of modified stock options, an expected loss on leased facilities of $500,000, and a fixed asset write-down of $50,000. We estimate that this restructuring will eliminate approximately $5.5 million of annual operating expenses.

        In the first quarter of 2002, we implemented a second workforce reduction in connection with the program discussed above, eliminating an additional 35 positions, or 13% or our workforce. Positions were eliminated from all functional areas. This reduction resulted from the continued integration of acquired companies, as well as continued execution of our product and technology strategy, whereby we decided to phase out the legacy storage subsystem board products we acquired from CMD and to develop new board products only if we believed it would facilitate or accelerate the use of our storage semiconductor products. In connection with this workforce reduction, we recorded a restructuring expense of $2.2 million in the first quarter of 2002, consisting of cash severance-related costs of $198,000, non-cash severance-related costs of $318,000 representing the intrinsic value of modified stock options, an expected loss on leased facilities of $1.2 million and fixed asset write-downs of $500,000. In addition, we reversed $76,000 of unearned compensation, a component of stockholders' equity, for unvested stock options that were cancelled in connection with employee terminations.

        In April 2002, we decided to transition to a licensing model for our storage subsystem board products, whereby instead of developing, manufacturing and selling board products to facilitate or accelerate the use of our storage semiconductor products, we will develop and license board designs in exchange for license fees, royalties and the use of our semiconductor products. In connection with this decision, we implemented a third workforce reduction, eliminating 14 positions, or 5%, of our workforce and recorded a restructuring expense of $3.5 million, consisting of cash severance-related costs of $450,000, non-cash severance-related costs of $1.6 million representing the intrinsic value of modified stock options and fixed asset write-downs of $1.5 million. We also reversed $302,000 of

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unearned compensation, a component of stockholders' equity, for unvested stock options that were cancelled in connection with employee terminations.

        In December 2002, we revised our estimate of the loss we expect to incur on subleased facilities and recorded a restructuring expense of $1.5 million. Real estate market conditions deteriorated in the fourth quarter of 2002, causing us to reassess the length of time it will take to find tenants and the fair value lease rate of our available space. As of December 31, 2002, our expected loss on subleased facilities is based on estimated sublease income of $1.6 million over the remaining lease terms. To the extent we are unable to generate $1.6 million of sublease income, our future results of operations and financial condition will be negatively affected.

        Severance related costs were determined based on the amount of pay people received that was not for services performed and by measuring the intrinsic value of stock options that were modified to the benefit of terminated employees. The expected loss on leased facilities resulted from our plan to consolidate our remaining workforce to the extent practicable and sublease any excess space. To determine the expected loss, we compared our lease and operating costs for the space to our estimate of the net amount we would be able to recover by subleasing the space. This estimate was based on a number of assumptions, including the length of time it will take to secure a tenant, the sublease rate per square foot, the cost of necessary improvements or modifications and real estate broker commissions. The fixed asset write-downs were determined based on the estimated fair value of assets, primarily computer hardware and software that would no longer be utilized after the employees' termination date.

        We expect severance and benefits payments to be completed by the second quarter of 2003. Lease payments will be made through the end of the related lease terms of July 2003 and November 2005. The following table presents restructuring activity for 2002 and 2001 (in thousands).

        Patent defense and acquisition integration costs.    Patent defense and acquisition integration costs were $7.0 million for 2002 and $1.8 million for 2001. Patent defense costs are related to the lawsuit we filed against Genesis Microchip in April 2001, and acquisition integration costs represent costs incurred to integrate CMD and SCL. The increase in 2002 can be attributed to discovery, motions, depositions and other activities in preparation for trial. We expect to incur patent defense costs at least until the middle of 2003. The amount of legal fees incurred in 2003 will depend on the duration of the litigation, as well as the nature and extent of the litigation activities. We are not able to accurately estimate the amount of legal fees we will incur in 2003 with respect to this matter, but do expect the amount to be substantially less than that incurred in 2002.

        Interest Income.    Interest income decreased to $1.0 million in 2002, from $2.7 million in 2001 and $4.1 million in 2000. These year-to-year decreases can be attributed to lower interest rates and decreased average cash and investment balances.

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        Interest Expense and Other Net.    Net interest expense and other was $240,000 for 2002, $309,000 for 2001 and $112,000 for 2000. The decrease in 2002 can be attributed to lower average outstanding debt balances in 2002. The increase from 2000 to 2001 resulted from the assumption of a bank loan in connection with our acquisition of CMD.

        Provision for Income Taxes.    Due to our losses in 2002 and 2001, no provision for income taxes was recorded in either of those years. In 2000, we recorded a provision for income taxes of $368,000, which was equal to 10.5% of our net income before taxes and non-cash charges, including in-process research and development, amortization of goodwill and intangible assets and stock compensation and warrant expense.

        At December 31, 2002, we had a net operating loss carryforward for federal income tax purposes of approximately $63.0 million, that expires through 2022. This future tax benefit has not been recognized as an asset on our balance sheet due to uncertainties surrounding our ability to generate sufficient taxable income in future periods to realize the benefits. Under the Tax Reform Act of 1986, the amounts of, and benefits from, net operating loss carryforwards may be restricted or limited in certain circumstances.

Liquidity and Capital Resources

        Since our inception, we have financed our operations through a combination of private sales of convertible preferred stock, our initial public offering, lines of credit and capital lease financing. At December 31, 2002, we had $27.8 million of working capital and $35.8 million of cash, cash equivalents and short-term investments. In the future, we expect to generate positive cash flow on an annual basis. The primary sources of cash flow will be operating activities. If we are not able to generate cash from operating activities, we will liquidate short-term investments or, to the extent available, utilize credit arrangements to meet our cash needs.

        Operating activities used $8.9 million of cash during 2002, used $14.2 million of cash during 2001, and generated $3.4 million of cash during 2000. For 2002, our net loss excluding depreciation, stock compensation expense, amortization and impairment of goodwill and intangible assets, in-process research and development and non-cash restructuring charges was $12.6 million. This was the most significant use of cash for operating activities. In addition, accounts receivable and inventories increased $4.9 million in 2002 as a result of increased business volume. These uses of cash were offset by increases in accounts payable of $5.1 million, accrued liabilities of $2.3 million and deferred margin on sales to distributors of $731,000. For 2001, net loss excluding depreciation, stock compensation and warrant expense, amortization and impairment of goodwill and intangible assets, in-process research and development and non-cash restructuring charges was $15.1 million. Inventories and accounts receivable increased from 2000 solely as a result of our acquisitions of CMD and SCL in 2001. However, decreases in both inventories and accounts receivable from operating activities provided $5.2 million of cash in 2001. Inventory levels at our distributors also decreased in 2001, causing our deferred margin on sales to distributors to decrease by $1.4 million. Additionally, we reduced accounts payable and accrued liabilities through operations by $3.1 million during 2001, which used cash. During 2000, net income excluding depreciation, stock compensation and warrant expense, amortization of goodwill and intangible assets and in-process research and development was $4.2 million and our deferred margin on sales to distributors increased $1.6 million. These sources of cash were partially offset by increases in accounts receivable and inventories of $2.5 million and $1.9 million, respectively. Accounts receivable and inventories increased as a result of our increased business volume. Deferred margin on sales to distributors increased as a result of higher inventory levels at our distributors, as demand for our products strengthened from the prior year.

