SILICON IMAGE INC - 10-Q Quarterly Report

UNITED STATES

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 June 30, 2003

	OR

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 July 31, 2003 was 70,589,476 shares.

Silicon Image, Inc.

Quarterly Report on Form 10-Q

Three and Six Months Ended

June 30, 2003

Table of Contents

Part I	Financial Information (Unaudited)

Item 1	Financial Statements

	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2003 and 2002

	Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002

	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 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

Exhibit Index

Exhibit	31.1

Exhibit	31.2

Exhibit	32.1

Exhibit	32.2

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 June 30						Six Months Ended June 30
	2003			2002			2003			2002

Revenue:
Product	$	19,745		$	18,222		$	39,467		$	34,827
Development, licensing and royalties	4,587			1,050			9,541			1,532
Total revenue	24,332			19,272			49,008			36,359

Cost and operating expenses:
Cost of revenue (1)	10,651			9,088			21,841			17,574
Research and development (2)	9,368			8,205			18,205			15,583
Selling, general and administrative (3)	4,355			4,576			8,663			9,510
Stock compensation expense (benefit)	2,253			(3,066		)	1,891			7,385
Amortization of intangible assets	373			857			373			1,766
Patent defense and acquisition integration costs	583			683			1,796			1,389
Restructuring	—			3,500			986			5,693
In-process research and development	5,482			—			5,482			—
Impairment of goodwill and intangible assets	—			5,200			—			5,200
Total cost and operating expenses	33,065			29,043			59,237			64,100

Loss from operations	(8,733		)	(9,771		)	(10,229		)	(27,741		)
Gain on escrow settlement, net	—			—			4,618			—
Interest income and other, net	67			163			176			433

Net loss	$	(8,666	)	$	(9,608	)	$	(5,435	)	$	(27,308	)

Net loss per share:
Basic and diluted	$	(0.13	)	$	(0.15	)	$	(0.08	)	$	(0.43	)

Weighted average shares	69,012			64,580			68,085			64,011

(1) Excludes stock compensation expense (benefit) of $78,000 and $(544,000) for the three months ended June 30, 2003 and June 30, 2002, respectively, and $(57,000) and $379,000 for the six months ended June 30, 2003 and 2002, respectively.

(2) Excludes stock compensation expense (benefit) of $1.8 million and $(833,000) for the three months ended June 30, 2003 and June 30, 2002, respectively, and $2.0 million and $5.1 million for the six months ended June 30, 2003 and 2002, respectively.

(3) Excludes stock compensation expense (benefit) of $334,000 and $(1.7) million for the three months ended June 30, 2003 and June 30, 2002, respectively, and $(20,000) and $2.0 million for the six months ended June 30, 2003 and 2002, respectively.

See accompanying Notes to the Unaudited Condensed Consolidated Financial Statements

Silicon Image, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share amounts)

(unaudited)

	June 30, 2003			Dec. 31, 2002

Assets
Cash and cash equivalents	$	25,187		$	26,263
Short-term investments	5,834			9,570
Accounts receivable, net of allowance for doubtful accounts of $519 at June 30 and at December 31	15,731			11,589
Inventories	7,391			7,301
Prepaid expenses and other current assets	1,405			2,510
Total current assets	55,548			57,233

Property and equipment, net	7,458			6,653
Goodwill	13,021			13,021
Intangible assets, net	3,904			—
Other assets	577			709
Total assets	$	80,508		$	77,616

Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable	$	9,714		$	10,314
Accrued liabilites	9,081			11,183
Capital lease and other obligations	2,821			3,816
Deferred margin on sales to distributors	3,993			4,133
Total current liabilities	25,609			29,446

Shareholders’ Equity:
Convertible preferred stock, par value $0.001; 5,000,000 shares authorized; no shares issued or outstanding	—			—
Common stock, par value $0.001; shares authorized: 150,000,000 - June 30 and December 31; shares issued and outstanding: 70,134,894 - June 30 and 66,639,522 - December 31	70			67
Additional paid-in capital	229,345			214,459
Notes receivable from stockholders	—			(109		)
Unearned stock compensation	(9,237		)	(6,403		)
Accumulated deficit	(165,279		)	(159,844		)
Total stockholders’ equity	54,899			48,170
Total liabilites and stockholders’ equity	$	80,508		$	77,616

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Silicon Image, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Six Months Ended June 30
	2003			2002

*Cash flows from operating activities:*
Net loss	$	(5,435	)	$	(27,308	)
Adjustments to reconcile net loss to cash used in operating activities:
Stock compensation expense	1,891			7,385
Amortization of intangible assets	373			1,766
Non-cash restructuring	646			3,965
Impairment of goodwill and intangible assets	—			5,200
In-process research and development expense	5,482			—
Non-cash gain on escrow settlement, before cash costs	(4,692		)	—
Depreciation and amortization	2,210			1,999
Changes in assets and liabilities, net of amounts acquired:
Accounts receivable	(4,142		)	(1,736		)
Inventories	(90		)	(903		)
Prepaid expenses and other assets	1,259			709
Accounts payable	(632		)	1,226
Accrued liabilities	(2,374		)	1,073
Deferred margin on sales to distributors	(140		)	1,302
Cash used in operating activities	(5,644		)	(5,322		)

*Cash flows from investing activities:*
Proceeds from sales and maturities of short-term investments	7,295			3,477
Purchases of short-term investments	(3,559		)	(955		)
Acquisition costs, net of cash acquired	3			—
Purchases of property and equipment	(2,560		)	(2,193		)
Cash provided by investing activities	1,179			329

*Cash flows from financing activities:*
Proceeds from issuances of common stock, net	4,658			5,285
Repayment of stockholders’ notes receivable	109			61
Repayments of capital lease and other obligations	(1,378		)	(1,131		)
Cash provided by financing activities	3,389			4,215

Net decrease in cash and cash equivalents	(1,076		)	(778		)
Cash and cash equivalents — beginning of period	26,263			18,946
Cash and cash equivalents — end of period	$	25,187		$	18,168

Non-cash investing and financing activities:
Financing of property and equipment	$	383		$	—
Stock and options issued in connection with the Transwarp acquisition	$	14,371		$	—

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements

Silicon Image, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 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 June 30, 2003 and the consolidated results of the Company’s operations and cash flows for the three and six months ended June 30, 2003 and 2002. All intercompany accounts and transactions have been eliminated. These interim financial statements should be read in conjunction with our audited consolidated 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 and six months ended June 30, 2003 are not necessarily indicative of future operating results.

