SILICON IMAGE INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2003

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

For the transition period from to .

Commission file number: 000-26887

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

Delaware		77-0396307
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

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

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) Yes ý No o and (2) has been subject to such filing requirements for the past 90 days Yes ý No o

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

The number of shares of the registrant’s Common Stock, $0.001 par value per share, outstanding as of April 30, 2003 was 69,393,266 shares.

Silicon Image, Inc.

Quarterly Report on Form 10-Q

Three Months Ended

March 31, 2003

Table of Contents

Part I		Financial Information (Unaudited)

Item 1		Financial Statements

		Condensed Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002

		Condensed Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002

		Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002

		Notes to Unaudited Condensed Consolidated Financial Statements

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

Item 3		Quantitative and Qualitative Disclosures About Market Risk

Item 4		Controls and Procedures

Part II		Other Information

Item 1		Legal Proceedings

Item 2		Change in Securities and Use of Proceeds

Item 3		Defaults Upon Senior Securities

Item 4		Submission of Matters to a Vote of Security Holders

Item 5		Other Information

Item 6		Exhibits and Reports on Form 8-K

Signatures

Certifications

Part I. Financial Information

Item 1. Financial Statements

Silicon Image, Inc.

Condensed Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended March 31,
	2003			2002

Revenue:
Product	$	19,722		$	16,605
Development, licensing and royalties	4,954			482
Total revenue	24,676			17,087

Cost and operating expenses:
Cost of revenue(1)	11,190			8,486
Research and development(2)	8,837			7,378
Selling, general and administrative(3)	4,308			4,934
Stock compensation expense (benefit)	(362		)	10,451
Amortization of intangible assets	—			909
Patent defense and acquisition integration costs	1,213			706
Restructuring	986			2,193

Total cost and operating expenses	26,172			35,057

Loss from operations	(1,496		)	(17,970		)
Gain on escrow settlement, net	4,618			—
Interest income and other, net	109			270

Net income (loss)	$	3,231		$	(17,700	)

Net income (loss) per share - basic	$	0.05		$	(0.28	)
Net income (loss) per share - diluted	$	0.04		$	(0.28	)

Weighted average shares - basic	66,828			63,360
Weighted average shares - diluted	73,696			63,360

(1) Excludes stock compensation expense (benefit) of ($135,000) and $923,000 for the three months ended March 31, 2003 and 2002, respectively.

(2) Excludes stock compensation expense of $127,000 and $5.9 million for the three months ended March 31, 2003 and 2002, respectively.

(3) Excludes stock compensation expense (benefit) of ($354,000) and $3.6 million for the three months ended March 31, 2003 and 2002, respectively.

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Silicon Image, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share amounts)

(unaudited)

	March 31, 2003			Dec. 31, 2002
Assets
Current Assets:
Cash and cash equivalents	$	24,975		$	26,263
Short-term investments	6,477			9,570
Accounts receivable, net of allowances for doubtful accounts of $523 at March 31 and $519 at December 31	13,548			11,589
Inventories	6,725			7,301
Prepaid expenses and other current assets	2,134			2,510
Total current assets	53,859			57,233
Property and equipment, net	7,371			6,653
Goodwill	13,021			13,021
Other assets	676			709
Total assets	$	74,927		$	77,616

Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable	$	8,333		$	10,314
Accrued liabilities	9,042			11,183
Capital lease and other obligations	3,500			3,816
Deferred margin on sales to distributors	4,297			4,133
Total liabilities	25,172			29,446

Stockholders’ Equity:
Common stock, par value $0.001; shares authorized: 150,000,000 – March 31 and December 31; shares issued and outstanding: 66,658,555 – March 31 and 66,639,522 – December 31	68			67
Additional paid-in capital	212,075			214,459
Notes receivable from stockholders	—			(109		)
Unearned stock compensation	(5,775		)	(6,403		)
Accumulated deficit	(156,613		)	(159,844		)
Total stockholders’ equity	49,755			48,170
Total liabilities and stockholders’ equity	$	74,927		$	77,616

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Silicon Image, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2003			2002

Cash flows from operating activities:
Net income (loss)	$	3,231		$	(17,700	)
Adjustments to reconcile net loss to cash used in operating activities:
Stock compensation expense (benefit)	(362		)	10,451
Amortization of intangible assets	—			909
Non-cash restructuring	646			818
Non-cash gain on escrow settlement, before cash costs	(4,692		)	—
Provision for doubtful accounts	4			31
Depreciation and amortization	947			997
Changes in assets and liabilities:
Accounts receivable	(1,963		)	(8		)
Inventories	576			(377		)
Prepaid expenses and other assets	409			570
Accounts payable	(1,981		)	(582		)
Accrued liabilities	(2,141		)	(95		)
Deferred margin on sales to distributors	164			906
Cash used in operating activities	(5,162		)	(4,080		)

Cash flows from investing activities:
Proceeds from sales of short-term investments	5,693			3,477
Purchases of short-term investments	(2,600		)	—
Purchases of property and equipment	(1,282		)	(702		)
Cash provided by investing activities	1,811			2,775

