10-K 1 form_10-k.htm FORM 10-K form_10-k.htm
 
 

 

 


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

Form 10-K

     
(Mark One)
 
     
þ
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
        For the fiscal year ended December 31, 2011
 
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 of organization)
 
 
(I.R.S. Employer Identification Number)
     
 
1140 East Arques Avenue
Sunnyvale, CA 94085
 (Address of principal executive offices)
(Zip Code)

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

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

Securities registered pursuant to section 12(g) of the Act:
None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o  No þ
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yeso Noþ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yesþ Noo
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o
 
Accelerated filer þ
 
Non-accelerated filer o
 
Smaller reporting company o
 
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).oYes Noþ

The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant was approximately $521,431,801 as of the last business day of Registrant’s most recently completed second fiscal quarter, based upon the closing sale price on the Nasdaq National Market reported on such date.

As of February 23, 2012, there were 83,070,126 shares of the Registrant’s Common Stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Definitive Proxy Statement for the 2012 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission no later than 120 days after the end of the fiscal year covered by this report, are incorporated by reference in Part III of this Form 10-K.
 
 
 



 
 

 

 
   
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Business                                                                                                                                        
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Risk Factors                                                                                                                                       
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Unresolved Staff Comments                                                                                                  
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Properties                                                                                                                                        
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Mine Safety Disclosures                                                                                                                                        
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Signatures                                                                                                                                                         
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This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities 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 Annual Report on Form 10-K entitled “Factors Affecting Future Results,” that may cause actual results to differ materially from those discussed in, or implied by, such forward-looking statements. Forward-looking statements within this Annual Report on Form 10-K are identified by words such as “believes,” “anticipates,” “expects,” “intends,” “may,” “will”, “can”, “should”, “could”, “estimate”, based on”, “intended”, “would”, “projected”, “forecasted” 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 updates or revisions to these forward-looking statements that may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-K with the Securities and Exchange Commission (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 us 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.
 
 
 

 
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Item 1.  Business

Company Background
 
Since our founding in 1995, Silicon Image, Inc. has been a leader in digital connectivity and interface solutions and standards, playing a key role in the global transition to high-definition (HD) equipment and interfaces. Our history is a story of innovation, pioneering new technologies for the consumer electronics and personal computing markets and more recently the large and expanding global mobile market.
 
Silicon Image is a leading provider of wireless and wired connectivity solutions that enable the reliable distribution and presentation of high-definition (HD) content for mobile, consumer electronics (CE) and personal computer (PC) markets. We deliver our technology via semiconductor and intellectual property (IP) products and services that are compliant with global industry standards and feature market leading Silicon Image innovations such as InstaPort™ and InstaPrevue™. Silicon Image’s products are deployed by the world’s leading electronics manufacturers in devices such as smart phones, tablets, digital televisions (DTVs), Blu-ray Disc™ players, audio-video receivers, as well as desktop and notebook PCs. Silicon Image’s current growth is being driven by its mobile solutions supporting the latest mobile HD video connectivity standard, Mobile High-Definition Link (MHL™).  Silicon Image has also driven the creation of the highly successful High-Definition Multimedia Interface (HDMI®) and Digital Visual Interface (DVI™) industry standards.  We have also established the Serial Port Memory Technology (SPMT™), a memory interface standard for mobile devices and are actively involved with the standard for 60GHz wireless HD video/audio – WirelessHD™. Via its wholly-owned subsidiary, Silicon Image offers manufacturers comprehensive product interoperability and standards compliance testing services from Simplay Labs LLC. 
 
We are a Delaware corporation headquartered in Sunnyvale, California. Our Internet website address is www.siliconimage.com.
 
We are not including the information contained on our website as a part of, or incorporating it by reference into, the Annual Report on Form 10-K. We make available through our Internet website - free of charge - our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable, after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.
 
Mission and Business Strategy
 
Our mission is to be the leader in advanced HD connectivity solutions.
 
We are committed to delivering “HD Connectivity That Just Works.”  We believe in creating innovative solutions that allow consumers and businesses to seamlessly connect their HD devices anywhere and anytime.  Our business strategy is to define and deliver new standards and technologies enabling advanced audio and video connectivity and interoperability among HD devices and to grow the available markets for our products and IP solutions through the development, introduction and promotion of market leading connectivity products based on those industry standards but also include Silicon Image innovations that are of value to our customers.  This “standards plus” strategy involves leveraging our unique ability to create innovative connectivity solutions and to promote the adoption of these solutions through the creation and evolution of new standards and new markets.  We look to continually evolve the standards and further develop Silicon Image innovations.
 
Given our strategy, we believe that continual investment in research and development and marketing activities is critical to our success.  These investments are targeted at and highlight our commitment to advancing connectivity through facilitating the broad market adoption of industry standards and the interoperability of our solutions throughout our target markets.  We have demonstrated our ability to execute successfully to this strategy through the creation of the DVI and HDMI standards and more recently with the growing MHL standard for mobile products.  As we continue to expand on our connectivity roadmap, our strategy also includes making strategic investments and opportunistic acquisitions of both businesses and technologies to broaden our connectivity product offerings and to expand or create opportunities within our existing markets or new markets, respectively.  We are committed to executing on our strategy and delivering on our mission.
 
 
 

 
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Markets
 
We sell our products and services primarily into three markets: mobile, CE and PC. While our CE business continued to be our largest revenue contributor in 2011, our mobile business was our primary growth driver, increasing to approximately 30% of our total revenue by the end of the year. We believe our mobile business will be our largest revenue contributor in 2012.
 
Mobile Market - The consumption of HD content has evolved from being solely an in-home entertainment and personal experience to one that is increasingly “on-the-go.”  A growing number of mobile devices now support the storage and viewing of HD video content, offering consumers new, convenient ways to share and experience mobile HD content, even if the viewing experience is limited due to the small form factor.  Smartphones have become more entertaining to use as well as more practical for business, and are taking a central role in how consumers stay connected and productive. Tablets have been introduced with mobile broadband access that can browse the Internet anywhere there is cellular reception, and cameras are now built into many portable gaming devices.  According to market research firm Parks Associates, the number of smartphone users is expected to quadruple, exceeding 1 billion worldwide by 2014.  Therefore the mobile market represents our fastest growing market.  In 2011, we shipped over 50 million mobile products and we expect to ship over 100 million mobile products in 2012.
 
CE Market – From DTVs to cable boxes to Blu-ray Disc and DVD players, gaming consoles and DVRs, set boxes bring in the content that fuels the home entertainment experience. Since its introduction in 2003, HDMI technology has become the de-facto worldwide standard for the transmission of HD content.  The HDMI Consortium has over 1100 licensed HMDI adopters that shipped over 600 million HDMI enabled devices in 2011.  The CE market is undergoing a significant shift as DTVs begin to transition to 4Kx2K resolutions and built in internet access becomes a major competitive threat to legacy source devices.  While our technology serves the entire CE market through our participation in the HDMI standard, our product focus continues to be in the DTV and AVR space where we maintain a strong share of the market as we sell into 9 of the top 10 Tier one DTV manufactures.
 
PC Market – The PC market continues to grow and there is an anticipated uptick in PC devices with the introduction of the Ultrabooks.  More and more there is a blurring of the line between mobile and PC devices.  In either case, these consumers of these devices demand the highest quality resolution and with the integration of our DVI and HDMI functionality into the various PC devices, our focus in this market includes MHL solutions for high end monitors as well as our 60Ghz wireless solutions for the PC and gaming industries.
 