2. Recent Accounting Pronouncements

In May 2003, the Financial Accounting Standard Board, or FASB, issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 establishes standards for how companies classify and measure certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires companies to classify a financial instrument that is within its scope as a liability (or an asset in some circumstances), and is effective beginning the third quarter of fiscal 2003. We believe that the adoption of this standard will have no material effect on our consolidated financial statements.

In January 2003, the FASB issued FASB Interpretation No. 46, or FIN 46, “Consolidation of Variable Interest Entities - an interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We believe that the adoption of this standard will have no material effect on our consolidated financial statements.

In November 2002, the Emerging Issues Task Force reached a consensus on Issue 00-21 (“EITF 00-21”), “Multiple-Deliverable Revenue Arrangements.” EITF 00-21 addresses how to account for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The consensus mandates how to identify whether goods or services or both which are to be delivered separately in a bundled sales arrangement should be accounted for separately because they are “separate units of accounting.” The guidance can affect the timing of revenue recognition for such arrangements, even though it does not change rules governing the timing or patterns of revenue recognition of individual items accounted for separately. The final consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. Additionally, companies will be permitted to apply the consensus guidance to all existing arrangements as the cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, “Accounting Changes.” We are assessing the potential effect of this guidance, but at this point we do not believe the adoption of EITF 00-21 will have a material effect on our consolidated financial statements.

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

	Three Months Ended						Six Months Ended
	June 30, 2003			June 30, 2002			June 30, 2003			June 30, 2002

Net loss — as reported	$	(8,666	)	$	(9,608	)	$	(5,435	)	$	(27,308	)
Stock-based employee compensation expense determined using fair value method	(5,586		)	(6,266		)	(11,606		)	(12,689		)
Stock-based employee compensation cost (benefit) included in the determination of net loss as reported	1,360			(4,506		)	949			5,343

Pro forma net loss	$	(12,892	)	$	(20,380	)	$	(16,092	)	$	(34,654	)

Basic and diluted net loss per share — pro forma	$	(0.19	)	$	(0.32	)	$	(0.24	)	$	(0.54	)
Basic and diluted net loss per share— as reported	$	(0.13	)	$	(0.15	)	$	(0.08	)	$	(0.43	)

The grant-date fair value was estimated using the Black-Scholes pricing model with the following assumptions:

	Three Months Ended June 30						Six Months Ended June 30
	2003			2002			2003			2002

Expected life	5			5			5			5
Interest rate	3.0		%	4.0		%	3.0		%	4.0		%
Volatility	90		%	90		%	90		%	90		%
Dividend yield	—			—			—			—
Weighted average fair value	$	3.69		$	7.19		$	4.15		$	4.74

The weighted average, grant-date fair value of stock purchase rights granted under our Employee Stock Purchase Plan and the assumptions used are as follows:

	Three Months Ended June 30						Six Months Ended June 30
	2003			2002			2003			2002

Expected life (years)	1.5			1.5			1.5			1.5
Interest rate	1.3		%	1.7		%	1.3		%	1.7		%
Dividend yield	—			—			—			—
Volatility	90		%	90		%	90		%	90		%
Weighted average grant date fair value	$	2.93		$	2.47		$	2.76		$	2.46

3. Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of common shares outstanding during the period, excluding shares subject to repurchase, and diluted net loss per share is computed uisng the weighted-average number of common shares and dilute equivalents outstanding during the period, if any, determined using the treasury stock method. The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share amounts):

	Three Months Ended June 30						Six Months Ended June 30
	2003			2002			2003			2002

Net loss	$	(8,666	)	$	(9,608	)	$	(5,435	)	$	(27,308	)

Weighted average shares	69,491			65,118			68,380			64,681

Less: unvested common shares subject to repurchase	(479		)	(538		)	(295		)	(670		)

	69,012			64,580			68,085			64,011
Basic and diluted net loss per share	$	(0.13	)	$	(0.15	)	$	(0.08	)	$	(0.43	)

As a result of our net losses, all common share equivalents would have been anti-dilutive and have therefore been excluded from the diluted net loss per share calculation. The weighted average securities that were anti-dilutive and excluded from our calculation of diluted net loss per share were approximately 21,843,000 and 20,268,000 for the three month periods ended June 30, 2003 and 2002, respectively, and approximately 22,002,000 and 20,777,000 for the six month periods ended June 30, 2003 and 2002, respectively.

Had we been profitable for the three and six month periods ended June 30, 2003, the number of weighted average securities outstanding that would have been added to weighted average shares for purposes of calculating diluted earnings per share would have been (in thousands):

	Three Months Ended June 30		Six Months Ended June 30
	2003	2002	2003	2002
Unvested common stock subject to repurchase	468	538	281	670

Stock options	6,612	19,730	6,915	20,107

4. Balance Sheet Components

	June 30, 2003		Dec. 31, 2002
Inventories:
Raw materials	$	1,553	$	1,376
Work in process	3,037		2,487
Finished goods	2,801		3,438
	$	7,391	$	7,301

Accrued liabilities:
Accrued payroll and related expenses	$	2,440	$	2,502
Restructuring accrual	2,354		2,736
Accrued legal fees	757		1,865
Warranty accrual	603		223
Other accrued liabilities	2,927		3,857
	$	9,081	$	11,183

Warranty Accrual

At the time of revenue recognition, we provide an accrual for estimated costs to be incurred pursuant to our warranty obligations. Our estimate is based primarily on historical experience. Warranty accrual activity for the six months ended June 30, 2003 was as follows (in thousands):

Balance at January 1, 2003	$	223
Provision for warranties issued during the period	480
Accruals related to pre-existing warranties	—
Cash and other settlements made during the period	(100		)
Balance at June 30, 2003	$	603

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 and six months ended June 30, 2003 and 2002 (in thousands):

	Three Months Ended June 30					Six Months Ended June 30
	2003		2002			2003			2002
Options granted to employees	$	58	$	244		$	280		$	681
Options granted to non-employees	425		625			784			1,226
Option repricings	527		(5,171		)	(831		)	2,761
Options assumed in connection with acquisitions	1,243		1,236			1,658			2,717
Stock compensation expense (benefit)	$	2,253	$	(3,066	)	$	1,891		$	7,385

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 in 2001 and 2002 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.