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        We generated $9.0 million of cash from investing activities in 2002, generated $12.6 million of cash from investing activities in 2001, and used $15.6 million of cash for investing activities in 2000. Net proceeds from sales and purchases of short-term investments generated $12.7 million of cash in 2002. During 2002, we used $3.7 million for purchases of property and equipment, primarily software tools for use in R&D activities. During 2001, we received net proceeds from sales and purchases of short-term investments of $17.4 million, and used $3.0 million of cash for acquisition costs and $1.8 million of cash for purchases of property and equipment. The primary uses of cash in 2000 were for net purchases of short-term investments and purchases of property and equipment.

        We generated $7.2 million of cash from financing activities in 2002, used $2.7 million of cash for financing activities in 2001 and generated $1.8 million of cash from financing activities in 2000. During 2002, we received $7.8 million of proceeds from issuances of common stock through our stock option and stock purchase plans, and our net borrowing activities, including releases of security deposits and debt repayments, used $0.7 million of cash during 2002. Cash used by financing activities in 2001 was from security deposits on lease financing and debt payments, partially offset by cash provided by issuances of common stock for stock option exercises and stock purchase plan sales. Cash provided by financing activities in 2000 was from issuances of common stock and repayments of stockholder notes, partially offset by a security deposit requirement for leased equipment.

Debt and Lease Obligations

        In October 2002, we entered into a new debt facility that includes a revolving line of credit of up to $7.5 million, a term loan of $3.6 million, and equipment advances of $1.0 million. Borrowings under the revolving line are limited to the lesser of $7.5 million or our borrowing base of 80% of eligible accounts receivable. The revolving line has a maturity date of September 26, 2003. There were no borrowings outstanding under this line at December 31, 2002. The $3.6 million term loan refinanced $3.1 million of debt acquired in connection with our acquisition of CMD and $500,000 of other bank debt, and requires monthly payments through its maturity of October 1, 2004. Equipment advances are available until March 31, 2003. All borrowings under this credit facility are at prime (4.25% at December 31, 2002) plus 0.25% and the facility is secured by substantially all of our assets, excluding intellectual property. This facility contains certain quarterly and annual financial covenants with which we must comply. We were not in compliance with one of the quarterly financial covenants at December 31, 2002; however, we were granted a waiver from the lending institution and are not in default of the loan agreement. However, non-compliance with these financial covenants in the future could result in all amounts outstanding becoming due and payable immediately. All amounts outstanding under the credit agreement, including $1.5 million due subsequent to December 31, 2003, have been classified as current liabilities.

        In October 2002, we financed a $351,000 insurance premium at an interest rate of 5.75%. Monthly payments of $40,000 are due through June 2003.

        We lease certain software and equipment under lease agreements accounted for as capital leases. These leases mature in 2003, require monthly payments of $26,000 and bear interest at rates ranging from 7.5% to 9.1%. Many of these leases include end of lease bargain purchase options that we intend to exercise. Our obligations under these leasing arrangements are secured by the leased equipment.

        In October 1999, we entered into a noncancelable operating lease through July 2003 for our principal operating facility. This lease requires average monthly rental payments of approximately $133,000 and is secured by a certificate of deposit in the amount of $283,000, which is included in prepaid expenses and other current assets on our balance sheet. This security requirement will be reduced to zero in July 2003. In December 2002, we entered into a noncancelable operating lease renewal for our principal operating facility that commences in August 2003 and expires in July 2010.

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The lease requires initial average monthly rental payments of $76,000 and provides for annual 3% rent increases thereafter. This lease will also require a security deposit of $152,000.

        In June 2001, in connection with our acquisition of CMD, we acquired the lease of an operating facility in Irvine, California with average monthly rental payments of approximately $100,000 through November 2005. A portion of this facility has been subleased through July 2003, generating monthly sublease income of approximately $35,000 to offset our payment obligations. Additionally, in connection with our acquisition of SCL in July 2001, we acquired the lease of a facility in Milpitas, California with average monthly rental payments of approximately $18,000 per month. We do not occupy the Milpitas facility and are attempting to sublease the space.

        Rent expense, net of sublease income, totaled $2,529,000, $2,419,000 and $1,549,000 in 2002, 2001 and 2000, respectively. Future minimum lease payments under operating leases have not been reduced by expected sublease rental income or by the amount of our restructuring accrual that relates to leased facilities. Future minimum payments for our operating leases, debt and capital leases outstanding at December 31, 2002 are as follows (in thousands):

        We plan to spend approximately $5 million during the next 12 months for equipment, furniture and software. Additionally, we plan to implement a new enterprise resource planning system in the second quarter of 2003, and have entered into a contract for implementation consulting services requiring cash payments of approximately $500,000.

        Based on our estimated cash flow for 2003, we believe our existing cash and short-term investments are sufficient to meet our capital and operating requirements for at least the next 12 months. Operating and capital requirements depend on many factors, including the levels at which we generate revenue and maintain margins, investments in inventory and accounts receivable, the cost of securing access to adequate manufacturing capacity, our operating expenses, including patent defense costs, and general economic conditions. In addition, cash may be required for future acquisitions should we choose to pursue any. To the extent existing resources and cash from operations are insufficient to support our activities, we may need to raise additional funds through public or private equity or debt financing. These funds may not be available, or if available, we may not be able to obtain them on terms favorable to us.

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Factors Affecting Future Results

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.

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

        The revenue and income potential of our business and the markets we serve is unproven. We began volume shipments of our first display products in the third quarter of 1997. The Digital Visual Interface, or DVI, specification, which is based on technology developed by us and used in many of our products, was first published in April 1999. The DVI specification defines a high-speed data communication link between computers and digital displays, such as flat panel displays, projectors and cathode ray tubes. We completed our first generation of consumer electronics and storage IC products in mid-to-late 2001. In addition, the preliminary serial ATA specification was first published in August 2001 and the High Definition Multimedia Interface (HDMI) specification was first released in December 2002. Accordingly, we face risks and difficulties frequently encountered by early-stage companies in new and rapidly evolving markets. If we do not successfully address these risks and difficulties, our results of operations could be negatively affected.

We have a history of losses and may not become profitable.

        We have incurred net losses in each quarter and fiscal year since our inception, including losses of $40.1 million, $76.1 million and $23.2 million for the years ended December 31, 2002, 2001, and 2000, respectively. We expect to continue to incur net losses for the foreseeable future. Accordingly, we may not achieve and sustain profitability.

Our quarterly operating results may fluctuate significantly and are difficult to predict.