In the markets we serve, we provide advanced connectivity solutions that enhance the consumer experience.  In the mobile space, our MHL products provide low pin count, connector agnostic solutions delivering full HD video and audio connectivity while enabling the continuous charging of the connected mobile device from the display.  Our CE solutions provide fast switching and live picture in picture video previewing of each connected device, making switching between source devices simple, intuitive and fast. Our 60 GHz, WirelessHD compliant, solution provides the closest cable-like experience possible without wires, allowing extreme PC gamers to interact with a big screen display wirelessly and with no latency. The markets we serve will continue to evolve and connectivity is certain to be a key in enabling devices to talk to one another, whether it is a mobile device, a CE device or a PC device.
 
Our IP revenues and product revenues over the past three years from the mobile, CE and PC markets were as follows (in thousands):
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Mobile
  $ 65,789     $ 10,525     $ 2,683  
Consumer Electronics
    87,922       118,192       97,502  
Personal Computers
    20,523       24,124       22,483  
Licensing
    46,775       38,506       27,921  
    $ 221,009     $ 191,347     $ 150,589  
 

 
 
 
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Previously, we reported our product revenue under the following three market categories: 1) CE, 2) PC and 3) Storage. As a result of this change, our mobile category now incorporates all mobile-related activities, including both mobile HDMI and MHL.  Our CE product category now consists of the DTV and Home Theater markets.  PC consists of all PC, Storage and related activities.

Standards Activity
 
We have been directly involved and instrumental in the following standards efforts:
 
 Mobile High-Definition Link (MHL™) Consortium
 
In 2010, Nokia, Samsung, Silicon Image, Sony, and Toshiba formed the MHL Consortium to develop technology and create an industry standard for an audio/video interface for mobile devices such as smartphones and tablets.  MHL technology is a low pin count, connector agnostic HD audio and video serial link specifically defined for connecting mobile devices to HD displays. MHL technology is based on our proprietary Transition-Minimized Differential Signaling (TMDS®), the same technology used in the DVI and HDMI specifications, while only requiring a single TMDS data pair to transmit video to MHL enabled DTVs at resolutions up to 1080p.  As a result, MHL technology requires only 5 pins, making it compatible with existing low pin-count connectors in mobile devices. Reduced pin-count connectors are critical in mobile devices given the greatly limited connector space compared to standard consumer electronic devices such as Blu-Ray players and set top boxes.  MHL technology also enables the charging of the mobile device when connected to a display, preserving the device’s battery life. Silicon Image shipped over 50 million MHL products in 2011.  In addition, 92 companies around the world have become MHL adopters.
 
MHL, LLC, our wholly-owned subsidiary, is the agent for overseeing and administering the adoption, licensing, and promotion of the MHL Specification.  
 
High-Definition Multimedia Interface (HDMI) Consortium
 
In 2002, we formed a consortium with Sony, Matsushita Electric Industrial Co. (Panasonic), Philips, Thomson (Technicolor), Hitachi and Toshiba to develop the HDMI specification, a next-generation digital interface for consumer electronics. The HDMI specification is based on our TMDS technology, the same technology underlying DVI, the predecessor to the HDMI specification, which we also developed.   The HDMI specification combines uncompressed high-definition video, multi-channel audio, and data into a single digital interface to provide crystal-clear digital quality over a single cable. HDMI technology is fully backward compatible with PCs, displays and consumer electronics devices incorporating the DVI standard.   As an HDMI founder, we have actively participated in the evolution of the HDMI specification, and we expect to continue our involvement in this and in other digital interface connectivity standards.
 
 We believe that our leadership in the market for HDMI-enabled products is due to our ability to introduce HDMI “standards plus” semiconductor and IP solutions to our customers and to continue to promote innovation within the standard. 
 
 For CE manufacturers, HDMI technology is a low-cost, standardized means of interconnecting CE devices that enables them to provide customers with feature-rich products delivering a true home theater entertainment experience. For PC and monitor manufacturers, HDMI technology enables a PC to connect to DTVs and monitors at HD quality levels. The market research firm In-Stat estimates that over 684 million HDMI-enabled products shipped worldwide in 2011, contributing to an installed base of over 2.4 billion HDMI enabled products. As of December 31, 2011, 1166 companies around the world are HDMI adopters representing growth by more than 12% and further strengthening the specification’s position as the worldwide standard for high-definition digital connectivity. According to market researcher In-Stat, the HDMI specification has become widely adopted and has moved from an emerging standard to a prevalent connectivity standard used in many consumer applications.
 
In November 2011, the HDMI Forum was established to foster broader industry participation in the development of future versions of the HDMI specification and providing for HDMI technology to extend into an increasingly wider array of devices, applications and industries, including PC, automotive, hospitality, IT, visual signage, airlines and others. We believe the HDMI Forum will move the HDMI specification to the next level.
 
HDMI Licensing, LLC, our wholly owned subsidiary, is the agent responsible for licensing the HDMI specification, promoting the HDMI standard and educating Adopters, retailers and consumers on the benefits of the HDMI specification.  
 
 
 

 
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WirelessHD™ Consortium
 
In 2007, the WirelessHD Consortium was formed by Broadcom, Intel, LG Electronics, NEC, Panasonic, Philips Electronics, Samsung, SiBEAM (acquired by Silicon Image in May 2011), Sony and Toshiba to create the industry’s first technical specification for multi-gigabit-per-second wireless transmission of high quality, lossless  high-definition (HD) video, multi-channel audio, and data for consumer electronics, PC and portable products. The WirelessHD specification, available since January 2008, has been architected and optimized for wireless display connectivity, achieving in its first generation implementation high-speed rates up to 10 Gbps at ten meters for the consumer electronics, personal computing and portable device products. Its core technology, based on the 60 GHz millimeter wave frequency band, promotes theoretical data rates as high as 28 Gbps, permitting it to scale to higher resolutions, color depth, and range.
 
Serial Port Memory Technology (SPMT™) Consortium
 
In 2009, The SPMT™ Consortium was established by Silicon Image, ARM, Hynix Semiconductor, LG Electronics, and Samsung Electronics, with Marvell joining the consortium in 2010. SPMT is a first-of-its-kind standard for dynamic random access memory (DRAM). SPMT technology is designed to enable extended battery life, bandwidth flexibility, reduced pin count and lower power demand for mobile and portable devices.  Demand by mobile service providers for solutions enabling more data-intensive, media-rich capabilities drove the formation of the SPMT Consortium.  
 
SPMT, LLC, our wholly-owned subsidiary, is the entity responsible for licensing the SPMT memory interface specification.
 
 Digital Visual Interface (DVI)
 
In 1998, together with Intel, Compaq, IBM, Hewlett-Packard, NEC and Fujitsu, Silicon Image announced the formation of the Digital Display Working Group (DDWG) and in 1999, published the DVI 1.0 specification. Today, in many applications, DVI is being replaced by the more feature-rich HDMI interface or DisplayPort, a digital display interface standard promoted by the Video Electronics Standards Association (VESA).
 
 Serial Advanced Technology Attachment (SATA)
 
 We have been a contributor to the SATA standard and a supplier of discrete SATA solutions including controllers, storage processors, port multipliers and bridges. Based on serial signaling technology, the SATA standard specifies a computer bus technology for connecting hard disk drives and other devices and was formed by Intel, Dell, Maxtor, Seagate and Vitesse in 1999.
 