Cash flows from financing activities:
Proceeds from issuances of common stock, net	2,653			3,029
Repayment of stockholders’ notes receivable	109			—
Repayments of capital lease and other obligations	(699		)	(663		)
Cash provided by financing activities	2,063			2,366

Net increase (decrease) in cash and cash equivalents	(1,288		)	1,061
Cash and cash equivalents – beginning of period	26,263			18,946
Cash and cash equivalents – end of period	$	24,975		$	20,007

Non-cash investing and financing activities:
Financing of property and equipment	$	383		$	—

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Silicon Image, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

March 31, 2003

1. Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Silicon Image, Inc. included herein have been prepared on a basis consistent with our December 31, 2002 audited financial statements and include all material adjustments, consisting of normal recurring adjustments, necessary to fairly state the consolidated financial position of Silicon Image and its subsidiaries (collectively, the “Company”) at March 31, 2003 and the consolidated results of the Company’s operations and cash flows for the three months ended March 31, 2003 and 2002. All intercompany accounts and transactions have been eliminated. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Form 10-K for the fiscal year ended December 31, 2002. Results of operations for the three months ended March 31, 2003 are not necessarily indicative of future operating results.

2. Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards 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. The restructuring charge we recorded in the first quarter of 2003 was recognized in accordance with SFAS No. 146. The adoption of SFAS No. 146 did not have a significant effect on our results of operations or financial condition.

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 adoption of Interpretation 45 did not have a significant effect on our results of operations or financial condition. Refer to Note 4 for the required warranty disclosure.

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 adopted the disclosure requirements of SFAS No. 148 on December 31, 2002.

Had we recorded compensation cost for our options based on the grant-date fair value as prescribed by SFAS No. 123 and SFAS No. 148, our net income (loss) would have been as follows (in thousands):

	Three Months Ended March 31,
	2003			2002
Net income (loss) - as reported	$	3,231		$	(17,700	)
Stock-based employee compensation expense determined using fair value method	(6,020		)	(6,422		)
Stock-based employee compensation cost (benefit) included in the determination of net loss as reported	(721		)	9,850
Pro forma net loss	$	(3,510	)	$	(14,272	)

Basic net income (loss) per share—pro forma	$	(0.05	)	$	(0.23	)
Basic net income (loss) per share—as reported	$	0.05		$	(0.28	)

Diluted net income (loss) per share—pro forma	$	(0.05	)	$	(0.23	)
Diluted net income (loss) per share—as reported	$	0.04		$	(0.28	)

3. Net Income (Loss) Per Share

Basic earnings per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted-average number of common shares and dilutive stock options, determined using the treasury stock method, outstanding during the period.

The following is a reconciliation of the weighted-average common shares used to calculate basic net income per share to the weighted-average common shares used to calculate diluted net income per share for the three months ended March 31, 2003 (in thousands):

Weighted-average common shares for basic net income per share		66,828
Weighted-average dilutive stock options outstanding under the treasury stock method		6,776
Unvested common shares subject to repurchase		92
Weighted-average common shares for diluted net income per share		73,696

The effect of dilutive stock options outstanding excludes approximately 8.6 million stock options that were anti-dilutive for net income per share calculations for the three months ended March 31, 2003.

Due to our net loss for the three months ended March 31, 2002, all stock options outstanding as of March 31, 2002 would have been anti-dilutive and were therefore excluded from the calculation of diluted net loss per share. A total of 21.3 million stock options were outstanding as of March 31, 2002.

4. Balance Sheet Components

	March 31, 2003		Dec. 31, 2002
	(in thousands)

Inventories:
Raw materials	$	1,989	$	1,376
Work in process	2,497		2,487
Finished goods	2,239		3,438
	$	6,725	$	7,301

Accrued liabilities:
Accrued payroll and related expenses	$	1,740	$	2,502
Restructuring accrual	2,882		2,736
Accrued legal fees	1,182		1,865
Warranty accrual	223		223
Other accrued liabilities	3,015		3,857
	$	9,042	$	11,183

Warranty Accrual

At the time of revenue recognition, we provide an accrual for estimated costs to be incurred pursuant to our warranty obligation. Our estimate is based primarily on historical experience. Warranty accrual activity for the three months ended March 31, 2003 was as follows (in thousands):

Balance at January 1, 2003	$	223
Provision for warranties issued during the period	50
Accruals related to pre-existing warranties	—
Cash and other settlements made during the period	(50		)
Balance at March 31, 2003	$	223

5. Stock-Based Compensation

We account for stock-based compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” and related interpretations, and comply with the disclosure provisions of Statement of Financial Accounting Standard No. 148 (SFAS No. 148), “Accounting for Stock-Based Compensation—Transition and Disclosure (an amendment of FASB Statement No. 123).” Expense associated with stock-based compensation is amortized over the vesting period of the individual award using an accelerated method, as described in Financial Accounting Standards Board Interpretation No. 28.

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.