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

•

the growth, evolution and rate of adoption of industry standards for our key markets, including digital-ready PCs and displays, consumer electronics and storage devices;



•

competitive pressures, such as the ability of competitors to successfully introduce products that are more cost-effective or that offer greater functionality than our products, including by integrating into their products functionality offered by our products, and the prices set by competitors for their products;



•

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



•

government regulations regarding the timing and extent to which digital content must be made available to consumers



•

the availability of other semiconductors or other key components that are required to produce a complete solution for the customer; usually, we supply one of many necessary components;



•

the fact that our licensing revenue is heavily dependent on a few key deals being completed, the timing of which is not always predictable and is especially susceptible to delay beyond the period in which they are expected, and our concentrated dependence on a few licensees for substantial portions of our expected licensing revenue;

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•

the cost of components for our products and prices charged by the third parties who manufacture, assemble and test our products;



•

fluctuations in the price of our common stock, which drive a substantial portion of our non-cash stock compensation and warrant expense; and



•

the nature and extent of litigation activities, particularly our patent infringement suit against Genesis.

        Because we have little or no control over these factors, 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.

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

        Our quarterly operating results may fluctuate based on how well we manage our business. Some of the factors that may affect how well we manage our business include the following:

•

our ability to manage product introductions and transitions;



•

our ability to successfully manage our entry into new markets such as storage and consumer electronics;



•

our ability to close licensing deals and make deliverables and milestones on which recognition of revenue often depends;



•

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 channels through which we choose to sell our products; and



•

our ability to manage expense and inventory levels.

        If we fail to effectively manage our business, this could adversely affect our results of operations.

The licensing component of our business strategy may not be successful.

        Part of our business strategy is to license certain of our technology to companies that address markets in which we do not want to directly participate. We have limited experience marketing and selling our technology on a licensing basis. In conjunction with the business strategy we adopted in late 2001, we signed our first license contract in December 2001, and signed several more during the fiscal year ended December 31, 2002; however, there can be no assurance that additional companies will be interested in licensing our technology on commercially favorable terms or at all. We also cannot ensure that companies who license our technology will introduce and sell products incorporating our technology, will accurately report royalties owed to us, will pay agreed upon royalties, will not infringe upon or misappropriate our intellectual property and will maintain the confidentiality of our proprietary information. Licensing revenue is heavily dependent on a few key deals being completed, the timing of which is not always predictable and is especially susceptible to delay beyond the period in which they are expected. Also, generating revenue from licensing arrangements is a lengthy and complex process that may last beyond the period in which efforts begin, and once an agreement is in place, the timing of revenue recognition may be dependent on customer acceptance of deliverables, achievement of milestones, and other factors. In addition, in any period, our expectation of licensing revenue is or may be dependent on one or a few licenses being completed. Due to these factors, the amount of license revenue recognized in any period may differ significantly from our expectations.

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Our strategic restructuring program may not be successful.

        During the third quarter of 2001, we began a program to focus our business on products and technology, including those obtained through acquisitions, in which we have, or believe we can achieve, a leadership position. As part of this program, we decided to cancel numerous products under development, to remove certain projects from our development plan, to phase out or de-emphasize certain existing products, to license our technology to companies that participate in markets we do not address and to integrate the operations of our two recently acquired companies, CMD and SCL. In particular, we intend to concentrate on our discrete transmitter and receiver products for PCs and displays, and on developing products and promoting adoption of the HDMI and serial ATA standards for the consumer electronics and storage markets, respectfully. Additionally, in the second quarter of 2002, we transitioned to a licensing model for our storage systems business and are therefore phasing out our board level products through the middle of 2003. We expect that we will continue to generate revenue from sales of products being phased out or de-emphasized for a limited period of time and that costs for selling and marketing these products will be minimal due to the limited resources allocated for this purpose. However, if demand for these products is not sufficient to use our existing inventory, we may incur charges for excess and obsolete inventory. Products to be phased out or de-emphasized represented approximately 25% of our revenue in 2001 and 10% of our revenue for the year ended December 31, 2002. In connection with this program, we have implemented three workforce reductions eliminating 109 positions, or 36% of our third quarter 2001 workforce, and have recorded restructuring expense of $8.6 million.

        There is no guarantee that our strategic restructuring program will be successful. The markets in which we are promoting new technologies and standards are still developing and evolving, and there can be no assurance as to the rate or extent of adoption of these new technologies and standards.

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

        The PC, CE and storage markets in which we operate are intensely competitive. These markets are characterized by rapid technological change, evolving standards, short product life cycles and declining selling prices. Our display products face competition from a number of sources, including analog solutions, DVI-based solutions, dual (analog and DVI based) solutions and other digital interface solutions. We expect competition in the display market to increase. For example, Analog Devices, ATI, Broadcom, Chrontel, Genesis Microchip, Matrox, National Semiconductor, nVidia, Phillips, Pixelworks, SIS, Smart ASIC, ST Microelectronics, Texas Instruments and Thine have all begun shipping products or announced intentions to introduce products that we expect will compete with our PanelLink products. Other companies have announced DVI-based solutions and we expect that additional companies are likely to enter the market. In the future, our current or potential customers may also develop their own proprietary solutions that would likely be the integration of a DVI transmitter into a graphics processing unit or integration of a DVI receiver into a monitor controller.

        In the CE market, our digital interface products are used to connect cable set-top boxes, satellite set-top boxes and DVD players to digital televisions. These products incorporate DVI and HDCP, or HDMI with or without HDCP support. Companies that have announced or are shipping DVI-HDCP solutions include TI, Thine, Broadcom and Genesis. In addition, our video processing products face competition from products sold by AV Science, Broadcom, Focus Enhancements, Genesis, Mediamatics, Micronas Semiconductor, Oplus, Philips, Pixelworks and Trident. We also compete, in some instances, against in-house processing solutions designed by large original equipment manufacturers. We expect competition for HDMI products from the other HDMI founders and adopters, including Hitachi, Matsushita, Philips, Sony, Thomson and Toshiba.

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        In the storage market, our Fibre Channel product faces competition from companies selling similar discrete products, including Agilent, PMC Sierra and Vitesse, from other Fibre Channel SerDes providers who license their core technology, such as LSI Logic, and from companies that sell HBA controllers with integrated SerDes, such as QLogic and Agilent.

        Our serial ATA products compete with similar products from Marvell / Promise. In addition, other companies such as Adaptec, APT, Intel, LSI Logic, ServerWorks and Vitesse, have developed or announced intentions to develop serial ATA controllers. We also may compete against Intel and other motherboard chip-set makers that may integrate serial ATA functionality into their chipsets; in fact, Intel has announced its intention to integrate this functionality into one of its upcoming chip sets.

        Our parallel ATA products compete with IC vendors including Promise and Highpoint. Our RAID controller board products face competition from Mylex, Infortrend, and Chaparral.

        Some of these competitors have already established supplier or joint development relationships with current or potential customers and may be able to leverage their existing relationships to discourage these customers from purchasing products from us or persuade them to replace our storage 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. In addition, some of our competitors could merge which may enhance their market presence. As a result, they may be able to adapt more quickly to new or emerging technologies and customer requirements, or devote more resources to the promotion and sale of their products. We cannot assure you that we can compete successfully against current or potential competitors, or that competition will not reduce our revenue and increase our losses.