Severance and benefits payments are substantially complete. 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 June 30, 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	(399		)	(323		)	—			(722		)
Non-cash activity	(646		)	—			—			(646		)
Balance as of June 30, 2003	$	79		$	2,275		$	—		$	2,354

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 June 30, 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 only 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 June 30, 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 June 30, 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 June 30, 2003.

8. Legal Proceedings

MOU in the manner we requested, and ruled that Genesis had engaged in efforts to avoid its obligations under the MOU. On August 6, 2003, the Court entered a final judgment based on its July 15, 2003 ruling. Under the final judgment order, Genesis was ordered to make a substantial cash payment, and to make royalty payments. To date, we have not recognized any income or revenue associated with the matter, including amounts previously received for which payment was not honored. Due to the continuing and contentious nature of this litigation, we will not record any income or revenue related to this matter until litigation is complete. Management intends to prosecute our position vigorously until this matter is resolved. Through June 30, 2003, we have spent approximately $10.0 million on this matter and expect to continue to incur significant costs through at least the third quarter of 2003, and longer if further litigation based upon or related to the breach of the MOU, or fraud, is commenced, or if Genesis appeals. Management intends to file a motion for reimbursement of some of our expenses, including some of our legal fees, but there is no assurance that the Court will grant such motion.

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 the underwriters’ motion to dismiss and ordered that the case may proceed against issuers including against Silicon Image. At this time, we cannot accurately predict the outcome of this litigation; however, a proposed settlement has been negotiated that has yet to be reviewed and approved by the Court. In the event that the settlement is approved, we do not expect it to have a material effect on our results of operations or financial position. In the event that the settlement is not approved, 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. The plaintiff in this matter has filed an amended complaint in which Silicon Image, and the named officers, were dropped as defendants. We believe that the proposed settlement described above, if approved, would encompass the claims in this case. We believe that these claims were without merit and, if revived, and not subject to the settlement, we would defend this matter vigorously.

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.

9. Customer and Geographic Information

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

	Three Months Ended June 30				Six Months Ended June 30
	2003		2002		2003		2002

Taiwan	$	8,622	$	6,554	$	18,437	$	12,639
Japan	3,029		2,196		5,623		4,363
United States	6,567		5,654		13,341		10,181
Hong Kong	1,459		2,043		2,978		3,614
Korea	1,004		1,532		2,125		2,600
Other	3,651		1,293		6,504		2,962
	$	24,332	$	19,272	$	49,008	$	36,359

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

	Three Months Ended June 30				Six Months Ended June 30
	2003		2002		2003		2002

PC	$	7,136	$	11,759	$	15,929	$	23,504
Consumer Electronics	5,255		2,097		8,505		3,506
Storage IC	6,774		2,977		13,410		4,581
Storage Systems	580		1,389		1,623		3,236
Development, licensing and royalties	4,587		1,050		9,541		1,532
	$	24,332	$	19,272	$	49,008	$	36,359

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

For the three months ended June 30, 2003, two customers each generated 15% and 12% of our revenue. For the six months ended June 30, 2003, two customers each generated 13.7% and 11.0% of our revenue and, as of June 30, 2003, 4 customers each represented 12.8%, 9.9%, 8.4% and 8.2% of gross accounts receivable.

For the three months ended June 30, 2002, two customers each generated 14% and 11% of our revenue. For the six months ended June 30, 2002, two customers each generated 13% of our revenue and, as of June 30, 2002, three customers each represented 18%, 13% and 10% of gross accounts receivable.

10. Guarantees

Certain of our licensing agreements indemnify our customers for 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 a claim. However, there can be no assurance that such claims will not be filed in the future.

11. Acquisition

Transwarp Networks, Inc:

In April 2003, we acquired TransWarp Networks, Inc. (“TWN”), a development stage enterprise. Through this transaction, we acquired certain intellectual property and engineering expertise that will enable us to broaden our storage product offerings and to develop more advanced storage products. TWN was acquired by means of a merger, pursuant to which all outstanding shares of TWN’s capital stock were exchanged for shares of Silicon Image’s common stock. In addition, all outstanding options to purchase TWN common stock were converted into options to purchase Silicon Image’s common stock. In accordance with EITF Issue No. 98-3, “Determining Whether a Nonmonetary Transaction Involves Receipt of Productive Assets or of a Business”, this transaction was accounted for as an asset purchase.

The total purchase price was approximately $14.7 million, consisting of the issuance of approximately 2.5 million shares of Silicon Image common stock, valued at $11.4 million, 0.8 million shares of Silicon Image common stock issuable upon exercise of options, valued at $3.0 million, and transaction costs of $0.3 million. The purchase price was allocated as follows (in thousands):

Assembled workforce	$	520

Core technology	1,295

Developed technology	548

In-process research and development	5,482

Non-compete agreement	1,914

Net tangible assets acquired	93

Unearned compensation	4,819

Total	$	14,671

The assembled workforce will be amortized over 18 months. Developed technology and the non-compete agreement will be amortized over a period of three years (the length of the non-compete agreement), and core technology will be amortized over a period of four years. Unearned compensation will be amortized over the remaining employee vesting period, which ranges from 27 months to 57 months.