The following table summarizes the components of our stock compensation expense (benefit) for the three months ended March 31, 2003 and 2002 (in thousands):

	Three Months Ended March 31,
	2003			2002

Options granted to employees	$	222		$	437
Options granted to non-employees	359			601
Option repricings	(1,358		)	7,932
Options assumed in connection with acquisitions	415			1,481
Stock compensation expense (benefit)	$	(362	)	$	10,451

During the three months ended March 31, 2003, we recorded a credit of $1.4 million in connection with our stock option repricings since the fair market value of our stock as of March 31, 2003 was less than our stock’s fair market value as of December 31, 2002. During the three months ended March 31, 2002, we recognized $7.9 million of expense relating to repriced stock options. Expense or benefit for the increase or decrease in the fair market value

of our stock relative to the exercise price of the repriced options is recognized immediately for vested options and is recognized over the remaining vesting period for unvested options using an accelerated method for employees.

During the three months ended March 31, 2003, we modified options for employees involuntarily terminated in connection with our restructuring program. A charge of $646,000 for these modifications is included in restructuring expense for the period ended March 31, 2003.

The weighted average, grant-date fair value of stock options granted during the three months ended March 31, 2003 and 2002 was $4.31 and $4.07 per option, respectively. The grant-date fair value was estimated using the Black-Scholes pricing model with the following assumptions:

	Three Months Ended March 31,
	2003		2002

Expected life (years)	5.0		5.0
Risk-free interest rate	3.1	%	3.5	%
Dividend yield	—		—
Volatility	90	%	90	%

The weighted average, grant-date fair value of stock purchase rights granted under our Employee Stock Purchase Plan was $2.76 and $2.46 per share during the three months ended March 31, 2003 and 2002, respectively. The grant-date fair value was estimated using the Black-Scholes pricing model with the following assumptions:

	Three Months Ended March 31,
	2003		2002

Expected life (years)	1.5		1.5
Risk-free interest rate	1.3	%	1.7	%
Dividend yield	—		—
Volatility	90	%	90	%

6. Restructuring and Impairment Activities

In connection with this program, we reduced our workforce in the fourth quarter of 2001 by approximately 60 people, or 20%. This workforce reduction was the initial step in eliminating duplicate positions that resulted from our acquisitions, and also represented the elimination of other positions based on our new product and technology focus. Positions were eliminated from all functional areas—operations, R&D and SG&A. Because of this workforce reduction, we recorded a restructuring expense of $1.5 million in the fourth quarter of 2001, consisting of cash severance-related costs of $599,000, non-cash severance-related costs of $303,000 representing the intrinsic value of modified stock options, an expected loss on leased facilities of $500,000 and fixed asset write-downs of $50,000. In addition, we reversed $286,000 of unearned compensation, a component of stockholders’ equity, for unvested stock options that were cancelled in connection with employee terminations.

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% of 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 for assets to be disposed of. 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 would 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 for assets to be disposed of. We also reversed $302,000 of unearned compensation, a component of stockholders’ equity, for unvested stock options that were cancelled in connection with employee terminations.

In connection with our decision to stop selling board products and to transition to a licensing model, we assessed recoverability of our intangible assets subject to amortization in accordance with SFAS No. 144. During the quarter ended June 30, 2002, an impairment expense of $749,000 was recognized for acquired technology and $60,000 was recognized for patent and other intangible assets, based upon our projection of significantly reduced future cash flows. Additionally, we reduced our estimate of the useful lives of the remaining intangible assets subject to amortization such that these assets were fully amortized by the end of 2002. We also tested the carrying value of goodwill for impairment in accordance with SFAS No. 142 and used the services of a third party to assist with the analysis. As a result of our impairment test, a goodwill impairment expense of $4.4 million was recognized during the second quarter of 2002. To determine the amount of the impairment, we estimated the fair value of our storage systems business based primarily on expected future cash flows. We then reduced this amount by the fair value of identifiable tangible and intangible assets other than goodwill (also based primarily on expected future cash flows), and compared the unallocated fair value of the business to the carrying value of goodwill. To the extent goodwill exceeded the unallocated fair value of the business, an impairment expense was recognized.

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.

In March 2003, we reorganized the company into lines of business for PC, CE and Storage products to enable us to better manage our long-term growth potential. In connection with this reorganization, we reduced our workforce by 27 people, or approximately 10%. These reductions were primarily in engineering and operations functions. Because of this workforce reduction, we recorded restructuring expense of $1.0 million in the first quarter of 2003, consisting of cash severance-related costs of $340,000 and non-cash severance-related costs of $646,000, representing the intrinsic value of modified stock options.

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. For those employees terminated in the three month period ending March 31, 2003, the remaining service period from the communication date did not exceed 60 days. 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 dates.

We expect severance and benefits payments to be completed by the second quarter of 2003. Lease payments will be made in the form of cash through the end of the related lease terms of July 2003 and November 2005. The following table presents restructuring activity for 2001 though March 31, 2003 (in thousands).