Growth of the market for our PC products depends on the widespread adoption and use of the DVI specification.

        Our success is largely dependent upon the rapid and widespread adoption of the DVI specification, which defines a high-speed data communication link between computers and digital displays. We cannot predict the rate at which manufacturers of computers and digital displays will adopt the DVI specification. To date, relatively few systems implementing all of the electrical and mechanical aspects of the DVI specification have been shipped. The DVI adoption rate in the PC market increased to 12% in 2002, from 7% in 2001. Adoption of the DVI specification may be affected by the availability of computer components able to communicate DVI-compliant signals, such as transmitters, receivers, connectors and cables necessary to implement the specification. Other specifications may also emerge that could adversely affect the acceptance of the DVI specification. For example, a number of companies have promoted alternatives to the DVI specification using other interface technologies, such as low voltage differential signaling, or LVDS. Further delays in the widespread adoption of the DVI specification could reduce acceptance of our products, limit or reduce our revenue growth and increase our losses.

Demand for our products for the consumer electronics market is dependent on the adoption and widespread use of the HDMI 1.0 specification.

        Our success in the consumer electronics market is largely dependent upon the rapid and widespread adoption of the HDMI 1.0 specification, which combines high-definition video and multi-channel audio in one digital interface and uses our patented underlying TMDS technology, and optionally Intel's HDCP technology, as the basis for the interface. Version 1.0 of the specification was published for adoption on December 9, 2002. We cannot predict the rate at which manufacturers will adopt the HDMI specification or if the specification will be adopted at all. Adoption of the HDMI specification may be affected by the availability of consumer products, such as DVD players and

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televisions, and of computer components that implement this new interface. Other competing specifications may also emerge that could adversely affect the acceptance of the HDMI specification. Delays in the widespread adoption of the HDMI specification could reduce acceptance of our products, limit or reduce our revenue growth and increase our losses.

Our ability to increase sales of our products for display systems depends on host system manufacturers including DVI-compliant transmitters in their systems.

        Our success depends on increasing sales of our receiver products to display manufacturers. To increase sales of our receiver products, we need computer manufacturers to incorporate DVI-compliant transmitters in their systems, making these systems digital-ready. During 2002, we introduced a low-cost add-in card that can be used in conjunction with Intel's 845G chip set to provide an all-digital connection to flat panels. Intel's 845G chip set is intended to provide an all-digital path on the motherboard bus, and should make it easier to provide digital video out. Use of Intel's 845G chip set, or any digital path chip set, is not universal and may not gain market acceptance. If computers are not digital-ready, they will not operate with their digital displays, which will limit and may reduce the demand for our digital receiver products, including our add-in card.

Our success depends on managing our relationship with Intel

        Intel has a dominant role in many of the markets in which we compete, such as PCs and storage, and is a growing power in the CE market. We have a multi-faceted relationship with Intel that is complex and requires significant management attention, including:

•

Intel has been an investor of ours;



•

Intel and we have been parties to a business cooperation agreement;



•

Intel and we are parties to a patent cross-license;



•

Intel and we worked together to develop HDCP;



•

Intel and we were two of the original founders of the DDWG;



•

Intel is a promoter of the serial ATA working group, of which we are a contributor;



•

Intel is a supplier to us and a customer of our products;



•

We believe that Intel has the power to drive adoption of DVI, serial ATA and HDMI, by making them widely available in its chip sets and motherboards, which could negatively affect demand for our products;



•

Intel may potentially integrate the functionality of our products, including fibre channel, serial ATA or DVI, into its own chips and chip sets, thereby displacing demand for our products;



•

Intel may design new technologies that would require us to re-design our products for compatibility, thus increasing our R&D expense and reducing our revenue;



•

Intel's technology, including its 845G chip set may lower barriers to entry to other parties who may enter the market and compete with us; and



•

Intel may enter into or continue relationships with our competitors that can put us at a relative disadvantage.

        Our cooperation and competition with Intel can lead to positive benefits if managed effectively. If our relationship with Intel is not managed effectively, it could seriously harm our business, negatively affect our revenue, and increase our operating expenses.

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Our success depends on the growth of the digital display market.

        Our business depends on the growth of the digital display market. The potential size of the digital display market and its rate of development are uncertain and will depend on many factors, including:

•

the number of digital-ready computers that are being produced and consumer demand for these computers;



•

the rate at which display manufacturers replace analog or non-compliant DVI interfaces with fully DVI-compliant interfaces;



•

the availability of cost-effective semiconductors that implement a fully DVI-compliant interface; and



•

improvements to analog technology, which may decrease consumer demand for our digital display products.

        In order for the digital display market to grow, digital displays must be widely available and affordable to consumers. In the past, the supply of digital displays, such as flat panels, has been cyclical and consumers have been very price sensitive. Also, some manufacturers have implemented DVI interfaces that are not fully DVI-compliant. These interfaces often interfere with the operability of our products which function best with a fully DVI-compliant interface. Our ability to sustain or increase our revenue may be limited should there not be an adequate supply of, or demand for, affordable digital displays with fully DVI-compliant interfaces.

Our success depends on the development and growth of markets for products based on new and emerging storage technologies.

        Our product development efforts in the storage market are focused on the development of products using new interface technologies such as fibre channel and serial ATA. The markets for these new interface technologies are at an early stage of development, and there can be no assurance that they will replace other storage interfaces that are now widely used, such as parallel ATA and SCSI. The potential size and rate of development of these markets are uncertain and will depend on many factors, including:

•

the rate at which manufacturers of storage subsystems adopt new interface technologies, which may be more costly to implement than existing interface technologies until volumes are sufficient to bring costs to competitive levels;



•

the availability of cost-effective semiconductors and components for storage subsystems, such as serial ATA-enabled hard drives, that implement new interface technologies for the storage market;



•

whether Intel or other motherboard manufacturers integrate the functionality of our products, such as serial ATA, into their chips and chip sets; and



•

improvement to existing storage interface technologies such as parallel ATA and SCSI, or the introduction of other new storage interface technologies, either of which may decrease consumer demand for our storage products.

        In particular, the rate of implementation of the serial ATA interface will depend on how quickly drive manufacturers, motherboard and PC providers and chipmakers are able to resolve technical communication and functionality issues to enable a "plug and play" environment in which a computer system is automatically able to recognize and configure storage devices. Resolution of these issues could be time-consuming, and will depend in good measure on the ability of chipmakers to incorporate the required high-speed serial data transfer capabilities into their semiconductors without sacrificing manufacturing yields.

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        Any delay in acceptance of new interface technologies, or a reduction in the growth or size of the market for systems based on serial ATA or fibre channel technologies, would limit sales of our storage products and reduce our revenue. Any delay in the availability of serial ATA compatible drives or acceleration of serial ATA or fibre channel SerDes integration efforts by motherboard or storage controller manufacturers may also reduce our revenue.