The value allocalted to in-process research and development (“IPR&D”) was calculated using established valuation techniques accepted in the high technology industry. These techniques give consideration to relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of new product introductions by us and by our competitors, individual product sales cycles, and the estimated lives of each of the product’s underlying technology. The value of IPR&D reflects the relative value and contribution of the acquired research and development. In determining the value assigned to IPR&D, we considered the R&D’s stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the project. A discount rate of 30% was used to determine the net present value of estimated cash flows for this project.

The values assigned to core technology and developed technology were based upon discounted cash flows related to the existing product’s projected income stream. Elements of the projected income stream includes revenue, cost of sales, SG&A expenses and R&D expenses. The discount rates used in the present value calculations range from 20% to 25% and were generally derived from a weighted average cost of capital, adjusted upward to reflect the additional risks inherent in the development life cycle. Such risks include the useful life of the technology, profitability levels of the technology, and the uncertainty of the technology advances that are known at the date of the acquisition.

Assembled workforce was valued based on the estimated costs to replace the existing staff, including recruiting, hiring and training costs for employees in all categories, and to fully deploy a work force of similar size and skill to the same level of productivity as the existing work force.

The value of the non-compete agreement was based on the Income Approach, which measures the difference between cash flows generated assuming the existence of the non-compete agreement (assuming no competition exists for the individuals covered by the non-compete) and the cash flows assuming competition. The resulting net cash flows were discounted using a discount rate of 25%.

12. Intangible Assets, net

Components of intangible assets are as follows (in thousands):

	June 30, 2003					December 31, 2002
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization

Intangible assets subject to amortization:
Acquired technology	$	1,843	$	(126	)	$	10,726	$	(10,726	)
Non-compete agreement	1,914		(160		)	—		—
Assembled workforce	520		(87		)	—		—
Patents and other	—		—			2,599		(2,599		)
	$	4,277	$	(373	)	$	13,325	$	(13,325	)

Intangible assets not subject to amortization:
Goodwill	$	13,021	$	—		$	13,021	$	—

Estimated amortization expense for our intangible assets is as follows for fiscal years ending December 31 (in thousands):

2003 *	$	1,118
2004	1,404
2005	1,144
2006	529
2007	82
	$	4,277

* Includes $373,000 of amortization for the first six months of 2003

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 33% of our revenue in the first six months of 2003, 58% of our revenue in 2002, and 65% of our revenue in the first six months of 2002.

Our PC products 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 accelerated DVI adoption, 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, has resulted in decreased 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, which should result in an expansion of the market suited to our product offering.

Products sold into the CE market generated 17% of our revenue in the first six months of 2003, 11% of our revenue in 2002, and 10% of our revenue in the first six months 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, such as DVI with HDCP, and industry standards, such as HDMI.

Semiconductor products sold into the storage market generated 27% of our revenue in the first six months of 2003, 15% of our revenue in 2002, and 13% of our revenue in the first six months 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, which would make our discrete devices unnecessary.

Sales of storage subsystems products generated 3% of our revenue in the first six months of 2003, 8% of our revenue in 2002, and 9% of our revenue in the first six months 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, we decided to design products for 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 approximately 15% to 20% 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 June 30, 2003, we had an accumulated deficit of $165 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.

On April 7, 2003, we issued approximately 2,501,000 shares of common stock in exchange for all outstanding shares of TransWarp Networks’ (TransWarp) capital stock, and converted all outstanding TransWarp options into options to purchase approximately 760,000 shares of our common stock. The purchase price for this acquisition was approximately $14.7 million. Approximately 392,000 shares of our issued common stock 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 116,000 shares of our common stock remained available for future issuance. This transaction has been accounted for as an asset purchase. We expensed $5.5 million of in-process research and development and recorded tangible and intangible assets of $4.3 million in connection with this transaction.

On July 15, 2003, the Federal District Court in Richmond, Virginia, upheld our interpretation of a previously agreed upon Memorandum of Understanding (MOU). On August 6, 2003, the Court entered a final judgment based on its July 15, 2003 ruling. Under the final judgement order, Genesis was ordered to make a substantial cash payment, and make royalty payments. To date we have not recognized any income or revenue associated with the matter, including amounts previously received for which payment was not honored. Under the settlement agreement, Genesis was granted a license for the right to use certain non-necessary patent claims referred to in the Digital Visual Interface (DVI) Adopters Agreement. In addition, upon Genesis’ becoming a signatory to the HDMI Adopters Agreement, Genesis will be granted a license for the right to use these claims as part of a High-Definition Multimedia Interface (HDMI) implementation. Genesis also was granted a license to expand use of certain DVI-related patent claims to the consumer electronics marketplace.

Outlook

We expect 2003 revenue to increase from the level achieved in 2002. We also expect to generate positive cash flow during the second half of 2003, independent of any settlement proceeds received in connection with the previously mentioned Genesis settlement.

Our expectation of overall revenue growth in 2003 is based on three assumptions. First, we have 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 and that revenue will grow quarter-over-quarter throughout the remainder of 2003. Second, 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. Third, we expect licensing and royalty revenue to reach approximately $18.0 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 begin receiving royalties from licenses entered into during 2001 and 2002. These factors will be somewhat offset by decreased revenue within the PC market, which can be attributed primarily to the integration of transmitters in graphics chips. Additionally, revenue from storage systems products is expected to decrease year-over-year due to our transition out of that product line.

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. Therefore, our discussion of gross margin percentage, R&D expense and SG&A expense expectations is on a non-GAAP basis.

Excluding non-cash charges for stock compensation expense, we expect our gross margin percentage in the third quarter of 2003 to increase 2% - 3% from the second 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.

Excluding non-cash charges for stock compensation expense, we expect the dollar amount of our R&D expense in the third quarter of 2003 to increase approximately 3%-5% from the second 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 in the third quarter of 2003 to increase approximately 2% from the second quarter of 2003, primarily as a result of increased commissions.

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 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 in any given period is highly dependent on changes in our stock price, it is not possible for us to reasonably estimate the amount of expense we will incur for a particular period.

During the second half of 2003, we expect to incur $0.7 million of expense for the amortization of intangible assets.

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.