	Severance and Benefits			Leased Facilities			Fixed Assets			Total
2001 provision	$	902		$	500		$	50		$	1,452
Cash payments	(191		)	—			—			(191		)
Non-cash activity	(303		)	(115		)	—			(418		)
Balance as of December 31, 2001	408			385			50			843
2002 provision	2,547			2,633			2,013			7,193
Cash payments	(865		)	(420		)	—			(1,285		)
Non-cash activity	(1,952		)	—			(2,063		)	(4,015		)
Balance as of December 31, 2002	138			2,598			—			2,736
2003 provision	986			—			—			986
Cash payments	(24		)	(170		)	—			(194		)
Non-cash activity	(646		)	—			—			(646		)
Balance as of March 31, 2003	$	454		$	2,428		$	—		$	2,882

As of March 31, 2003 and December 31, 2002, 31 and 4 terminated employees, respectively, had not yet received their severance payments.

7. Debt Facility

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 March 31, 2003. 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. During the three months ended March 31, 2003, we borrowed $383,000 under the equipment advances portion of the facility. This term loan bears interest at 5% and requires monthly payments through its maturity in February 2005. Equipment advances were available to us through March 31, 2003; therefore, the unused portion of this facility of $617,000 expired as of March 31, 2003. All borrowings under the revolving line and the $3.6 million term loan are at prime (4.25% at March 31, 2003) 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 covenants at December 31, 2002; however, we were granted a waiver from the lending institution and were not in default of the loan agreement. As of March 31, 2003, we were in compliance with all of our financial covenants. However, since we were not in compliance at December 31, 2002, and cannot be assured we will be in compliance in the future, we have classified all amounts outstanding under the credit agreement as current liabilities as of March 31, 2003.

8. Legal Proceedings

(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 March 31, 2003, we have spent approximately $9.4 million on this matter and expect to continue to incur significant costs through at least the second quarter 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 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 received 949,780 of the escrowed shares, valued at approximately $4.7 million, and recorded a net non-operating gain of $4.6 million in the first quarter of 2003.

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.

9. Customer and Geographic Information

Revenue by geographic area was as follows (in thousands):

	Three Months Ended March 31,
	2003		2002
Taiwan	$	9,814	$	6,085
Japan	2,594		2,167
United States	6,774		4,527
Hong Kong	1,519		1,571
Korea	1,120		1,068
Other	2,855		1,669
	$	24,676	$	17,087

Revenue by product line was as follows (in thousands):

	Three Months Ended March 31,
	2003		2002
PC	$	8,793	$	11,745
Consumer Electronics	3,250		1,409
Storage IC	6,635		1,604
Storage Systems	1,044		1,847
Development, licensing and royalties	4,954		482
	$	24,676	$	17,087

For each period presented, substantially all long-lived assets were located within the United States.

For the three months ended March 31, 2003, one customer generated 12% of our revenue and two customers each generated 10% of our revenue. As of March 31, 2003, one customer represented 12% of gross accounts receivable. For the three months ended March 31, 2002, three customers generated 17%, 14% and 11% of our revenue. At December 31, 2002, two customers represented 13% and 10% of gross accounts receivable.

10. Guarantees

Certain of our licensing agreements indemnify our customers for any expenses or liabilities resulting from claimed infringements of patent, trademark or copyright by third parties related to the intellectual property content of our products. Certain of these indemnification provisions are perpetual from execution of the agreement and, in some instances, the maximum amount of potential future indemnification is not limited. To date, we have not paid any such claims or been required to defend any lawsuits with respect to any claim. However, there can be no assurance that such claims will not be filed in the future.

11. Business Combination

On April 7 2003, we issued approximately 2,500,817 shares of common stock in exchange for all of the outstanding shares of TransWarp Networks (TransWarp) capital stock, and converted all outstanding TransWarp options into options to purchase approximately 760,145 shares of our common stock. We currently estimate that the purchase price of this acquisition will be approximately $14.7 million. Approximately 391,579 shares of our common stock issued will be held in escrow for a period of eighteen months as collateral for indemnity obligations of the principal TransWarp stockholders. We also assumed TransWarp’s 2002 Stock Option / Stock Issuance Plan, under which a reserve of approximately 116,461 shares of our common stock remained available for future issuance as of April 7, 2003. This transaction will be recorded during the quarter ended June 30, 2003 using the purchase method of accounting. The operating results of TransWarp will be combined with our results from the date of acquisition.

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

This report contains forward-looking statements within the meaning of Section 21E of the 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-Q 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-Q 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-Q with the SEC. Our actual results could differ materially from those anticipated in, or implied by, forward-looking statements as a result of various factors, including the risks outlined elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made by Silicon Image, Inc. in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risks and factors that may affect our business.

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 36% of our revenue in the first quarter of 2003, 58% of our revenue in 2002, and 69% of our revenue in the first quarter of 2002.

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 accelerated 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. We believe that the display portion of the PC market will eventually transition to a pure digital solution that could result in an expansion in the market suited to our product offering.

Products sold into the CE market generated 13% of our revenue in the first quarter of 2003, 11% of our revenue in 2002, and 8% of our revenue in the first quarter of 2002. Our CE products offer a secure digital video and audio transmission for consumer devices such as digital TVs and DVD players. 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 27% of our revenue in the first quarter of 2003, 15% of our revenue in 2002, and 9% of our revenue in the first quarter of 2002. Demand for our storage products is dependent upon the rate at which interface 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 devices unnecessary.