Products
 
Mobile
 
 HDMI and MHL Transmitters.  Our mobile HDMI and MHL transmitter products have been optimized for small-form factor and low-power and are targeted for mobile devices, such as smartphones, and tablets.  Mobile HDMI transmitters convert digital video into the HDMI format.  MHL transmitters convert digital video into the MHL format enabling mobile devices to connect to DTVs and displays with MHL inputs, or alternatively, to connect to DTVs and displays with HDMI inputs via an MHL-to-HDMI adapter.   In 2011, we introduced the SiI8332, SiI8336, and SiI8334 MHL transmitters targeted for mobile devices, including smartphones and tablets.  The SiI8332 and SiI8336 feature MIPI DSI input and integrate a high-speed switch to reduce system bill-of-materials (BOM) cost.  The SiI8334 features an HDMI input, and integrates a high-speed switch.
 
MHL-to-HDMI Bridges.  Our MHL-to-HDMI bridge products are targeted for docking stations and adapters, connecting new MHL mobile products with existing HDMI-enabled DTVs and displays.  The SiI9292 is an MHL-to-HDMI bridge which is integral to the design of low-power, MHL-to-HDMI accessory devices such as docking stations, converters and adapters, enabling HD video and audio connectivity between MHL-ready mobile devices and DTVs and displays with legacy HDMI inputs.
 
 
 

 
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CE (DTV & Home Theater)
 
 HDMI Port Processors.  Our HDMI port processors are targeted for CE products, such as DTVs, AV receivers, sound bars and Home-Theater-In-a-Box (HTIB).  Our port processors support the latest version of the HDMI specification and can quickly switch between up to six HDMI inputs using our InstaPort technology.  With InstaPort technology, switching time between various HDMI devices attached to a DTV is reduced from approximately 5 seconds to approximately 1 second.    In 2011, we introduced our new InstaPrevue™ technology. InstaPrevue™ technology makes TVs and AV receivers easier to use by taking the guesswork out of switching between HDMI sources. Instead of having to remember what is playing on the connected devices, InstaPrevue provides a live picture-in-picture video preview of each connected device, making it simple and intuitive to switch between the cable box, the disc player, the gaming console, and any other HDMI-connected source. In 2011, we introduced four new DTV port processors, the SiI9587-3, SiI9589-3, SiI9573, and SiI9575.  The SiI9587-3 and SiI9589-3 port processors – targeted at DTV applications - include up to five 300MHz HDMI inputs, feature InstaPort S – Silicon Image’s single-second HDMI port switching technology,  integrate HDMI 1.4 Audio Return Channel, and seamlessly interface with MHL-enabled mobile devices such as smartphones and tablets.  The SiI9573 and SiI9575 port processors – targeted at home theater applications – include up to six 300MHz HDMI inputs, feature InstaPrevue and InstaPort S for fast visual switching and picture-in-picture capability, include an on-screen display (OSD) engine, provide full Matrix Switching, and integrate dual MHL inputs to support MHL-enabled mobile devices and accessories.
 
HDMI Transmitters. Our HDMI transmitter products are targeted for CE products, such as Blu-Ray players, STBs,  and AV receivers (AVRs). HDMI transmitters convert digital video and audio into HDMI format enabling products to connect to DTVs and other display that have HDMI inputs.  In 2011, we introduced a new HDMI transmitter, the SiI9136-3, targeted at home theater applications, such as Blu-ray players and AVRs. The SiI9136-3 converts digital video into HDMI 1.4 format with speeds up to 300MHz, enabling support for 4Kx2K, 1080p120, and 1080p60 3D.
 
HDMI Receivers.  Our HDMI receiver products are targeted for high-definition displays, such as projectors and PC monitors, as well as AV receivers (AVRs). HDMI receivers convert an incoming encrypted serialized stream to digital video and audio, which is then processed by a television or PC monitor for display.
 
PC
 
MHL/HDMI-to-HDMI Bridges.  Our MHL/HDMI-to-HDMI bridge products are targeted for high-definition displays, such as PC monitors and DTVs, enabling added support for MHL. The SiI1292 is an MHL/HDMI-to-HDMI bridge designed to enable single port displays such as HDTVs, PC monitors, multi-function monitors or HD projectors, to connect to MHL-enabled mobile devices via an MHL cable.
 
DVI Receivers.  Our DVI receiver products are targeted for high-definition PC displays, such as monitors and projectors.
 
SATA controllers. We provide a full line of SATA controllers used in PC, DVR and network attached storage (NAS) applications. Our controllers provides SATA Gen II features including eSATA signal levels, 3.0 Gbps, native command queuing (NCQ), hot-plug and port multiplier support.
 
Our bridge products such as the SiI3811 provide PC OEMs with a solution that connects legacy PATA optical drives to the current generation of motherboard chip sets and are used primarily in desktop and laptop PC applications.
 
Simplay Labs, LLC
 
We believe Simplay Labs LLC, our wholly owned subsidiary, has further enhanced our reputation for quality, reliable products and leadership in the HDMI and MHL markets. The Simplay HD™ Interoperability Program offers one of the most robust and comprehensive testing engagements to manufacturers in the consumer electronics industry as device interoperability and consumer quality of experience are of significant concern to retailers and consumers.  Devices that pass the Simplay HD testing regime are verified to meet Simplay Labs’ developed interoperability specifications, and have also demonstrated interoperability through empirical testing against “peer” devices maintained by Simplay Labs. Simplay Labs has service centers operating in the U.S., South Korea and China providing compliance, interoperability, quality of experience and performance testing at global testing centers. Simplay Labs also verifies MHL devices for standards compliance and interoperability. A number of products use the SimplayHD logo on product packaging, within product literature and on website promotions.
 
 
 

 
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Simplay Labs also offers system level test systems to manufacturers in supporting their efforts in quickly bringing products to market.  The Simplay test system products include the Explorer HDMI-CEC test tool, which was approved as an official HDMI Authorized Test Center (ATC) test tool in 2009. The first HDMI-CEC R&D tool of its kind for CE manufacturers, the Simplay CEC Explorer sets a higher standard for development of HDMI CEC features and enables manufacturers to bring products to market faster. The Simplay Labs Universal Test System (UTS) is a new generation test system that utilizes a shelf-based modular slot approach to support many HD standards and function within a single chassis.  The UTS is the first test system of its kind to offer both HDMI and MHL system test capabilities within a single platform.
 
Customers
 
 We focus our sales and marketing efforts on achieving design wins with original equipment manufacturers (OEMs) of mobile, CE and PC products. A small number of customers and distributors have generated and are expected to continue to generate a significant portion of our revenue. Our top five customers, which include distributors, generated 61.4%, 58.3% and 44.2%, of our total revenue in 2011, 2010 and 2009, respectively. For the year ended December 31, 2011, sales to Samsung Electronics, and our distributors Edom Technology and Weikeng accounted for 23.4%, 13.8% and 10.2% of our total revenue, respectively. The percentage of revenue generated through distributors is significant, since many OEMs rely upon third-party manufacturers or distributors to provide purchasing and inventory management functions. Our revenue generated through distributors was 50.1%, 61.1% and 59.2% of our total revenue in 2011, 2010 and 2009, respectively. Please refer to the section of this report titled “Risk Factors” for a discussion of risks associated with the sell-through arrangement with our distributors.
 
A substantial portion of our business is conducted outside the United States; therefore, we are subject to foreign business, political and economic risks. For the years ended December 31,2011, 2010 and 2009, approximately 67.1%, 78.9% and 79.4%  of our total revenue, respectively, was generated from customers and distributors located outside of North America, primarily in Asia.
 