Additionally, if our litigation against Genesis is completed during the quarter, and we receive a cash payment from Genesis due to us pursuant to the MOU, we will recognize the settlement funds amount as non-operating income and the amount of the payment attributable to royalties will be recognized as licensing revenues. 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 third quarter of 2003, and longer if further litigation based upon or related to the breach of the MOU, or fraud, is commenced, or if Genesis appeals.

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 such a warrant at June 30, 2003 would be $1.5 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 45% of our revenue in the second quarter of 2003, 40% of our revenue during 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 second quarter of 2003, 39% of our revenue was generated through distributors, compared to 36% during the first quarter of 2003 and 42% in 2002.

A significant portion of our revenue is generated from products sold overseas. Sales to customers in Asia, including distributors, generated 68% of our revenue in the second quarter of 2003, compared to 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.

Our lease and debt obligations as of June 30, 2003 are consistent with the information presented in our Form 10K for the fiscal year ended December 31, 2002.

Recent Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46, or FIN 46, “Consolidation of Variable Interest Entities—an interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We believe that the adoption of this standard will have no material effect on our consolidated financial statements.

In November 2002, the Emerging Issues Task Force reached a consensus on Issue 00-21(“EITF 00-21”), “Multiple-Deliverable Revenue Arrangements.” EITF 00-21 addresses how to account for arrangements that may involve the delivery or performance of multiple products, services and/or rights to use assets. The consensus mandates how to identify whether goods or services or both which are to be delivered separately in a bundled sales arrangement should be accounted for separately because they are “separate units of accounting.” The guidance can affect the timing of revenue recognition for such arrangements, even though it does not change rules governing the timing or patterns of revenue recognition of individual items accounted for separately. The final consensus will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. Additionally, companies will be permitted to apply the consensus guidance to all existing arrangements as the cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, “Accounting Changes.” We are assessing the potential effect of this guidance, but at this point we do not believe the adoption of EITF 00-21 will have a material effect on our consolidated financial statements.

Results of Operations for the Three and Six Months Ended June 30, 2003, Compared to Results of Operations for the Three and Six Months Ended June 30, 2002

Revenue. Revenue was $24.3 million for the three months ended June 30, 2003, compared to $19.3 million for the three months ended June 30, 2002, an increase of 26%. Revenue was $49.0 million for the six months ended June 30, 2003, compared to $36.4 million for the six months ended June 30, 2002, an increase of 35%. The $12.6 million increase in revenue during the six month periods is primarily due to increased licensing activity, which contributed an additional $8.0 million of revenue. 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 primarily to a higher level of integration of our technology by our customers, which eliminates the need for our discrete products, and decreased revenue from our storage subsystems products, which resulted from our decision to phase out this product line.

Cost of revenue. Cost of revenue consists primarily of costs incurred to manufacture, assemble, test and ship 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 $78,000 and $(544,000) for the three months ended June 30, 2003 and 2002, respectively, and $(57,000) and $379,000 for the six months ended June 30, 2003 and 2002, respectively. Including stock compensation expense, our cost of revenue and gross margin (revenue minus cost of revenue, as a percentage of revenue) would have been $10.7 million, or 55.9%, and $8.5 million, or 55.7%, for the three month periods ended June 30, 2003 and 2002, respectively and $21.8 million, or 55.6% of revenue and $18.0 million, or 50.6% of revenue, for the six months ended June 30, 2003 and 2002, respectively. Excluding stock compensation expense, gross margin increased to 55.4% for the six month period ended June 30, 2003, from 51.7% for the same period in 2002. This increase is attributable primarily to increased licensing revenue, which has no associated cost of sales, and, to a lesser extent, reduced sales of storage subsystems products which are lower margin products than our PC products. These factors were offset by decling ASP’s, yield and quality issues for certain new products, and increased sales of storage IC products, which have lower margins than other PC products.

Research and development. R&D consists primarily of compensation and related costs for employees, fees for independent contractors and development tools and materials. R&D expense was $9.4 million, or 38.5% of revenue, and $8.2 million, or 42.6% of revenue, for the three months ended June 30, 2003 and 2002, respectively. R&D expense was $18.2 million, or 37.1% of revenue, and $15.6 million, or 42.9% of revenue, for the six months ended June 30, 2003 and 2002, respectively.

The increase in absolute dollars in both periods 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 additional personnel, including personnel from Transwarp Networks. R&D excludes non-cash stock compensation expense (benefit) of $1.8 million and $(833,000) for the three months ended June 30, 2003 and 2002, respectively. Including stock compensation expense, R&D would have been $11.2 million and $7.4 million, or 45.9% and 38.3% of revenue, for the three months ended June 30, 2003 and 2002, respectively. R&D excludes $2.0 million and $5.1 million of non-cash stock compensation expense for the six months ended June 30, 2003 and 2002, respectively. Including stock compensation expense, R&D would have been $20.2 million and $20.7 million, or 41.2% and 56.9% of revenue, for the six months ended June 30, 2003 and 2002, respectively.

Selling, general and administrative. SG&A consists primarily of employee compensation and benefits, sales commissions, and marketing and promotional expenses. SG&A expense was $4.4 million, or 17.9% of revenue, and $4.6 million, or 23.7% of revenue, for the three months ended June 30, 2003 and 2002, respectively. SG&A expense was $8.7 million, or 17.7% of revenue, and $9.5 million, or 26.2% of revenue, for the six months ended June 30, 2003 and 2002, respectively. The decrease in absolute dollars in both periods was primarily due to a decrease in headcount. SG&A excludes non-cash stock compensation expense (benefit) of $334,000 and $(1.7) million for the three months ended June 30, 2003 and 2002, respectively. Including stock compensation expense, SG&A expense would have been $4.7 million and $2.9 million, or 19.3% and 14.9% of revenue, for the three months ended June 30, 2003 and 2002, respectively. SG&A excludes non-cash stock compensation expense (benefit) of $(20,000) and $2.0 million for the six months ended June 30, 2003 and 2002, respectively. Including stock compensation expense, SG&A expense would have been $8.6 million and $11.5 million, or 17.6% and 31.7% of revenue, for the six months ended June 30, 2003 and 2002, respectively.