Sales of storage subsystems products generated 4% of our revenue in the first quarter of 2003, 8% of our revenue in 2002, and 11% of our revenue in the first quarter of 2002. 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.

We also derive revenue from licensing our intellectual property. Our licensing activity is complementary to our product sales and we believe this activity can help accelerate adoption curves associated with our technology. We expect licensing and royalties to account for 10% to 15% of our revenue over the next few years.

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 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 and most quarterly periods since our inception and as of March 31, 2003, we had an accumulated deficit of $156.6 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 SCL, a provider of mixed-signal and high-speed circuit designs.

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. We also focused on improving our 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 second quarter of 2003 will increase 3% - 8% from the first quarter of 2003. We expect to generate positive cash flow for the year 2003.

Our expectation of overall revenue growth and positive cash flows 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 during 2003. 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 exceed $15.0 million 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, acceptance of all digital solutions in the PC market, 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 and serial ATA functionality into their chip sets, 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 subject to competition and general economic and market conditions, none of which can be accurately predicted.

Since the amount of stock compensation expense we record in any period is dependent on changes in our stock price, we are not able to reasonably estimate the amount of stock compensation we will record in future periods. Additionally, we have not yet completed the purchase price allocation for our most recent acquisition, and therefore cannot reasonably estimate stock compensation expense in future periods resulting from this acquisition. Therefore, our discussion of gross margin percentage, R&D expense and SG&A expense expectations will be done on a non-GAAP basis.

Excluding non-cash charges for stock compensation expense, we expect our gross margin percentage in the second quarter of 2003 to increase 2% - 3% from the first quarter of 2003 as a result of a shift in product mix to products with higher gross margins and improved yields and product quality, offset somewhat by declines in average selling prices and lower licensing revenue, for which there is no associated cost of sales. .

Excluding non-cash charges for stock compensation expense, we expect the dollar amount of our R&D expense to increase in the second quarter of 2003 by approximately 5% - 7% from the first quarter of 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 to increase in the second quarter of 2003 by approximately 5% from the first quarter of 2003, primarily as a result of our scheduled implementation of a new enterprise resource planning software system

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 acquisitions, the issuance of stock options to consultants, and modifications to stock options. We may also incur non-cash stock compensation expense in connection with recent or future acquisitions. The amount of stock compensation expense in each period will fluctuate with changes in our stock price and volatility. Since the amount of stock compensation expense or benefit is highly dependent on fluctuations in our stock price, it is not possible for us to reasonably estimate the amount of

expense we will incur for a particular period. Additionally, we recently completed an acquisition that will affect the amount of our stock compensation for the second quarter of 2003. Since we are in the early stages of allocating the purchase price to the various assets and liabilities acquired, including unearned stock compensation, it is not possible to reasonably estimate the effect of the acquisition on the amount of stock compensation expense we will incur for the second quarter of 2003.

Because of our recent acquisition of TransWarp, we will also incur expenses in the second quarter of 2003 for in-process research and development and amortization of intangible assets. These expenses are also not reasonably estimable at this time due to the fact that we are still in the early stages of allocating the purchase price to these items. During 2003 and future periods, we may also incur non-cash expenses for the impairment of intangible assets, which is something we cannot reasonably predict or estimate at this time.

We will also incur legal fees in the second quarter of 2003 in conjunction with our patent infringement lawsuit against Genesis Microchip (Genesis). The amount of legal fees incurred will depend on 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 legal expenses through at least the second quarter of 2003.

During the first quarter of 2003, we reorganized our company into lines of business and incurred $1.0 million of restructuring expense. We may incur additional restructuring expenses in the second quarter of 2003 associated with this reorganization or with changes in estimates relative to our leased facility space available for sublease. We cannot reasonably predict the amount of these expenses at this time.

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 March 31, 2003 was $1.1 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 40% of our revenue in the first quarter of 2003 and 41% of our revenue in 2002. 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 the first quarter of 2003, 36% of our revenue was generated through distributors, compared to 42% in 2002. Our licensing revenue is not generated through distributors, and to the extent licensing revenue increases faster than product revenues, 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 71% of our revenue in the first quarter of 2003 and 64% of our revenue in 2002. 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.

Recent Accounting Pronouncements

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. The restructuring charge we recorded in the first quarter of 2003 was recognized in accordance with SFAS No. 146. The adoption of SFAS No. 146 did not have a significant effect on our results of operations or financial condition.

Results of Operations for the Three Months Ended March 31, 2003 Compared to Results of Operations for the Three Months Ended March 31, 2002

Revenue. Revenue was $24.7 million for the first quarter of 2003, an increase of 44% from the year ago quarter. Of this increase, $4.5 million can be attributed to licensing of our intellectual property, which first became part of our business strategy in late 2001 when we decided to license our technology in order to complement our product strategy and to enable markets for new standards we were developing. The remainder of the increase is primarily attributable to our new product offerings in consumer electronics and storage, as well as overall growth in these markets. The effect of these increases was partially offset by a decrease in demand for our PC products, which can be attributed to a weak PC market, competition and some level of integration of our technology by our customers which eliminates the need for our discrete devices.