Research and Development
 
Our research and development efforts continue to focus on innovative technologies standards, and products featuring higher-bandwidth and lower-power links, efficient algorithms, architectures and feature-rich implementations for mobile, CE and PC applications. By utilizing our patented technologies and optimized architectures, we believe our products can scale with advances in semiconductor manufacturing process technology, simplify system design and provide innovative solutions for our customers. As of December 31, 2011, we had been issued 383 United States and International patents and had 444 United States and International patent applications pending. Our U.S. issued patents have expiration dates which range from 2015 to 2030 subject to our payment of periodic maintenance fees.  Our policy is to seek to protect our intellectual property rights throughout the world by filing counterparts or our US patent applications in select foreign jurisdictions. A discussion of risks related to our intellectual property is set forth in the section of this report titled “Risk Factors”.
 
We have extensive experience in the areas of high-speed interconnect architecture, circuit design, logic design/verification, firmware/software, digital audio/video systems and wireless baseband and radio frequency (RF) technology and architecture. We have invested and expect that we will continue to invest, significant funds for research and development activities. Our research and development expenses were approximately $66.5 million, $55.3 million and $68.2 million in 2011, 2010 and 2009, respectively, including stock-based compensation expense of $3.8 million, $2.6 million and $6.3 million for 2011, 2010 and 2009, respectively.
 
 Sales and Marketing
 
We sell our products using a direct sales support and marketing field offices located in North America, Europe, Taiwan, China, Japan and Korea and through a network of distributors located throughout North America, Asia and Europe. Our sales strategy for all products is to achieve design wins with key industry companies in order to grow the markets in which we participate and to promote and accelerate the adoption of industry standards that we support or are developing.
 
 
 

 
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Manufacturing
 
Wafer Fabrication
 
Our semiconductor products are designed using standard, complementary metal oxide semiconductor (CMOS) processes, which permit us to use independent wafer foundries to fabricate them. By outsourcing the manufacture of our semiconductor products, we are able to avoid the high cost of owning and operating a semiconductor wafer fabrication facility and to take advantage of our contract manufacturers’ high-volume economies of scale. Outsourcing our manufacturing also gives us direct and timely access to various process technologies. This allows us to focus our resources on the innovation, design and quality of our products.
 
We rely almost entirely on Taiwan Semiconductor Manufacturing Company (TSMC) to manufacture all of our semiconductor products. Our semiconductor products are currently fabricated using 0.35, 0.25, 0.18, 0.13 and 0.065 micron processes. We continuously evaluate the benefits, primarily the improved performance, costs and feasibility, of migrating our products to smaller geometry process technologies. Because of the cyclical nature of the semiconductor industry, capacity availability can change quickly and significantly.  We discuss the risks related to our sole sourcing of the manufacturing of our products in the section of this report titled “Risk Factors.”
 
 Assembly and Test
 
Our semiconductor products are designed to use low-cost standard packages and to be tested with widely available semiconductor test equipment. We outsource all of our packaging and our test requirements. This enables us to take advantage of high-volume economies of scale and supply flexibility and gives us direct and timely access to advanced packaging and test technologies. Since the fabrication yields of our products have historically been high and the costs of our packaging have historically been low, we test our products after they are assembled. This testing method has not caused us to experience unacceptable failures or yields. Our operations personnel closely review the process and control and monitor information provided to us by our foundries. To ensure quality, we have established firm guidelines for rejecting wafers that we consider unacceptable. However, lack of testing prior to assembly could have adverse effects if there are significant problems with wafer processing. Additionally, for newer products and products for which yield rates have not stabilized, we may conduct bench testing using our personnel and equipment, which is more expensive than fully automated testing.
 
Quality Assurance
 
We focus on product quality through all stages of the design and manufacturing process. Our designs are subjected to in depth circuit simulation at temperature, voltage and processing extremes before being fabricated. We also subject pre-production parts to extensive characterization and reliability testing. We also sample early production parts to ensure we are getting the same results as we did during pre-production. We pre-qualify each of our subcontractors through an audit and analysis of the subcontractor’s quality system and manufacturing capability. We also participate in quality and reliability monitoring through each stage of the production cycle by reviewing data from our wafer foundries and assembly subcontractors. We closely monitor wafer foundry production to ensure consistent overall quality, reliability and yields. Our independent foundries and our assembly and test subcontractors have achieved International Standards Organization (ISO) 9001 certification.
 
 Competition
 
The markets in which we participate are intensely competitive and are characterized by rapid technological change, evolving standards, short product life cycles and decreasing prices. We believe that some of the key factors affecting competition in our markets are levels of product integration, compliance with industry standards, time-to-market, cost, product capabilities, system design costs, intellectual property, customer support, quality and reputation.
 
 
 

 
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 In addition, the competitive landscape includes other connectivity solutions such as Wi-Fi®, Bluetooth® and AirPlay™.  These solutions provide our customers with alternative technologies for solving their various connectivity requirements.
 
Mobile - In the mobile market, our products are designed into a variety of devices, including smartphones, tablets, digital still cameras, and camcorders.  Our products compete against discrete HDMI products offered by companies such as Analog Devices, Analogix Semiconductor, and Explore.  We anticipate similar companies to begin to offer discrete MHL solutions in the near future.  Our products also face competition from companies integrating HDMI or MHL transmit functionality into SoCs, such as Broadcom, Intel, Qualcomm, TI, Nvidia, Marvell, ST Ericsson, and MediaTek.  In addition, we also compete in some instances against in-house semiconductor solutions designed by large consumer electronics OEMs.
 
 CE  - In the consumer electronics market, our products are designed into a variety of devices, including DTVs, STBs, Blu-ray players, AV receivers, soundbars, and home theater in a box (HTIBs).  Our products compete against discrete HDMI products offered by companies such as Analog Devices, Analogix Semiconductor, Parade Technologies, Explore and NXP.  Our products face competition from companies integrating HDMI receive or HDMI transmit functionality into SoC’s, such as Broadcom, Intel, MediaTek, Mstar, Trident, Marvell, and STM.  We also compete in some instances against in-house semiconductor solutions designed by large consumer electronics OEMs. While we currently are the only company to offer CE solutions which incorporate both HDMI and MHL in a dual standard product, we anticpate similar discrete competitors to offer similar products in the near future.
 
 PC - In the PC market, Intel, AMD, Nvidia and other competitors have integrated HDMI and/or DVI into their PC processor and chips sets.  Our HDMI and DVI products also face competition from products based on the DisplayPort standard, which is a digital display interface standard being put forth by the Video Electronics Standards Association (VESA) that defines a digital audio/video interconnect intended to be used primarily between a computer and a display. DisplayPort is increasingly replacing DVI as the default standard for PC digital video interconnects technology.
 
Storage - Our legacy SATA products compete with similar products from ACARD, Atmel, J-Micron, and Marvell. We also compete against AMD, Intel, nVidia, Silicon Integrated Systems, VIA Technologies and other motherboard chip-set makers, which have integrated SATA functionality into their chipsets.  Many of our competitors have longer operating histories and greater presence in key markets, greater name recognition, access to larger customer bases and significantly greater financial, engineering, intellectual property, sales and marketing, manufacturing, distribution, technical and other resources than we do.  We cannot assure that we can compete successfully against current or potential competitors, or that competition will not seriously harm our business.
 
 Employees
 
 As of December 31, 2011, we had a total of 521 full-time employees, including162 located outside of the United States. None of our employees are represented by a collective bargaining agreement. We have never experienced any work stoppages. We consider our relations with our employees to be good. We depend on the continued service of our key technical, sales and senior management personnel and our ability to attract and retain additional qualified personnel.
 