        We have promulgated a SATALite specification to which we have invited key industry members to participate. This program includes certain licenses to our technology that we hope will increase market acceptance of our serial ATA products. There can be no assurance that this program will succeed, or that SATALite participants will not use our technology to compete against us.

        To date, we have achieved a number of design wins for our serial ATA and fibre channel storage products. Even after we have achieved a design win from an OEM, we may not realize any revenue, or significant revenue, from that OEM since a design win is not a binding commitment to purchase our products and the OEM may not achieve market acceptance for their product. Further delay in serial ATA-enabled drive availability may lead OEMS to re-open their designs and designs we have won may be subject to being lost, which could reduce our revenue and increase our operating expenses in competing to re-win designs.

A significant amount of our revenue is associated with the adoption of new or emerging technologies within the PC industry. The PC industry has slowed and the adoption of these new technologies may not occur as planned.

        Substantially all of our revenue is directly or indirectly related to the PC industry and the adoption of new or emerging technologies within the PC industry. Accordingly, we are highly dependent on the adoption of new or emerging technologies within the PC industry, which experienced a slowdown in growth during the second half of 2000 that continued throughout 2001, and 2002. We cannot predict the duration or severity of the downturn in the PC and display market, or in the general economy, or its effect on our revenue and operating results, including the adoption of these new or emerging technologies. If the market for PCs and PC-related displays continues to grow at a slow rate or contracts whether due to reduced demand from end users, macroeconomic conditions or other factors, our business and results of operations could be negatively affected.

        Although we are attempting to broaden our product offerings to include more products for the consumer electronics market, there can be no guarantee that we will succeed in this effort. To date, we have only achieved limited design wins in the consumer electronics industry. If we fail to consistently achieve design wins in the consumer electronics market, we will remain highly dependent on the PC industry.

We do not have long-term commitments from our customers and we allocate resources based on our estimates of customer demand.

        Substantially all of our sales are made on the basis of purchase orders, rather than long-term agreements. In addition, our customers may cancel or reschedule purchase orders. We purchase inventory components and build our products according to our estimates of customer demand. This process requires us to make multiple assumptions, including volume and timing of customer demand for each product, manufacturing yields and product quality. If we overestimate customer demand or product quality or under estimate manufacturing yields, we may build products that we may not be able to sell at an acceptable price or at all. As a result, we would have excess inventory, which would increase our losses. Additionally, if we underestimate customer demand or if sufficient manufacturing capacity is unavailable, we will forego revenue opportunities or incur significant costs for rapid increases in production, lose market share and damage our customer relationships.

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Our lengthy sales cycle can result in a delay between incurring expenses and generating revenue, which could harm our operating results.

        Because our products are based on new technology and standards, a lengthy sales process, typically requiring several months or more, is often required before potential customers begin the technical evaluation of our products. This technical evaluation can exceed nine months, and it can then be an additional nine months before a customer commences volume shipments of systems incorporating our products, if at all. Given our lengthy sales cycle, we may experience a delay between the time we incur expenditures and the time we generate revenue, if any. As a result, our operating results could be seriously harmed if a significant customer reduces or delays orders, or chooses not to release products incorporating our products.

We depend on a few key customers and the loss of any of them could significantly reduce our revenue.

        Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For the year ended December 31, 2002, shipments to World Peace International, an Asian distributor, generated 15% of our revenue and shipments to Weikeng, an Asian distributor, generated 11% of our revenue. For the year 2001, shipments to Samsung, a Korean customer, and Compaq, a global customer, each generated 12% of our revenue, and shipments to World Peace International generated 11% of our revenue. In addition, an end-customer may buy through multiple distributors, contract manufacturers, and / or directly, which could create an even greater concentration. 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 and generate revenue. As a result of this concentration of our customers, our results of operations could be negatively affected if any of the following occurs:

•

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



•

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



•

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

        Due to our entrance into new markets, our customer base has broadened significantly and we therefore anticipate being less dependent on a relatively small number of customers to generate revenue. However, as product mix may fluctuate from quarter to quarter, we may become more dependent on a small number of customers or a single customer for a significant portion of our revenue in a particular quarter, the loss of which could adversely affect our operating results.

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

        Many original equipment manufacturers rely on third-party manufacturers or distributors to provide inventory management and purchasing functions. Distributors generated 42% of our revenue for the year ended December 31, 2002 and 40% of our revenue for 2001. We expect the percentage of revenue generated through distributors in 2003 to decrease as our licensing revenue, which is direct, becomes a higher percentage of our revenue. 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 and manage 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

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•

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

        Any failure to manage these challenges could disrupt or reduce sales of our products.

        We are sometimes required to maintain certain levels of our inventory at a customer's or intermediary's site in line with a customer's projection of their requirements. These customer projections are generally non-binding and we risk excess and obsolete inventory in the event that the customer's projections decrease or do not materialize and we cannot re-allocate the inventory to other customers. Any of these events may adversely affect our results of operations.

Our success depends on the development and introduction of new products, which we may not be able to do in a timely manner because the process of developing high-speed semiconductor products is complex and costly.

        The development of new products is highly complex, and we have experienced delays, some of which exceeded one year, in the development and introduction of new products on several occasions in the past. In 2001 and 2002, we announced our first products for the storage market and we expect to introduce new consumer electronics, storage and DVI products in the future. As our products integrate new, more advanced functions, they become more complex and increasingly difficult to design, manufacture and debug. Successful product development and introduction depends on a number of factors, including, but not limited to:

•

accurate prediction of market requirements and evolving standards, including enhancements to existing standards such as DVI, HDCP and SATA and development and adoption of new or emerging standards such as HDMI;



•

development of advanced technologies and capabilities, and new products that satisfy customer requirements;



•

timely completion and introduction of new product designs;



•

use of leading-edge foundry processes and achievement of high manufacturing yields; and market acceptance.

        Accomplishing all of this is extremely challenging, time-consuming and expensive and there is no assurance that we will succeed. Product development delays may result from unanticipated engineering complexities, changing market or competitive product requirements or specifications, difficulties in overcoming resource limitations, the inability to license third party technology or other factors. If we are not able to develop and introduce our products successfully and in a timely manner, our costs could increase or our revenue could decrease, both of which would adversely affect our operating results. In addition, it is possible that we may experience delays in generating revenue from these products or that we may never generate revenue from these products. We must work with a semiconductor foundry and with potential customers to complete new product development and to validate manufacturing methods and processes to support volume production and potential re-work. Each of these steps may involve unanticipated difficulties, which could delay product introduction and reduce market acceptance of the product. In addition, these difficulties and the increasing complexity of our products may result in the introduction of products that contain defects or that do not perform as expected, which would harm our relationships with customers and our ability to achieve market acceptance of our new products. There can be no assurance that we will be able to achieve design wins for our planned 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.

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We have made acquisitions in the past and may make acquisitions in the future, if advisable, and these acquisitions involve numerous risks.