Cost of revenue. Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as related overhead costs and provisions for excess and obsolete inventories. Cost of revenue excludes non-cash stock compensation expense (benefit) of $(135,000) and $923,000 for the first quarter of 2003 and 2002, respectively. Including stock compensation and warrant expense, our cost of revenue and gross margin (revenue minus cost of revenue, as a percentage of revenue) would have been $11.1 million or 55.2%, and $9.4 million or 44.9%, for the first quarters of 2003 and 2002, respectively. Gross margin, excluding non-cash stock compensation expense, increased to 54.7% for the first quarter of 2003, from 50.3% for the first quarter of 2002. The increase in gross margin was primarily due to the shift in our overall product revenue, whereby license revenue, which has no associated cost of sales, was 20% of our revenue in the first quarter of 2003, compared to only 3% of our revenue in the first quarter of 2002. This was offset by an increase in sales of our storage products in the first quarter of 2003, which are lower margin products, and higher manufacturing costs of $1.0 million, including a $600,000 provision against inventories, in the first quarter of 2003 associated with lower than expected yields and lack of automated testing for recently-introduced products. We expect to resolve some of the manufacturing yield and test issues during the second quarter of 2003, and to reduce our manufacturing costs by approximately $0.5 million in the second quarter of 2003 as a result.

Research and Development. R&D consists primarily of compensation and related costs for employees, fees for independent contractors and prototypes. R&D excludes non-cash stock compensation expense of $127,000 and $5.9 million for the first quarters of 2003 and 2002, respectively. Including stock compensation expense, R&D would have been $9.0 million and $13.3 million, or 36% and 78%, of revenue for the first quarters of 2003 and 2002, respectively. R&D, excluding non-cash stock compensation expense, was $8.8 million, or 36% of revenue, for the first quarter of 2003, and $7.4 million, or 43% of revenue, for the first quarter of 2002. The increase in absolute dollars was primarily due to an increase in the number of R&D projects to support the multiple markets in which we operate, as well as to additional personnel, as headcount increased from 102 at March 31, 2002 to 128 for the three months ended March 31, 2003.

Selling, General and Administrative. SG&A consists primarily of employee compensation and benefits, sales commissions, and marketing and promotional expenses. SG&A excludes non-cash stock compensation expense (benefit) of ($354,000) for the first quarter of 2003 and $3.6 million for the first quarter of 2002. Including stock compensation and warrant expense, SG&A expense would have been $4.0 million and $8.5 million, or 16% and 50% of revenue, for the first quarters of 2003 and 2002, respectively. Excluding non-cash stock compensation expense, SG&A was $4.3 million, or 17% of revenue, for the first quarter of 2003, and $4.9 million, or 29% of revenue, for the first quarter of 2002. The decrease in absolute dollars was primarily due to reduced headcount, as headcount decreased from 99 at March 31, 2002 to 77 at March 31, 2003.

Stock Compensation Expense. Stock compensation expense (benefit) was ($362,000), or 1% of revenue, for the first quarter of 2003, and $10.5 million, or 61% of revenue, for the first quarter of 2002. The decrease in expense can be attributed primarily to a decline in our stock price as of March 31, 2003, versus our stock price at March 31, 2002. The amount of stock compensation expense we recognize in connection with repriced stock options is dependent on changes in our stock price. The following table summarizes the components of our stock compensation and warrant expense for the first quarters of 2003 and 2002 (in thousands).

	Three Months Ended March 31,
	2003			2002

Options granted prior to our initial public offering	$	222		$	437
Options granted to non-employees	359			601
Option repricings	(1,358		)	7,932
Options assumed in connection with acquisitions	415			1,481
	$	(362	)	$	10,451

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 non-employees, (2) the option repricing programs we implemented in 2000 and 2001, and (3) amortization of our existing unearned compensation balance. Since the expense associated with our option repricing and grants to non-employees is dependent on our stock price and volatility, it will fluctuate from period to period and may increase significantly.

Amortization of Intangible Assets. We did not record any expense in the first quarter of 2003 for amortization of intangible assets. This is due to the fact that our intangible assets subject to amortization were fully amortized as of December 31, 2002. For the first quarter of 2002, we recorded $909,000 of expense for the amortization of intangible assets recorded in connection with our acquisitions.

Restructuring. During the first quarter of 2002, we implemented a second workforce reduction in connection with the program we began in the third quarter of 2001, eliminating 35 positions or 13% of our workforce. Positions were eliminated from all functional areas – operations, R&D and SG&A. This reduction resulted from the continued integration of recently 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 restructuring expense in the first quarter of 2002 of $2.2 million, 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 for assets to be disposed of. 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. Since some of the affected employees had termination dates in the second quarter of 2002, we recorded additional expense at that time for the modification of their stock options.