 Item 1A.  Risk Factors

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

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

Our future growth and success depends on our ability to continuously develop and bring to market new and innovative semiconductor products on a timely basis - such as semiconductor products supporting the Mobile High-Definition Link (MHL) and WirelessHD standards. There can be no assurance that we will be successful in developing and marketing these new or other future products. Moreover, there is no assurance that our new or future products will incorporate the innovations, features or functionality or be available at the price points necessary to achieve the desired level of market acceptance in the anticipated timeframes or that any such new or future products will contribute significantly to our revenue. We face significant competition from startups having the resources, flexibility and ability to innovate faster than we can. We also face competition from established companies having greater financial resources and greater breadth of product line than we have, providing them with a competitive advantage in the marketplace. Our inability to continue to innovate and to develop and market new products could negatively affect our business and results of operations.
 
The development of new semiconductor products is highly complex. On several occasions in the past, we have experienced delays, some of which exceeded one year, in the development and introduction of our new semiconductor products. As our products integrate new, more advanced functions and transition to smaller geometries, they become more complex and increasingly difficult to design, manufacture and debug.
 
Our ability to successfully develop and introduce new products also depends on a number of factors, including, but not limited to:
 
·
our ability to accurately predict market trends and requirements, the establishment and adoption of new standards in the market and the evolution of existing standards, including enhancements or modifications to existing standards such as HDMI,  MHL and WirelessHD;
 
·
our ability to identify customer and consumer market needs where we can apply our innovation and skills to create new standards or areas for product differentiation that improve our overall competitiveness either in an existing market or in a new market;

·
our ability to develop advanced technologies and capabilities and new products that satisfy customer and consumer market requirements;
 
·
how quickly our competitors and customers integrate the innovation and functionality of our new products into their semiconductor products, putting pressure on us to continue to develop and introduce innovative products with new features and functionality;

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

·
our ability to transition our product designs to leading-edge foundry processes in response to market demands, while achieving and maintaining of high manufacturing yields and low testing costs;
 
·
the consumer electronics market’s  acceptance of our new technologies, architectures and  products; and

·
consumers’ shifting preferences for how they purchase and consume HD content, which may not be met by our products.
   
Accomplishing what we need to do to be successful is extremely challenging, time-consuming, and expensive; and there is no assurance that we will succeed. We may experience product development delays from unanticipated engineering complexities, changing market or competitive product requirements or specifications, difficulties in overcoming resource constraints, the inability to license third-party technology or other factors. Also our competitors and customers may integrate the innovation and functionality of our products into their own products, thereby reducing demand for our products. If we are not able to develop and introduce new and innovative products successfully and in a timely manner, our costs could increase or our revenue could decrease, both of which would adversely affect our operating results. And, even if we are successful in our product development efforts, it is possible that we may experience delays in generating revenue from our new products or that we may never generate revenue from these products.
 
 
 

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

We have made acquisitions of companies and intangible assets in the past and expect to continue to make such acquisitions in the future as we look to develop and bring to market new and innovative semiconductor and products and technologies on a timely basis. Acquisitions of companies or intangible assets  involve numerous risks and uncertainties.
 
Our growth depends on the growth of the markets we serve and our ability to enhance our existing products and technologies and to introduce new products and technologies for those markets on a timely basis. The acquisition of companies or intangible assets is a strategy we have and will continue to use to develop new technologies and products and enter new markets. Acquisitions involve numerous risks, including, but not limited to, the following:
 
·  
suitable acquisition opportunities may not be available, or if available, may not be available in the time frame necessary for us to take advantage of market opportunities or may not be available at a price that we can afford;
 
·  
the difficulty and increased costs of integrating the operations and employees of the acquired business, including our possible inability to keep and retain key employees of the acquired business;
 
·  
the disruption to our ongoing business of the acquisition process itself and subsequent integration;
 
·  
the risk of undisclosed liabilities of the acquired businesses and potential legal disputes with founders or stockholders of acquired companies;
 
·  
our inability to commercialize acquired technologies; 
 
·  
the need to take impairment charges or write-downs with respect to acquired assets and technologies; and
 
·  
the risk that the future business potential as projected is not realized and as a result, we may be required to take a charge to earnings that would impact our profitability.
 
We cannot assure you that our prior acquisitions or our future acquisitions, if any, will be successful or provide the anticipated benefits, or that they will not adversely affect our business, operating results or financial condition. Our failure to manage growth effectively and to successfully integrate acquisitions made by us could materially harm our business and operating results.

             In January 2007, we completed the acquisition of sci-worx, now Silicon Image, GmbH.  In 2009, because of our decision to focus on discrete semiconductor products and related intellectual property, we decided to restructure our research and development operations resulting in the closure of our two sites in Germany. We acquired Anchor Bay Technologies in February 2011 and SiBEAM, Inc. in May 2011.  Due to the risks associated with integrating the operations and employees of these two acquisitions and with our ability to develop and commercialize the technologies acquired, we may not realize the expected benefits from these strategic transactions. The success of the acquisitions depends, in part, on our ability to realize the anticipated benefits and cost savings (if any) from combining the businesses of the acquired companies and our business, which may take longer to realize than expected.
 
We have made and continue to make strategic investments in and enter into strategic partnerships with third parties.  The anticipated benefits of these investments and partnerships may never materialize.
 
We have made and continue to make strategic investments in and enter into strategic partnerships with third parties with the goal of acquiring or gaining access to new and innovative semiconductor products and technologies on a timely basis.  Negotiating and performing under these arrangements involves significant time and expense, and we cannot assure you that the anticipated benefits of these arrangements will ever materialize or that  the products or technologies involved will ever be commercialized or that, as a result, we will not have write down a portion or all of our investment.
 
For example, in 2011, we converted $8.5 million of secured promissory notes from a third-party company into advances for intellectual properties. In the fourth quarter of 2011 and again subsequent to our year ended December 31, 2011, we assessed our advances for intellectual properties for impairment. We concluded that the intangible assets related to these advances were fully impaired as of December 31, 2011, and have written them off. This conclusion was based on our determination that certain of the technologies was no longer aligned with our product roadmap due to a change in strategic focus and therefore, would not be used. The remaining technologies were impaired due to an adverse change in the extent and manner in which the technology was expected to be utilized by a strategic customer, as well as the competitive environment in which the technology was intended for use. In connection with this assessment, we recognized an impairment charge of $8.5 million in our 2011 consolidated statement of operations.
 
In February 2007, we entered into a licensing agreement with Sunplus Technology Co., Ltd. (Sunplus), which granted us the rights to use and further develop advanced IP technology. Previously, we believed that the IP licensed under this agreement enhanced our ability to develop DTV technology and other related consumer product offerings. Based on our product strategy as of October 2009, we realized the IP obtained through the Sunplus agreement did not align with our product roadmap and during October 2009, we decided to write off our investment in Sunplus IP of $28.3 million. This decision was prompted by a change in our product strategy due to market place and related competitive dynamics.
 
 
 

 
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Our annual and quarterly operating results are highly dependent upon how well we manage our business.
 