Stock compensation expense (benefit). Stock compensation expense (benefit) was $2.3 million, or 9.3% of revenue, and $(3.1) million, or (15.9)% of revenue, for the three months ended June 30, 2003 and 2002, respectively. Stock compensation expense was $1.9 million, or 3.9% of revenue, and $7.4 million, or 20.3% of revenue, for the six months ended June 30, 2003 and 2002, respectively. The increase in expense during the three month periods was due primarily to higher levels of expense associated with repriced options, as our stock price was higher as of June 30, 2003 than it was as of June 30, 2002. The decrease in expense during the six month periods can be attributed primarily to our stock option repricing programs, which generated a significant amount of expense in the first quarter of 2002 due to a relatively high stock price as of March 31, 2002, which was also the first time the repriced options were in-the-money.

The following table summarizes the components of our stock compensation expense (benefit) for the three and six month periods ended June 30, 2003 and 2002 (in thousands):

	Three Months Ended June 30					Six Months Ended June 30
	2003		2002			2003			2002

Options granted to employees	$	58	$	244		$	280		$	681
Options granted to non-employees	425		625			784			1,226
Option repricings	527		(5,171		)	(831		)	2,761
Options assumed in connection with acquisitions	1,243		1,236			1,658			2,717
Stock compensation expense (benefit)	$	2,253	$	(3,066	)	$	1,891		$	7,385

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

Amortization of intangible assets. For the three months ended June 30, 2003, we recorded $373,000 of expense for the amortization of intangible assets recorded in connection with our acquisition of Transwarp Networks’ assets. This compares to expense of $857,000 for the three months ended June 30, 2002. For the six months ended June 30, 2003 and 2002, we recorded amortization expense of $373,000 and $1.8 million, respectively. The decrease for both periods is attributable to a lower amount of amortizable intangibles.

Patent defense and acquisition integration costs. Patent defense and acquisition integration costs were $583,000 and $1.8 million for the three and six months ended June 30, 2003, compared to $683,000 and $1.4 million for the three and six months ended June 30, 2002. Patent defense costs increased in 2003 due to increased activity in connection with the patent infringement lawsuit we filed against Genesis Microchip in April 2001. Acquisition integration costs represent costs incurred to integrate CMD and SCL.

Restructuring. During the second quarter of 2002, we implemented a third workforce reduction, eliminating 14 positions, in connection with the program we began in the third quarter of 2001. Positions were eliminated from all functional areas - operations, R&D and SG&A. This reduction resulted primarily from our decision to transition to a licensing model for our storage subsystem board products, whereby instead of developing, manufacturing and selling board products to facilitate or accelerate the use of our storage semiconductor products, we will develop and license board designs in exchange for license fees, royalties and the use of our semiconductor products. In connection with this workforce reduction, we recorded restructuring expense in the second quarter of 2002 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. The second quarter restructuring expense also included a net benefit of $97,000, resulting from a change in estimate of the amount of space that will be subleased and the lease rate to be obtained. In addition, we reversed $302,000 of unearned compensation, a component of stockholders’ equity, for unvested stock options that were cancelled in connection with employee terminations.

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-downs in 2001 and 2002 were determined based on the estimated fair value of assets, primarily computer hardware and software, that would no longer be utilized after the employees’ termination date.

	Severance and Benefits			Leased Facilities			Fixed Assets			Total
2001provision	$	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	(399		)	(323		)	—			(722		)
Non-cash activity	(646		)	—			—			(646		)
Balance as of June 30, 2003	$	79		$	2,275		$	—		$	2,354

Impairment of goodwill and intangible assets. In the second quarter of 2002, we decided to transition to a licensing model for our storage subsystem board products, whereby instead of developing, manufacturing and selling board products to facilitate or accelerate the use of our storage semiconductor products, we will develop and license board designs in exchange for license fees, royalties and the use of our semiconductor products. This decision resulted in a decrease to our estimate of future cash flows from these products, which in turn resulted in a $5.2 million impairment of goodwill and intangible assets acquired in connection with our acquisition of CMD.

In-process research and development (IPR&D). During the quarter ended June 30, 2003, we completed the acquisition of the assets of Transwarp Networks, Inc. (“TWN”) and recorded a one-time expense of $5.5 million for in-process research and development. As of the acquisition date, there was one identified development project that met the necessary criteria - Polaris. The value of this project was determined by estimating the future cash flows from the time it was expected to be commercially feasible, discounting the net cash flows to present value, and applying a percentage of completion to the calculated values. The net cash flows from the identified project were based on estimates of revenue, cost of revenue, research and development expenses, selling, general and administrative expenses, and applicable income taxes. Revenue for Polaris is expected to commence in 2004 and extend through 2007. We based our revenue projections on estimates of market size and growth, expected trends in technology and the expected timing of new product introductions by our competitors and us. The discount rate used for this project was 30%, which we believe is appropriate based on the risk associated with technology that is not yet commercially feasible. The percentage of completion for this project was based on research and development expenses incurred immediately prior to the acquisition as a percentage of the total estimated research and development expenses to bring this project to technological feasibility. As of the date of the acquisition, we estimated that Polaris was 17% complete, with total projected costs of approximately $3,250,000.

Given the uncertainties of the commercialization process, we cannot assure you that deviations from our estimates will not occur. We believe there is a reasonable chance of realizing the economic return expected from the acquired in-process technology. However, there is a risk associated with the realization of benefits related to commercialization of an in-process project due to rapidly changing customer needs, complexity of technology and growing competitive pressures. Therefore, we cannot assure you that any project will achieve commercial success. Failure to successfully commercialize an in-process project would result in the loss of the expected economic return inherent in the fair value allocation.

Gain on escrow settlement, net. During the quarter ended March 31, 2003, we recognized a net gain of $4.6 million associated with settlement of an escrow claim against the selling shareholders of a company we acquired in 2001.