In March 2003, we reorganized the company into lines of business for PC, CE and Storage products to enable us to better manage our long-term growth potential. In connection with this reorganization, we reduced our workforce by 27 people, or approximately 10%. These reductions were primarily in R&D and operations functions. Because of this workforce reduction, we recorded a restructuring expense of $1.0 million in the first quarter of 2003, consisting of cash severance-related costs of $340,000 and non-cash severance-related costs of $646,000 representing the intrinsic value of modified stock options.

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-down was 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.

	Severance and Benefits			Leased Facilities			Fixed Assets			Total
2001 provision	$	902		$	500		$	50		$	1,452
Cash payments	(191		)	—			—			(191		)
Non-cash activity	(303		)	(115		)	—			(418		)
Balance as of December 31, 2001	408			385			50			843
2002 provision	2,547			2,633			2,013			7,193
Cash payments	(865		)	(420		)	—			(1,285		)
Non-cash activity	(1,952		)	—			(2,063		)	(4,015		)
Balance as of December 31, 2002	138			2,598			—			2,736
2003 provision	986			—			—			986
Cash payments	(24		)	(170		)	—			(194		)
Non-cash activity	(646		)	—			—			(646		)
Balance as of March 31, 2003	$	454		$	2,428		$	—		$	2,882

As of March 31, 2003 and December 31, 2002, 31 and 4 terminated employees, respectively, had not yet received their severance payments.

Patent defense and acquisition integration costs. Patent defense and acquisition integration costs were $1.2 million for the first quarter of 2003, compared to $706,000 for the first quarter of 2002. 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 can be attributed to increased activity relative to the Genesis lawsuit in the first quarter of 2003.

Interest Income and other, net. Interest income and other, net decreased to $109,000 for the first quarter of 2003, from $270,000 for the first quarter of 2002. The decrease is due to lower interest rates and a $7.4 million decrease in our cash and investment balances.

Provision for Income Taxes. We generated book income in the first quarter of 2003; however, the gain on escrow settlement is a non-taxable event and therefore we did not generate taxable income in the first quarter of 2003. We did not record a provision for income tax in the first quarter of 2002 due to our taxable loss in that quarter.

At March 31, 2003, we had a net operating loss carryforward for federal income tax purposes of approximately $64.0 million that expires in various years through 2022. These future tax benefits have 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. We do not expect to be subject to these restrictions or limitations.

Gain on escrow settlement, net. We recorded a net gain of $4.6 million, net of legal expenses, in the first quarter of 2003 in connection with the settlement of the CMD escrow claim, as discussed in Note 8 to the accompanying unaudited condensed consolidated financial statements.

Liquidity and Capital Resources

At March 31, 2003, we had $28.7 million of working capital and $31.5 million of cash, cash equivalents and short-term investments.

Operating activities used $5.2 million of cash during the first quarter of 2003 and $4.1 million of cash during the first quarter of 2002. During the first quarter of 2003, our net loss excluding depreciation, stock compensation expense, a non-cash gain on escrow settlement and the non-cash portion of our restructuring charges was $230,000, which accounts for some of the cash used in operating activities. Other uses of cash for operating activities consisted of decreases in accounts payable and accrued liabilities of $4.1 million, and an increase in accounts receivable of $2.0 million. These uses of cash were somewhat offset by a $409,000 decrease in prepaid expenses and other assets. During the first quarter of 2002, net loss excluding depreciation, stock compensation expense, amortization of intangible assets and the non-cash portion of restructuring charges was $4.5 million, which accounted for most of the cash used in operating activities. Decreases in accounts payable and accrued expenses used $677,000 of cash and an increase in inventories used $377,000 of cash. These uses were somewhat offset by an increase in deferred margin of $906,000 and a decrease in prepaid expenses and other assets of $570,000.

We generated $1.8 million of cash from investing activities during the first quarter of 2003 and $2.8 million during the first quarter of 2002. The source of cash in both periods was net proceeds from sales of short-term investments, partially offset by capital expenditures.

Financing activities provided $2.1 million of cash in the first quarter of 2003 and $2.4 million in the first quarter of 2002. Cash provided by financing activities in both periods was primarily from stock option exercises and proceeds from sales of shares under our employee stock purchase plan, partially offset by repayments of our capital leases and other obligations.

Our contractual obligations at March 31, 2003, and the effect such obligations are expected to have on our liquidity and cash flow in future periods, have not changed materially since December 31, 2002, as described in our Form 10-K for the year ended December 31, 2002. As of March 31, 2003, we were in compliance with all of our financial covenants. However, since we were not in compliance at December 31, 2002, and cannot be assured we will be in compliance in the future, we have classified all amounts outstanding under the credit agreement as current liabilities as of March 31, 2003.

We believe our existing cash balance is sufficient to meet our capital and operating requirements for at least the next 12 months based on our business plan. Operating and capital requirements depend on many factors, including the levels at which we generate revenue and maintain margins, inventory and accounts receivable, the cost of securing access to adequate manufacturing capacity and our operating expenses. 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 our stockholders or us.