           Our annual and quarterly operating results are highly dependent upon and may fluctuate based on how well we manage our business, including without limitation:
 
·
our ability to manage product introductions and transitions, develop necessary sales and marketing channels and manage our entry into new market segments;
 
·
our ability to manage sales into multiple markets such as mobile, CE and PC, which may involve additional research and development, marketing or other costs and expenses;

·
our ability to enter into licensing transactions when expected and make timely deliverables and milestones on which recognition of revenue often depends;
 
·
our ability to develop customer solutions that adhere to industry standards in a timely and cost-effective manner;

·
our ability to achieve acceptable manufacturing yields and develop automated test programs within a reasonable time frame for our new products;
 
·
our ability to manage joint ventures and projects, design services and our supply chain partners;

·
our ability to monitor the activities of our licensees to ensure compliance with license restrictions and remittance of royalties;
 
·
our ability to structure our organization to enable achievement of our operating objectives and to meet the needs of our customers and markets;

·
the success of the distribution and partner channels through which we choose to sell our products and our ability to manage expenses and inventory levels; and
 
·
our ability to successfully maintain certain structural and various compliance activities in support of our global structure which is designed to result in certain operational benefits as well as an overall lower tax rate and which, if not maintained, may result in us losing these operational and tax benefits; and
 
          Our failure to effectively manage our business, could adversely affect our results of operations.

Our annual and quarterly operating results may fluctuate significantly and are difficult to predict, particularly given adverse domestic and global economic conditions.
 
          Our annual and quarterly operating results are likely to fluctuate significantly in the future based on a number of factors many of which we have little or no control over. These factors include, but are not limited to:

·  
the growth, evolution and rate of adoption of industry standards in our key markets, including mobile, CE and PCs;
 
·  
our licensing revenue is heavily dependent on a few key licensing transactions being completed in 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 we depend on a few licensees in any period for substantial portions of our anticipated licensing revenue and profits;
 
·  
our licensing revenue has been uneven and unpredictable over time and is expected to continue to be uneven and unpredictable in the future, resulting in considerable fluctuation in the amount of revenue recognized in a particular quarter;
 
·  
the impact on our operating results of the results of the royalty compliance audits which we regularly perform;
 
·  
competitive pressures, such as the ability of our competitors to offer or introduce products that are more cost-effective or that offer greater functionality than our products, including through the integration into their products of innovation or functionality offered by our products, the prices set by competitors for their products and the potential for alliances, combinations, mergers and acquisitions among our competitors;
 
·  
average selling prices and gross margins of our products, which are influenced by competition and technological advancements, among other factors;
 
·  
government regulations impacting the industry standards in our key markets or our products;
 
·  
the availability or continued viability of other semiconductors or key components required for a customer solution where we supply one or more of the necessary components;
 
·  
the cost to manufacture our products, including the cost of gold, and prices charged by the third parties who manufacture, assemble and test our products; and
 
·  
fluctuations in market demand, one-time sales opportunities and sales goals, which sometimes result in heightened sales efforts during a given period that may adversely affect our sales in future periods.
    
 
 

 
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Because we have little or no control over these factors and/or their magnitude, our operating results are difficult to predict. Any substantial adverse change in any of these factors could negatively affect our business and results of operations.

Our business has been and may continue to be significantly impacted by the deterioration in worldwide economic conditions and uncertainty in the outlook for the global economy makes it more likely that our actual results will differ materially from expectations.
 
            Global credit and financial markets have experienced disruptions, and may continue to experience disruptions in the future, including diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and continued uncertainty about economic stability. These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. The continued or further tightening of credit in financial markets may lead consumers and businesses to postpone spending, which may cause our customers to cancel, decrease or delay their existing and future orders with us. In addition, financial difficulties experienced by our suppliers or distributors could result in product delays, increased accounts receivable defaults and inventory challenges. The volatility in the credit markets has severely diminished liquidity and capital availability.  Our mobile and CE product revenue, which comprised approximately 69.5%, 67.3% and 66.5% of total revenue for the years ended December 31, 2011, 2010 and 2009, respectively, is dependent on continued demand for consumer electronics, including but not limited to, DTVs, STBs, AV receivers, tablets, digital still cameras, and smartphones.  Demand for consumer electronics is a function of the health of the economies in the United States, Japan and around the world. As a result of the recent global recession experienced by the U.S. and other economies around the world, as well as the European sovereign debt crisis, the overall demand for consumer electronics has been and may continue to be adversely affected. As a result, the demand for our mobile, CE and PC products and our operating results have been and may continue to be adversely affected as well. We cannot predict the timing, strength or duration of any economic disruption or subsequent economic recovery, worldwide, in the United States, in our industry, or in the consumer electronics market. These and other economic factors have had and may continue to have a material adverse effect on demand for our mobile, CE and PC products and on our financial condition and operating results.
 
Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate debt securities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates. We may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. Recent adverse events in the global economy and in the credit markets could negatively impact our return on investment for these debt securities and thereby reduce the amount of cash and cash equivalents and investments on our balance sheet.
 
The licensing component of our business strategy increases our business risk and market volatility.
 
            Our business strategy includes licensing our IP to companies for incorporating into their respective technologies that address markets in which we do not directly participate or compete and we license into markets where we do participate and to compete. There can be no assurance that these customers will continue to be interested in licensing our technology on commercially favorable terms or at all. There also can be no assurance that our licensing customers will introduce and sell products incorporating our technology, will accurately report royalties owed to us, will pay agreed upon royalties, will honor agreed upon market restrictions, will not infringe upon or misappropriate our intellectual property or will maintain the confidentiality of our proprietary information. Our IP licensing agreements are complex and depend upon many factors including completion of milestones, allocation of values to delivered items and customer acceptances. Many of these require significant judgments. Our licensing revenue fluctuates, sometimes significantly, from period to period because it is heavily dependent on a few key transactions being completed in a given period, the timing of which is difficult to predict and may not match our expectations. Because of its high margin, the licensing revenue portion of our overall revenue can have a disproportionate impact on gross profit and profitability. Also, generating revenue from IP licenses is a lengthy and complex process that may last beyond the period in which our efforts begin and, once an agreement is in place, the timing of revenue recognition may be dependent on the customer acceptance of deliverables, achievement of milestones, our ability to track and report progress on contracts, customer commercialization of the licensed technology and other factors. The accounting rules governing the recognition of revenue from IP licensing transactions are increasingly complex and subject to interpretation. Due to the foregoing, the amount of license revenue recognized in any period may differ significantly from our expectations.
 
 
 

 
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We face intense competition in our markets, which may lead to reduced revenue and gross margins from sales of our products and losses.
 
            The markets in which we operate are intensely competitive and characterized by rapid technological change, evolving standards, short product life cycles and declining selling prices. We expect competition to increase, as industry standards become widely adopted, new industry standards are introduced, competitors reduce prices and offer products with greater levels of integration, and new competitors enter the markets we serve.
 
            Our products face competition from companies selling similar discrete products and from companies selling products such as chipsets and system-on-a-chip (SoC) solutions with integrated functionality. Our competitors include semiconductor companies that focus on the mobile, CE and PC markets, as well as major diversified semiconductor companies and we expect that new competitors will enter our markets.
 