Interest Income and other, net. Net interest income and other decreased to $67,000 for the three months ended June 30, 2003, from $163,000 for the three months ended June 30, 2002. Net interest income and other decreased to $176,000 for the six months ended June 30, 2003, from $433,000 for the six months ended June 30, 2002. The decrease, in both periods, is primarily due to lower interest rates and, to a lesser extent, a decrease in our cash and investment balances.

Provision for income taxes. We did not record a provision for income taxes in the three or six months ended June 30, 2003 or June 30, 2002, as we did not generate book or taxable income during those periods.

At June 30, 2003, we had a net operating loss carryforward for federal income tax purposes of approximately $70.0 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.

Liquidity and Capital Resources

At June 30, 2003, we had $29.9 million of working capital and $31.0 million of cash, cash equivalents and short-term investments.

Operating activities used $5.6 million of cash for the six months ended June 30, 2003, and $5.3 million of cash during the six months ended June 30, 2002. During the six months ended June 30, 2003, net income, excluding depreciation, stock compensation expense, amortization of intangible assets, non-cash restructuring charges, non-cash gains on escrow settlement, and the non-cash charge relating to in-process research and development, was $0.5 million. Increases in accounts receivable, inventories, and decreases in accounts payable and accrued liabilities, used $7.2 million of cash, which was partially offset by $1.3 million of cash provided by decreased prepaid expenses and other assets. During the six months ended June 30, 2002, net loss, excluding depreciation, stock compensation expense, amortization and impairment of intangible assets, and non-cash restructuring charges, was $7.0 million, which accounts for most of the cash used in operating activities during this period. Increases in accounts payable, accrued liabilities and deferred margin provided $3.6 million of cash, offset somewhat by a $1.7 million increase in accounts receivable.

We generated $1.2 million of cash from investing activities during the six months ended June 30, 2003, and $329,000 during the six months ended June 30, 2002. The primary source of cash in both periods was net proceeds from purchases and sales of short-term investments of $3.7 million in 2003 and $2.5 million in 2002, partially offset by capital expenditures of $2.6 million in 2003 and $2.2 million in 2002.

Financing activities provided $3.4 million of cash during the six months ended June 30, 2003, and $4.2 million of cash during the six months ended June 30, 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 lease and other obligations.

Our contractual obligations at June 30, 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.

Based on our expected cash usage, we believe our existing cash and short-term investment balance is sufficient to meet our capital and operating requirements for at least the next 12 months. Operating and capital requirements depend on many factors, including the levels at which we generate revenue and maintain margins, 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.

RISK FACTORS

You should carefully consider the following risk factors, together with all other information contained or incorporated by reference in this prospectus, 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 net losses of $40.1 million and $76.1 million for the years ended December 31, 2002 and 2001, respectively, and a net loss of $5.4 million for the six months ended June 30, 2003. 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 thatoffer 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, and the potential for alliances, combinations, mergers and acquisitions among our competitors;

• 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 for any given period, the timing of which is not always predictable and is especially susceptible to delay beyond the period in which completion is 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 automated 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 others 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 completion is 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, customer commercialization of the licensed technology, 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. Licensing that occurs in the course of actual or contemplated litigation is subject to risk that the adversarial nature of the transaction will induce non-compliance or non-payment. 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 Technology and Silicon Communication Lab. 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 regarding 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 are shipping products or have 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. Current or potential customers, including our own licensees, may also develop solutions that could compete with us, directly or indirectly, such as 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 High-bandwidth Digital Content Protection (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 products face 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 Host Bust Adaptors (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 compete against Intel and other motherboard chip-set makers that have integrated serial ATA functionality into their chipsets.

Our parallel ATA products compete with similar products from 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 (for example, Genesis and Pixelworks announced, and then terminated, such a merger), 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 consumer electronics products 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 transition minimized differential signaling (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 in the PC market 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 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 presence 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 Digital Display Working Group (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 for our products;

• We believe that Intel has the power to drive adoption of DVI and serial ATA by making them widely available in its chip sets and motherboards, which could 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 some of 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 PC 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 Original Equipment Manufacturer (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 second 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 six months of 2003, shipments to World Peace International, an Asian distributor, generated 14% of our revenue, and licensing revenues and royalties from Sunplus accounted for 11% 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 selects 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 fluctuates 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 37% of our revenue in the first six months 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 six months 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. 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 micron 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 on Taiwan Semiconductor Manufacturing Company (TSMC), an outside foundry, to produce the vast majority all of our semiconductor products. We also rely on Kawasaki, UMC and Atmel, for outside foundry services, and 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 subcontractors. We do not have a long-term supply agreement with our subcontractors, 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 subcontractors 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 six months ended June 30, 2003 and year ended December 31, 2002 72% 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. In addition, practicality also limits our assertion of intellectual property rights. Patent litigation is expensive and its results are often unpredictable. Assertion of intellectual property rights often results in counterclaims for perceived violations of the defendant’s intellectual property rights and/or antitrust claims. Certain parties after receipt of an assertion of infringement will cut off all commercial relationships with the party making the assertion, thus making assertions against suppliers, customers, and key business partners unwise. Accordingly, if we forgo making such claims, we may risk creating legal and equitable defenses for an infringer.

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 DDWG, 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 DDWG 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; however, a proposed settlement has been negotiated that has yet to be reviewed and approved by the Court. In the event that the settlement is not approved, 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, were 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. The plaintiff in this matter has filed an amended complaint in which Silicon Image, and the named officers, were dropped as defendants. We believe that the settlement described above, if approved, would encompass the claims in this case. We believe that these claims were without merit and, if revived, and not subject to the settlement, we intend to defend vigorously against them. However, these claims and any others 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 December 2002, the parties entered into a memorandum of understanding (MOU) to settle the case. In January, the parties presented different interpretations of the MOU to the Court. On July 15, 2003, the Court granted our motion to interpret the MOU in the manner we requested, and ruled that Genesis had engaged in efforts to avoid its obligations under the MOU. On August 6, 2003, the Court entered a judgment based on its July 15, 2003 ruling.