        Our growth depends upon market growth and our ability to enhance our existing products and introduce new products on a timely basis. One of the ways we develop new products and enter new markets is through acquisitions of other companies. In 2000, we completed the acquisitions of Zillion and DVDO, and in 2001, we completed the acquisitions of CMD and SCL. We may acquire additional companies or technologies. Acquisitions involve numerous risks, including, but not limited to, the following:

•

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



•

disruption of our ongoing business;



•

discovery of undisclosed liabilities of the acquired companies and legal disputes with founders or shareholders of acquired companies;



•

inability to successfully incorporate acquired technology and operations into our business and maintain uniform standards, controls, policies and procedures; and



•

inability to commercialize acquired technology.

        No assurance can be given that our acquisitions of Zillion, DVDO, CMD or SCL, 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. Failure to manage growth effectively and to successfully integrate acquisitions made by us could materially harm our business and operating results.

The cyclical nature of the semiconductor industry may create fluctuations in our foundry, test and assembly capacity.

        In the past, the semiconductor industry has been characterized by significant downturns and wide fluctuations in supply and demand. For example, demand in the semiconductor industry rose to record levels in 1999, but is currently in a downward cycle. The industry has also experienced significant fluctuations in anticipation of changes in general economic conditions. This cyclicality has led to significant fluctuations in product demand and in the foundry, test and assembly capacity of third party suppliers. Production capacity for semiconductors fabricated using 0.18 micro technology could be subject to allocation, whereby not all of our production requirements would be met. This may impact our ability to meet demand and could also increase our production costs. 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.

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

        We do not own or operate a semiconductor fabrication facility. We rely almost entirely on Taiwan Semiconductor Manufacturing Company (TSMC), an outside foundry, to produce all of our display-related semiconductor products. We also rely on Kawasaki, UMC and Atmel, who are also outside foundries, to produce our storage semiconductor products and we rely on Amkor and ASE to test certain of our semiconductor products. Our reliance on independent foundries, 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;

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•

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



•

our ability to transition to alternate sources if services are unavailable from primary suppliers.

        In addition, our semiconductor products are assembled and tested by several independent sub-contractors. We do not have a long-term supply agreement with our sub-contractors, and instead obtain production services on a purchase order basis. Our outside sub-contractors have no obligation to 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. Our requirements represent a small portion of the total production capacity of our outside foundries, assembly and test facilities and our sub-contractors may reallocate capacity to other customers even during periods of high demand for our products. These foundries may allocate or move production of our products to different foundries under their control, even in different locations, which may be time consuming, costly, and difficult, have an adverse affect on quality, yields, and costs, and require us and/or our customers to re-qualify the products, which could open up design wins to competition and result in the loss of design wins and design-ins. If our sub-contractors are unable or unwilling to continue manufacturing our products in the required volumes, at acceptable quality, yields and costs, and in a timely manner, our business will be substantially harmed. As a result, we would have to identify and qualify substitute contractors, which would be time-consuming, costly and difficult. 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 and design-ins. 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 nature of our production process is complex, which reduces identification of problems until well into the production cycle or in some cases, 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 yield problems can 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.

        Although we test our products before shipment, they are complex and may contain defects and errors. 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, 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.

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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.

        A substantial portion of our business is conducted outside of the United States, and 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, and for the year ended December 31, 2002 and 2001, 72% and 79%, respectively, of our revenue was generated from customers and distributors located outside of the United States, 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. Accordingly, we are subject to international risks, including, but not limited to:

•

difficulties in managing from afar;



•

political and economic instability, including international tension in Iraq, Korea and the China Strait and lack of normal diplomatic relationships between the United States and Taiwan;



•

less developed infrastructures in newly industrializing countries;



•

susceptibility of foreign areas to terrorist attacks;



•

bias against foreign, especially American, companies;



•

difficulties in collecting accounts receivable;



•

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



•

difficulties in complying with multiple, conflicting and changing laws and regulations, including export requirements, tariffs, import duties, visa restrictions, environmental laws and other barriers;



•

exposure to possible litigation or claims in foreign jurisdictions; and



•

competition from foreign-based suppliers and the existence of protectionist laws and business practices that favor these suppliers, such as withholding taxes on payments made to us.

        These risks could adversely affect our business and our results of operations. In addition, original equipment manufacturers 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 reduction in sales and profits in that country.

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 proprietary technologies. We have been issued patents and have a number of pending patent applications. However, we cannot assure you that any patents will be issued as a result of any applications or, if issued, that any claims allowed will protect our technology. In addition, we do not file patent applications on a worldwide basis, meaning we do not have patent protection in some jurisdictions. It is possible that existing or future patents may be challenged, invalidated or circumvented and effective patent, copyright, trademark and trade secret protection may be unavailable or limited in foreign countries. 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. As a result, despite our

46

efforts and expenses, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business.

Our participation in the Digital Display Working Group requires us to license some of our intellectual property for free, which may make it easier for others to compete with us in the DVI PC market.

        We are a promoter of the Digital Display Working Group, which published and promotes the DVI specification. Our strategy includes establishing the DVI specification as the industry standard, promoting and enhancing this specification and developing and marketing products based on this specification and future enhancements. As a result:

•

we must license for free specific elements of our intellectual property to others for use in implementing the DVI specification; and



•

we may license additional intellectual property for free as the Digital Display Working Group promotes enhancements to the DVI specification.

        Accordingly, companies that implement the DVI specification in their products can use specific elements of our intellectual property for free to compete with us.

Our participation as a founder in the working group developing HDMI requires us to license some of our intellectual property, which may make it easier for others to compete with us in the market.

        In April 2002, together with Sony, Philips, Thomson, Toshiba, Matsushita and Hitachi, we announced the formation of a working group to define the next-generation digital interface specification for consumer electronics products. Version 1.0 of the specification was published for adoption on December 9, 2002. The HDMI specification combines high-definition video and multi-channel audio in one digital interface and uses Silicon Image's patented underlying TMDS technology along with Intel's HDCP as the basis for the interface. The founders of the working group have signed a founder's agreement in which each commits to license certain intellectual property to each other, and to adopters of the specification.

        Our strategy includes establishing the HDMI specification as the industry standard, promoting and enhancing this specification and developing and marketing products based on this specification and future enhancements. As a result:

•

we must license specific elements of our intellectual property to others for use in implementing the HDMI specification; and



•

we may license additional intellectual property as the HDMI founders group promotes enhancements to the HDMI specification.

        Accordingly, companies that implement the HDMI specification in their products can use specific elements of our intellectual property to compete with us. Although there will be license fees and royalties associated with the adopters agreements, there can be no assurance that such license fees and royalties will adequately compensate us for having to license our intellectual property. Fees and royalties received during the early years of adoption will be used to cover costs we incur to promote the HDMI standard and to develop and perform interoperability tests; in addition, after an initial period, the HDMI founders may reallocate the license fees and royalties amongst themselves to reflect each founder's relative contribution of intellectual property to the HDMI specification.

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We have granted Intel 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 have entered into a patent cross-license agreement with Intel in which each of us granted the other a license to use the grantor's patents, 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.