Some of our current or potential customers, including our own licensees, have their own internal semiconductor capabilities or other semiconductor suppliers or relationships, and may also develop solutions integrating the innovations, features and  functionality of our products for use in their own products rather than purchasing products from us. Some of our competitors have already established supplier or joint development relationships with some of our current or potential customers and may be able to leverage these relationships to discourage these customers from purchasing products from us or to persuade them to replace our products with theirs. Many of our competitors have longer operating histories, greater presence in key markets, better name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do and therefore may be able to adapt more quickly to new or emerging technologies and customer requirements, or to devote greater resources to the promotion and sale of their products. In particular, well-established semiconductor companies, such as Analog Devices, NXP, Broadcom, Intel, MediaTek, Mstar and Texas Instruments and CE manufacturers, such as Panasonic, Sony, Samsung and Toshiba, may compete against us in the future. Mergers and acquisitions are very common in our industry and some of our competitors could merge, which may enhance their market presence. Existing or new competitors may also develop technologies that more effectively address our markets with products that offer enhanced features and functionality, lower power requirements, greater levels of integration or lower cost. Increased competition has resulted in and is likely to continue to result in price reductions and loss of market share in certain markets. We cannot assure you that we can compete successfully against current or potential competitors, or that competition will not reduce our revenue and gross margins.
 
We operate in rapidly evolving markets, which makes it difficult to evaluate our future prospects.
 
          The markets in which we compete are characterized by rapid technological change, evolving customer needs and frequent introductions of new products and standards. As we adjust to evolving customer requirements and technological advances, we may be required to further reposition our existing offerings and to introduce new products and services. We may not be successful in developing and marketing such new offerings, or we may experience difficulties that could delay or prevent the development and marketing of new products.  In addition, new standards that compete with standards that we promote have been and in the future may be introduced from time to time, which could impact our success. Accordingly, we face risks and difficulties frequently encountered by companies in new and rapidly evolving markets. If we do not successfully address these risks and difficulties, our results of operations could be negatively affected.
 
We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration, which may result in reduced manufacturing yields, delays in product deliveries and increased expenses.
 
           To remain competitive, we expect to continue to transition our semiconductor products to increasingly smaller geometries. This requires us to change the manufacturing processes for our products and to redesign some products as well as standard cells and other integrated circuit designs that we may use in multiple products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs. Currently most of our products are manufactured in 180 nanometer and 130 nanometer, geometry processes. We are now designing new products in 65 nanometer process technology and planning for the transition to smaller process geometries. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, resulting in reduced manufacturing yields, delays in product deliveries and increased expenses. The transition to 65 nanometer geometry process technology has and will continue to result in significantly higher mask and prototyping costs, as well as additional expenditures for engineering design tools and related computer hardware. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes.
 
 
 

 
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            We are dependent on our relationship with our foundry to transition to smaller geometry processes successfully. We cannot assure you that the foundries that we use will be able to effectively manage the transition in a timely manner, or at all, or that we will be able to maintain our existing foundry relationships or develop new ones. If any of our foundry subcontractors or we experience significant delays in this transition or fail to efficiently implement this transition, we could experience reduced manufacturing yields, delays in product deliveries and increased expenses, all of which could harm our relationships with our customers and our results of operations.
 
We will have difficulty selling our products if customers do not design our products into their product offerings or if our customers’ products are not commercially successful.
 
Our products are generally incorporated into our customers’ products at the customers’ design stage. We rely on OEMs in the markets we serve to select our products to be designed into their products. Without having our products designed into our customers’ products (we refer to such design integration as “design wins”), it is very difficult to sell our products. We often incur significant expenditures on the development of a new product under the hope for such “design wins” without any assurance that a manufacturer will select our product for design into its own product. Additionally, in some instances, we are dependent on third parties to obtain or provide information that we need to achieve a design win. Some of these third parties may be competitors and, accordingly, may not supply this information to us on a timely basis, if at all. Once a manufacturer designs a competitor’s product into its product offering, it becomes significantly more difficult for us to sell our products to that customer because changing suppliers involves significant cost, time, effort and risk for the customer. Furthermore, even if a manufacturer designs one of our products into its product offering, we cannot be assured that its product will be commercially successful or that we will receive any revenue from sales of that product. Sales of our products largely depend on the commercial success of our customers’ products. Our customers generally can choose at any time to stop using our products if their own products are not commercially successful or for any other reason. We cannot assure you that we will continue to achieve design wins or that our customers’ products incorporating our products will ever be commercially successful.
 
Our products typically have lengthy sales cycles. A customer may decide to cancel or change its product plans, which could cause us to lose anticipated sales. In addition, our average product life cycles tend to be short and, as a result, we may hold excess or obsolete inventory that could adversely affect our operating results.
 
Our customers will usually test and evaluate our products prior to deciding to design our product into their own products. Our customers generally need from three to over six months to test, evaluate and adopt our product and then an additional three months to over nine months to begin volume production of products incorporating our products. This lengthy sales cycle may cause us to experience significant delays from the time we incur operating expenses and make investments in inventory until the time that we generate revenue from our products. It is possible that we may never generate any revenue from products after incurring significant expenditures. Even if we achieve a design win with a customer, we cannot assure you that the customer will ultimately market and sell its products or that our customer’s efforts will be successful. The length of our sales cycle increases the risk that a customer will decide to cancel or change its product plans, which would cause us to lose sales that we had anticipated. In addition, anticipated sales could be materially and adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle or chooses not to release equipment that contains our products. Further, the combination of our lengthy sales cycles coupled with worldwide economic conditions could have a compounding negative impact on the results of our operations.
 
While our sales cycles are typically long, our average product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, from time to time, our product sales and marketing efforts may not generate sufficient revenue requiring that we write off excess and obsolete inventory. If we incur significant marketing expenses and investments in inventory in the future that we are not able to recover and we are not able to compensate for those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions but still hold higher cost products in inventory, our operating results would be harmed.
 
 
 

 
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Our customers may not purchase anticipated levels of products, which can result in excess inventories.
 
We generally do not obtain firm, long-term purchase commitments from our customers and, in order to accommodate the requirements of certain customers, we may from time to time build inventory that is specific to that customer in advance of receiving firm purchase orders. The short-term nature of our customers’ commitments and the rapid changes in demand for their products reduce our ability to accurately estimate the future requirements of those customers. Should the customer’s need shift so that they no longer require such inventory, we may be left with excessive inventories, which could adversely affect our operating results.
 
We depend on a few key customers and the loss of any of them could significantly reduce our revenue and gross margins and adversely affect our results of operations.
 
            Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For the year ended December 31, 2011, revenue from Samsung Electronics and our distributors Edom Technology and Weikeng accounted for 23.4 %, 13.8% and 10.2% of our total revenue, respectively.  For the year ended December 31, 2010, revenue from Samsung Electronics and our distributors Innotech Corporation and Microtek, Inc. accounted for 17.0%, 11.3% and 11.0% of our total revenue, respectively.  For the year ended December 31, 2009, revenue from Microtek, Inc. and Weikeng accounted for 11.9% and 10.3% of our total revenue, respectively.  In addition, an OEM customer of ours may buy our products through multiple distributors, contract manufacturers and /or directly from us, which could mean an even greater concentration of revenue in such a customer. We cannot be certain that customers and key distributors that have accounted for significant revenue in past periods, individually or as a group, will continue to sell our products or products incorporating our products and generate revenue for us. As a result of this concentration of revenue in few customers, our results of operations could be adversely affected if any of the following occurs:
 
·
one or more of our customers or distributors becomes insolvent or goes out of business;
 
·
one or more of our key customers or distributors significantly reduces, delays or cancels orders; and/or

·
one or more significant customers selects products manufactured by one of our competitors for inclusion in their future product generations.
     
While our participation in multiple markets has broadened our customer base, we remain dependent on a small number of customers or, in some cases, a single customer for a significant portion of our revenue in any given quarter, the loss of which could adversely affect our operating results.
 
We sell our products through distributors, which limits our direct interaction with our end customers, therefore reducing our ability to forecast sales and increasing the complexity of our business.
 