There can be no assurance that Genesis will not undertake further efforts to avoid its obligations under the MOU, and that further proceedings (lawsuits, contempt citations, etc.) against Genesis, and certain of its executives, its counsel, its former merger partner, Pixelworks, and others may not be required to obtain compliance or to obtain redress for non-compliance. There can be no assurance that Genesis will not appeal, and that further delays or noncompliance may be required. The Court’s ruling of July 15, 2003 also indicated that Genesis may have violated certain provisions of the MOU, including disclosure of confidential information to Pixelworks. On August 5, 2003, Genesis and Pixelworks issued a joint press release terminating their proposed merger. In that press release, Genesis and Pixelworks jointly stated that "Pixelworks has confirmed that prior to signing the merger agreement, it reveiwed the Memorandum of Understanding that purported to settle the lawsuit between Genesis Microchip and Silicon Image, Inc." The effects of these disclosures have not been fully analyzed, and may result in further proceedings. While this litigation, including any appeal or derivative proceedings, 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 prevail in this litigation, uncertainties regarding the outcome prior to that time may reduce demand for our products. In addition, if the MOU is unappealed or upheld on appeal, future disputes may occur, including those regarding whether and what intellectual property licenses were granted and the scope of any such licenses and the royalty rates and payment terms for such licenses, whether the MOU was breached, whether consent was fraudulently obtained, and whether a merger partner may succeed to the rights and/or the obligations under the MOU. 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 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 and second quarters 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 both the third and fourth quarters 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 six months ended June 30, 2003, customers and distributors located in Taiwan generated 38% of our revenue and customers and distributors located in Japan generated 11% of our revenue. For the six months ended June 30, 2002, customers and distributors located in Taiwan generated 35% of our revenue and customers and distributors located in Japan generated 12% 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.

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 and currently has an occupation force there and in Afghanistan. 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 effect 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) We have 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 (as defined in Exchange Act Rule 13a-15 and 15(d)-15). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report 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 has been no change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

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 in 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 December 2002, the parties entered into a memorandum of understanding (MOU) to settle the case. In January, the parties presented different interpretations of the MOU to the Court. On July 15, 2003, the Court granted our motion to interpret the MOU in the manner we requested, and ruled that Genesis had engaged in efforts to avoid its obligations under the MOU. On August 6, 2003, the Court entered a final judgment based on its July 15, 2003 ruling. Under the final judgment order, Genesis was ordered to make a substantial cash payment, and to make royalty payments. To date, we have not recognized any income or revenue associated with the matter, including amounts previously received for which payment was not honored. Due to the continuing and contentious nature of this litigation, we will not record any income or revenue related to this matter until litigation is complete. Genesis may appeal. Management intends to prosecute our position vigorously until this matter is resolved. Through June 30, 2003, we have spent approximately $10.0 million on this matter and expect to continue to incur significant costs through at least the third quarter of 2003, and longer if further litigation based upon or related to the breach of the MOU, or fraud, is commenced, or if Genesis appeals. Management intends to file a motion for reimbursement of some of our expenses, including some of our legal fees, but there is no assurance that the Court will grant such motion.

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 accurately predict the outcome of this litigation; however, a proposed settlement has been negotiated that has yet to be reviewed and approved by the Court. In the event that the settlement is approved, we do not expect it to have a

material effect on our results or financial position. In the event that the settlement is not approved, 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. The plaintiff in this matter has filed an amended complaint in which Silicon Image, and the named officers, were dropped as defendants. We believe that the proposed settlement described above, if approved, would encompass the claims in this case. We believe that these claims are without merit and, if revived, and not subject to the settlement, we would defend this matter vigorously.

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 third quarter of 2003, and longer if further litigation based upon or related to the breach of the MOU, or fraud, is commenced, or if Genesis appeals.

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 June 30, 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

We held our 2003 Annual Meeting of Stockholders on May 20, 2003. The first matter voted upon at the meeting was the election of two Class I directors to serve until the 2006 Annual Meeting of Stockholders. At the meeting, Keith McAuliffe and Douglas Spreng were elected as Class I directors by the following votes:

Name	Shares For	Shares Against	Shares Abstaining	Shares Withheld	Broker Non-Votes
Keith McAuliffe	53,354,614	—	—	544,880	—
Douglas Spreng	51,776,581	—	—	2,122,913	—

Our board of directors consists of six members and is divided into three classes, with each class consisting of two members and each class serving staggered three-year terms. The term of the Class II directors, who are currently David Hodges and Ronald Schmidt, will expire at the 2004 Annual Meeting of Stockholders, and the term of the Class III directors, who are currently David Courtney, David Lee and Andrew Rappaport, will expire a the 2005 Annual Meeting of Stockholders.

The second matter voted upon at the meeting was the amendments to our 1999 Equity Incentive Plan to increase the size of the automatic annual option grant to directors for board service from 20,000 to 30,000 shares, and to extend the automatic annual option grant to directors for committee service from only the audit and compensation committees to any standing committee of the board. At the meeting, these amendments to the 1999 Equity Incentive Plan were approved by the following vote:

Shares For		Shares Against		Shares Abstaining		Shares Withheld		Broker Non-Votes
36,591,033		17,244,252		64,209		—		—

The third matter voted upon at the meeting was the ratification of the appointment of PricewaterhouseCoopers LLP as independent accountants of Silicon Image for the fiscal year ending December 31, 2003. At the meeting, the appointment of PricewaterhouseCoopers LLP as independent accountants was ratified by the following vote:

Shares For		Shares Against		Shares Abstaining		Shares Withheld		Broker Non-Votes
53,513,389		354,574		31,531		—		—

Item 5. Other Information

Not applicable.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit Number		Exhibit Title
31.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

On April 21, 2003, we filed a current report on Form 8-K to report under Item 2 that we 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, conference call script and transcript for the first quarter of 2003.

On May 29, 2003, we filed a current report on Form 8-K to report under Item 5 that David Lee, our Chief Executive Officer and Chairman of the Board, entered into a Rule 10b5-1 sales plan with Deutsche Bank Alex. Brown.

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: August 14, 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)

EXHIBIT INDEX

Exhibit Number		Exhibit Title
31.1		Certification by pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification by pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification by pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification by pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.