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

        Securities class action 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. We and certain of our officers and directors, together with certain investment banks, have been named as defendants in a securities class action suit filed against us on behalf of purchasers of our securities between October 5, 1999 and December 6, 2000. It is alleged that the prospectus related to our initial public offering was misleading because it failed to disclose that the underwriters of our initial public offering had solicited and received excessive commissions from certain investors in exchange for agreements by investors to buy our shares in the aftermarket for predetermined prices. Due to inherent uncertainties in litigation, we cannot accurately predict the outcome of this litigation. We believe that these claims are without merit and we intend to defend vigorously against them. However, these claims and any other that may be brought, even if meritless, could require us to incur expenses and could divert our management's attention and resources. In addition, any unfavorable outcome of this possible litigation could adversely impact our business, financial condition and results of operations.

We are currently engaged in intellectual property litigation that is time-consuming and expensive to prosecute. We may become engaged in additional intellectual property litigation that could be time-consuming, maybe 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 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

48

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.

        In April 2001, we filed suit against Genesis Microchip for infringement of one of our U.S. patents. At that time, we also filed a complaint against Genesis for unlawful trade practices related to the importation of articles infringing our patent. In February 2002, our motion to dismiss the unlawful trade practices complaint was granted and we filed an amended complaint against Genesis alleging infringement of two of our U.S. patents. These patents relate to our DVI receiver products, which generate a significant portion of our revenue. The amended complaint seeks a declaration that Genesis has infringed our patents, that Genesis's behavior is not licensed, an injunction to halt the importation, sale, manufacture and use of Genesis DVI receiver chips that infringe our patents, and monetary damages. In April 2002, Genesis answered and made counterclaims against us for non-infringement, license, patent invalidity, fraud, antitrust, unfair competition and patent misuse. We filed a motion to dismiss certain of Genesis's counterclaims. In addition, we filed a motion to bifurcate trial of the counterclaims to the extent the court does not dismiss them. In May 2002, the Court granted our motion to dismiss certain of the counterclaims, with leave to amend. Genesis re-filed counterclaims against us for fraud and patent misuse. We filed another motion to dismiss these counterclaims. In August 2002, the Court granted our motion and dismissed Genesis's re-filed counterclaims with prejudice. In September 2002, we filed a motion for summary judgment, upon which the Court has yet to rule. In October 2002, both parties filed several more motions for summary judgment, upon which the Court has yet to rule. Several dispositive motions have subsequently been filed under seal and were heard by the Court in March 2003; the Court has yet to rule on these motions. Depending on the outcome of such motions, a trial date may be set, the case may be dismissed, or other orders may be entered. We intend to prosecute our position vigorously until this matter is resolved.

        There can be no assurance that we will prevail in this litigation. While this litigation is pending, Genesis can use the technology covered by these patents to develop products that might compete with ours. If we are unsuccessful in this litigation, we could be unable to prevent Genesis or others from using the technology covered by this patent. Even if we do prevail in this litigation, uncertainties regarding the outcome prior to that time may reduce demand for our products. In addition, disputes may occur regarding whether any intellectual property licenses were granted and the scope of any such licenses, based on our interactions in various standards bodies, including the Digital Display Working Group and for HDMI. These disputes may result in additional costly and time-consuming litigation or the license of additional elements of our intellectual property for free.

        Any potential intellectual property litigation against us could also force us to do one or more of the following:

•

stop selling products or using technology that contain 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 are forced to 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.

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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.

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. Although we have entered into a limited number of employment contracts with certain executive officers, we generally do not have employment contracts with our key employees. We do not have key person life insurance for any of our key personnel. 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 location. 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.

        The pressure on 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. In addition, new regulations proposed by The NASDAQ National Market requiring shareholder approval for all stock option plans, as well as new regulations proposed by the New York Stock Exchange prohibiting NYSE member organizations from giving a proxy to vote on equity compensation plans unless the beneficial owner of the shares has given voting instructions, could make it more difficult for us to grant options to employees in the future. There have been several proposals on whether and/or how to account for stock options. To the extent that new regulations 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 use contractors to provide services to the company, which often involves contractual complexity, tax and employment law compliance, and being subject to audits and other governmental actions. We have been audited for our contracting policies in the past, and may be in the future. Burdening our ability to freely use contractors to provide services to the company may increase the expense of obtaining such services, and/or require us to discontinue using contractors and attempt to find, interview, and hire employees to provide similar services. Such potential employees may not be available in a reasonable time, or at all, or may not be hired without undue cost.

In the past, we implemented mandatory unpaid company-wide shutdowns as a cost reduction measure, but we may not continue to implement these programs.

        In the last two fiscal years, we have implemented mandatory company-wide shutdowns. Although these shutdown periods represent a cost savings to us, they may be perceived negatively by our customers, vendors and employees. We currently intend to implement a company-wide shutdown in the

50

first quarter of 2003, and another during the second half of 2003. In addition, we may continue to implement company-wide shutdowns in future periods, which may negatively impact employee morale or the perception of our company by our customers and vendors. If we elect not to implement these shutdowns, our operating expenses will increase.

Our workforce reductions may seriously harm our business.

        In connection with the program we began in the third quarter of 2001 to focus our business on products and technology in which we have, or believe we can achieve, a leadership position, we have implemented three workforce reductions, eliminating a total of 109 positions. As a result of the elimination of these positions, our marketing, sales and customer support capabilities could be reduced, our ability to respond to unexpected challenges may be impaired, and we may be unable to take advantage of new opportunities. These workforce reductions, or future workforce reductions, if any, may reduce employee morale and create concern among existing employees about job security, which could lead to increased turnover. Workforce reductions may also raise concerns among customers, suppliers and other corporate partners regarding our continued viability. Further, these workforce reductions may subject us to the risk of litigation, which could be costly to defend, divert the attention of management and subject us to possible liability for damages.

Industry cycles may strain our management and resources.

        Cycles of growth and contraction in our industry may 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.

Our operations and the operations of our significant customers, third-party wafer foundries and third-party assembly and test subcontractors are located in areas susceptible to natural disasters.

        Our operations are headquartered in the San Francisco Bay Area, which is susceptible to earthquakes, and the operations of CMD, which we acquired, are based in the Los Angeles area, which is also susceptible to earthquakes. TSMC and UMC, the outside foundries that produce the majority of our semiconductor products, are located in Taiwan. Advanced Semiconductor Engineering, or ASE, one of the subcontractors that assembles and tests our semiconductor products, is also located in Taiwan. For the year ended December 31, 2002, customers and distributors located in Taiwan generated 34% of our revenue and customers and distributors located in Japan generated 12% of our revenue. For 2001, customers and distributors located in Taiwan generated 25% of our revenue and customers and distributors located in Japan generated 16% of our revenue. Both Taiwan and Japan are susceptible to earthquakes, typhoons and other natural disasters.