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 makes 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 (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 fiscal year since our inception, including losses of $40.1 million and $76.1 million for the years ended December 31, 2002 and 2001, 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;

• 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 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 achieve acceptable manufacturing yields and develop automatic test programs within a reasonable time frame for our new products;

• 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 have signed numerous more since then; 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.

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, respectively. 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. In addition, we reduced our workforce by 27 people, or approximately 10%, in the first quarter of 2003 in connection with a realignment of our company into lines of business. In connection with this workforce reduction, we recorded $1.0 million of restructuring expense in the first quarter of 2003.

There is no guarantee that our strategic restructuring program or reorganization 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.

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. In the future, our current or potential customers may also develop their own proprietary solutions that may include integration of SerDes.

Our serial ATA products compete with similar products from Marvell and 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 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 host and receiver products.

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;

• An Intel subsidiary has the exclusive right to license HDCP, of which we are a licensee;

• 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.

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 and serial ATA enabled optical drives (CD and DVD), 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.

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.

A large portion 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 has continued through the first quarter of 2003. 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 and storage markets, there can be no guarantee that we will succeed in this effort. To date, we have achieved reasonable success, but if we fail to consistently achieve design wins in the consumer electronics and storage markets, 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.

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 first quarter of 2003, shipments to World Peace International, an Asian distributor, generated 12% of our revenue and shipments to Weikeng, an Asian distributor, and Sunplus, a licensee, each generated 10% of our revenue. For the year ended December 31, 2002, shipments to World Peace International generated 15% of our

revenue and shipments to Weikeng 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 36% of our revenue in the first quarter of 2003 and 42% of our revenue for the year ended December 31, 2002. The decrease is as expected as our licensing revenue, which is direct, was a higher percentage of our revenue in the first quarter of 2003 than it was in 2002. 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

• 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.

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 low cost testing; and

• market acceptance of new products.

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.

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. In April 2003, we acquired TransWarp Networks. 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, SCL or TransWarp 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;

• 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.

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 three months ended March 31, 2003 and year ended December 31, 2002, 73% and 72%, 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;

• susceptibility to interruptions of travel, including those due to international tensions (including the war in Iraq), the SARS epidemic (particularly affecting the Asian markets we serve), and the financial instability and bankruptcy of major air carriers;

• 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 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.

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. We and certain of our officers, together with certain investment banks and their current or former employees have been named as defendants in a securities class action suit filed against us on behalf of a putative class of shareholders who purchased stock from some or 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. 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 either of these litigations 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 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.

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 and in the first quarter of 2003, we 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 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 restructuring 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, and the reorganization of the company in the first quarter of 2003 into lines of business, we have implemented four workforce reductions, eliminating a total of 136 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 quarter ended March 31, 2003, customers and distributors located in Taiwan generated 40% of our revenue and customers and distributors located in Japan generated 11% of our revenue. For the quarter ended March 31, 2002, customers and distributors located in Taiwan generated 36% of our revenue and customers and distributors located in Japan generated 13% 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;

• 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

• 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 3. Quantitative and Qualitative Disclosures About 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 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 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 change in foreign currency rates would likely result in increased wafer, packaging, assembly or testing costs.

Item 4. 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.

Part II. Other Information

Item 1. 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 March 31, 2003, we have spent approximately $9.4 million on this matter and expect to continue to incur significant costs through at least the second quarter of 2003.

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.

Item 2. Changes in Securities and Use of Proceeds

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 March 31, 2003, 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 3. Defaults Upon Senior Securities

Not applicable.

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

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

10.50 Separation Agreement for Badar Baqai dated April 9, 2003

(b) Reports on Form 8-K

On February 20, 2003, we filed a current report on Form 8-K to report under Item 5 that Robert G. Gargus, Vice President Finance and Administration and Chief Financial Officer, entered into a Rule 10b5-1 sales plan with Deutsche Bank Alex. Brown.

On March 3, 2003, we filed a current report on Form 8-K to report under Item 5 that Steve Tirado, President and Chief Operating Officer, entered into a Rule 10b5-1 sales plan with Financial West Group/Correspondent Services Corp.

On April 21, 2003, we filed a current report on Form 8-K to report under Item 2 that we have completed our acquisition of TransWarp Networks, Inc.

On April 23, 2003, we furnished a current report on Form 8-K to furnish under Item 12 our earnings release and conference call script and transcript for the first quarter of 2003.

Signatures

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

Dated: May 8, 2003	Silicon Image, Inc.


	/s/ Robert G. Gargus
	Robert G. Gargus
	Vice President Finance and Administration and Chief Financial Officer
	(Principal Financial and Accounting Officer)

Certifications

I, David D. Lee, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Silicon Image, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 8, 2003

/s/ David D. Lee
David D. Lee
Chief Executive Officer and Chairman of the Board
(Principal Executive Officer)

I, Robert G. Gargus, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Silicon Image, Inc.;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: May 8, 2003

/s/ Robert G. Gargus
Robert G. Gargus
Vice President, Finance and Administration and Chief Financial Officer
(Principal Financial Officer)

For the quarterly period ended March 31, 2003

Delaware

77-0396307

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