        Our business would be negatively affected if any of the following occurred:

•

an earthquake or other disaster in the San Francisco Bay Area or the Los Angeles area damaged our facilities or disrupted the supply of water or electricity to our headquarters or our Irvine facility;

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•

an earthquake, typhoon or other disaster in Taiwan or Japan resulted in shortages of water, electricity or transportation, limiting the production capacity of our outside foundries or the ability of ASE to provide assembly and test services;



•

an earthquake, typhoon or other disaster in Taiwan or Japan damaged the facilities or equipment of our customers and distributors, resulting in reduced purchases of our products; or



•

an earthquake, typhoon or other disaster in Taiwan or Japan disrupted the operations of suppliers to our Taiwanese or Japanese customers, outside foundries or ASE, which in turn disrupted the operations of these customers, foundries or ASE and resulted in reduced purchases of our products or shortages in our product supply.

Our implementation of a new ERP system may negatively affect our business.

        In order to respond to the growth we anticipate in our business, we have decided implement a new enterprise resource planning (ERP) system to replace the multiple, sometimes non-interoperable systems currently used in various aspects of our business. We have entered into commitments to purchase software licenses and services, many of which we expect to be expensed and introduced during future periods, particularly our second fiscal quarter of 2003. The ERP system will affect numerous operational and financial systems, reporting and processes. Even after introduction of the new system, it will need to be tested further. In the event that the ERP system is delayed, lacks necessary features, or has runtime errors, or we are unable to train our personnel to use the ERP system in an efficient and timely manner, our business could be adversely affected. Moreover, there can be no assurance that the ERP system will be able to support the anticipated growth of our business. Additionally, systems conversions can be disruptive to a company's business.

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

        Several jurisdictions are considering whether to implement rules that would require that certain products, including semiconductors, be made lead-free. We anticipate that some jurisdictions may finalize and enact such requirements. Some jurisdictions are also considering whether to require abatement or disposal obligations for products made prior to the enactment of any such rules. Although several of our products are available to customers in a lead-free condition, most of our products are not lead-free. Any requirement that would prevent or burden the development, manufacture or sales of lead-containing semiconductors would likely reduce our revenue for such products and would require us to incur costs to develop substitute lead-free replacement products, which may take time and may not always be economically or technically feasible, and 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;



•

prohibiting cumulative voting in the election of directors;



•

requiring super-majority voting to amend some provisions of our certificate of incorporation and bylaws;



•

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

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•

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.

Continued terrorist attacks or war could lead to further 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 has engaged in war with Iraq. In addition, the current nuclear arms crisis in North Korea 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.

Item 7A. Quantitative and Qualitative Disclosures of Market Risk

Interest Rate Risk

        Our cash equivalents and short-term investments consist primarily of fixed-income securities that are subject to interest rate risk and will decline in value if interest rates increase. Due to the short duration of our cash equivalents and short-term investments, an immediate 10% change in interest rates would not be expected to have a material effect on our near-term results of operations or financial condition. Our long-term capital lease obligations bear interest at fixed rates; therefore, our results of operations would not be affected by immediate changes in interest rates. Also, components of

53

our stock compensation expense are tied to our stock price. Changes in our stock price can have a significant affect on the amount recorded as stock compensation expense.

Foreign Currency Exchange Risk

        All of our sales are denominated in U.S. dollars, and substantially all of our expenses are incurred in U.S. dollars, thus limiting our exposure to foreign currency exchange risk. We currently do not enter into forward exchange contracts to hedge exposures denominated in foreign currencies and do not use derivative financial instruments for trading or speculative purposes. The direct effect of an immediate 10% change in foreign currency exchange rates should not have a material effect on our future operating results or cash flows; however, a long term increase in foreign currency rates would likely result in increased wafer, packaging, assembly or testing costs. Additionally, many of our foreign distributors price our products in the local currency of the countries in which they sell. Therefore, significant strengthening of the U.S. dollar relative to those foreign currencies could result in reduced demand or lower U.S. dollar prices for our products, which would negatively affect our operating results.

Item 8. Financial Statements and Supplementary Data

        The Financial Statements and Supplemental Data required by this item are set forth at the pages indicated at Item 15(a).

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

        Not applicable.

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PART III

Item 10. Directors and Executive Officers of the Registrant

        The information required by this Item, which will be set forth under the captions "Proposal No. 1 Election of Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership Compliance" in Silicon Image's Proxy Statement for its 2003 Annual Meeting of Stockholders, is incorporated herein by reference.

Item 11. Executive Compensation

        The information required by this Item, which will be set forth under the captions "Director Compensation," "Executive Compensation" and "Compensation Committee Interlocks and Insider Participation" in Silicon Image's Proxy Statement for its 2003 Annual Meeting of Stockholders, is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

        The information required by this Item regarding ownership of Silicon Image's securities, which will be set forth under the caption "Security Ownership of Certain Beneficial Owners and Management" in Silicon Image's Proxy Statement for its 2003 Annual Meeting of Stockholders, is incorporated herein by reference. The information required by this Item regarding Silicon Image's equity compensation plans, which will be set forth under the caption "Equity Compensation Plans" in Silicon Image's Proxy Statement for its 2003 Annual Meeting of Stockholders, is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

        The information required by this Item, which will be set forth under the caption "Certain Relationships and Related Transactions" in Silicon Image's Proxy Statement for its 2003 Annual Meeting of Stockholders, is incorporated herein by reference.

Item 14. Controls and Procedures

(a)

Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in our periodic SEC filings.

(b)

There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out this evaluation.

        A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are 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. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all errors, control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls is also based in part on certain assumptions regarding the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become

55

inadequate because of changes in conditions, or the degree of compliance with the policies and procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a)

The following documents are filed as a part of this Form:

1.

Financial Statements:

Consolidated Statements of Operations for the three years ended December 31, 2002
Consolidated Balance Sheets at December 31, 2002 and December 31, 2001
Consolidated Statements of Stockholders' Equity for the three years ended December 31, 2002
Consolidated Statements of Cash Flows for the three years ended December 31, 2002
Notes to Consolidated Financial Statements
Report of Independent Accountants

2.

Financial Statement Schedules.

        Financial statement schedules have been omitted because the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements or the notes to those financial statements.

3.

Exhibits.

        The exhibits listed in the Index to Exhibits are filed as a part of this Report on Form 10-K.

(b)

Reports on Form 8-K:

On December 2, 2002 and December 3, 2002, we filed current reports on Form 8-K regarding planned stock sales by two of the Company's executives.

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SILICON IMAGE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(1)

Excludes non-cash stock compensation expense of $1.2 million, $279,000 and $593,000 for 2002, 2001 and 2000, respectively.

(2)

Excludes non-cash stock compensation expense of $7.4 million, $9.3 million and $10.2 million for 2002, 2001 and 2000, respectively.

(3)

Excludes non-cash stock compensation expense of $2.5 million, $2.8 million and $2.8 million for 2002, 2001 and 2000, respectively.

See accompanying Notes to Consolidated Financial Statements

57

SILICON IMAGE, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

See accompanying Notes to Consolidated Financial Statements

58

SILICON IMAGE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)