             Many OEMs rely on third-party manufacturers or distributors to provide inventory management and purchasing functions.  Distributors generated 50.1%, 61.1% and 59.2% of our total revenue for the years ended December 31, 2011, 2010 and 2009, respectively. Selling through distributors reduces our ability to forecast sales and increases the complexity of our business, requiring us to:
 
·
manage a more complex supply chain;
 
·
monitor the level of inventory of our products at each distributor;

·
estimate the impact of credits, return rights, price protection and unsold inventory at distributors; and
 
·
monitor the financial condition and credit-worthiness of our distributors, many of which are located outside of the United States and not publicly traded.

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

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

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires the Securities and Exchange Commission to adopt additional disclosure requirements related to certain minerals, so called "conflict minerals", sourced from the Democratic Republic of Congo and adjoining countries for which such conflict minerals are necessary to the functionality of a product manufactured, or contracted to be manufactured.  These regulations also require a reporting company to disclose efforts to prevent the use of such minerals.

In our industry, such conflict minerals are most commonly found in metals.  Some of our products use certain metals, such as gold, as part of the manufacturing process.  Although we have not yet determined whether the gold used in the manufacture of our products would be considered conflict minerals, if such a determination is made, we may not be able to obtain alternative supplies for such metals due to the limited number of sources of non conflict metals.  If we are required to use alternative supplies, the price we pay for such metals may increase.

Governmental action against companies located in offshore jurisdictions may lead to a reduction in the demand for our common shares.
 
Federal and state legislation has been proposed in the past, and similar legislation may be proposed in the future which, if enacted, could have an adverse tax impact on both us and our stockholders. For example, the ability to defer taxes as a result of permanent investments offshore could be limited, thus raising our effective tax rate.
 
The cyclical nature of the semiconductor industry may create constraints in our foundry, test and assembly capacities and strain our management and resources.
 
            The semiconductor industry is characterized by significant downturns and wide fluctuations in supply and demand. This cyclicality has led to significant fluctuations in product demand and in the foundry, test and assembly capacity of third-party suppliers. During periods of increased demand and constraints in manufacturing capacity, production capacity for our semiconductors may be subject to allocation, in which case not all of our production requirements may be met. This may impact our ability to meet demand and could also increase our production costs and inventory levels. Cyclicality has also accelerated decreases in average selling prices per unit. We may experience fluctuations in our future financial results because of changes in industry-wide conditions. Our financial performance has been and may in the future be, negatively impacted by downturns in the semiconductor industry. In a downturn situation, we may incur substantial losses if there is excess production capacity or excess inventory levels in the distribution channel.
 
The cyclicality of the semiconductor industry may also strain our management and resources. To manage these industry cycles effectively, we must:
 
·
improve operational and financial systems;
 
·
train and manage our employee base;

·
successfully integrate operations and employees of businesses we acquire or have acquired;
 
·
attract, develop, motivate and retain qualified personnel with relevant experience; and

·
adjust spending levels according to prevailing market conditions.
    
If we cannot manage industry cycles effectively, our business could be seriously harmed.
 
 
 

 
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We depend on third-party sub-contractors to manufacture, assemble and test nearly all of our products, which reduce our control over the production process.
 
We do not own or operate a semiconductor fabrication facility. We rely on one third party semiconductor foundry overseas to produce substantially all of our semiconductor products.   We also rely on outside assembly and test services to test all of our semiconductor products. Our reliance on independent foundries and assembly and test facilities involves a number of significant risks, including, but not limited to:
 
·
reduced control over delivery schedules, quality assurance, manufacturing yields and production costs;
 
·
lack of guaranteed production capacity or product supply, potentially resulting in higher inventory levels; and

·
lack of availability of, or delayed access to, next-generation or key process technologies.
     
We do not have a long-term supply agreement with our third party semiconductor foundry or many of our other subcontractors and instead obtain these services on a purchase order basis. Our outside sub-contractors have no obligation to manufacture our products or supply products to us for any specific period of time, in any specific quantity or at any specific price, except as set forth in a particular purchase order or multi month quote. Our requirements represent a small portion of the total production capacity of our outside foundry, assembly and test facilities and our sub-contractors may reallocate capacity on short notice to other customers who may be larger and better financed than we are, or who have long-term agreements with our sub-contractors, even during periods of high demand for our products. We may elect to have our suppliers move or expand production of our products to different facilities under their control, even in different locations, which may be time consuming, costly and difficult, have an adverse effect on quality, yields and costs and require us and/or our customers to re-qualify our products, which could open up design wins to competition and result in the loss of design wins. If our subcontractors are unable or unwilling to continue manufacturing, assembling or testing our products in the required volumes, at acceptable quality, yields and costs and in a timely manner, our business will be substantially harmed. In this event, we would have to identify and qualify substitute sub-contractors, which would be time-consuming, costly and difficult; and we cannot guarantee that we would be able to identify and qualify such substitute sub-contractors on a timely basis or obtain commercially reasonable terms from them. This qualification process may also require significant effort by our customers and may lead to re-qualification of parts, opening up design wins to competition and loss of design wins. Any of these circumstances could substantially harm our business. In addition, if competition for foundry, assembly and test capacity increases, our product costs may increase and we may be required to pay significant amounts or make significant purchase commitments to secure access to production services.
 
The complex nature of our production process can reduce yields and prevent identification of problems until well into the production cycle or, in some cases, until after the product has been shipped.
 
           The manufacture of semiconductors is a complex process and it is often difficult for semiconductor foundries to achieve acceptable product yields. Product yields depend on both our product design and the manufacturing process technology unique to the semiconductor foundry. Since low yields may result from either design or process difficulties, identifying problems can often only occur well into the production cycle, when an actual product exists that can be analyzed and tested.
 
            Further, we only test our products after they are assembled, as their high-speed nature makes earlier testing difficult and expensive. As a result, defects often are not discovered until after assembly. This could result in a substantial number of defective products being assembled and tested or shipped, thus lowering our yields and increasing our costs. These risks could result in product shortages or increased costs of assembling, testing or even replacing our products.
 
           Although we test our products before shipment, they are complex and may contain defects and errors. In the past we have encountered defects and errors in our products. Because our products are sometimes integrated with products from other vendors, it can be difficult to identify the source of any particular problem. Delivery of products with defects or reliability, quality or compatibility problems, may damage our reputation and our ability to retain existing customers and attract new customers. In addition, product defects and errors could result in additional development costs, diversion of technical resources, delayed product shipments, increased product returns, warranty and product liability claims against us that may not be fully covered by insurance. Any of these circumstances could substantially harm our business.
 
 
 
 
 
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We face foreign business, political and economic risks because a majority of our products and our customers’ products are manufactured and sold outside of the United States and because we have employees in research and development centers and sales offices throughout the world.
 
A substantial portion of our business is conducted outside of the United States and we have a significant portion of our workforce in research and development centers and sales offices throughout the world. As a result, we are subject to foreign business, political and economic risks. Nearly all of our products are manufactured in Taiwan or elsewhere in Asia. For the years ended December 31, 2011, 2010 and 2009, approximately 67.1%, 78.9% and 79.4% of our total revenue respectively, was generated from customers and distributors located outside of North America, primarily in Asia. We anticipate that sales outside of the United States will continue to account for a substantial portion of our revenue in future periods.
 
In addition to our headquarters in Sunnyvale, California, we maintain research and development centers in Shanghai, China, and Hyderabad, India, and undertake sales and marketing activities through regional offices in several other countries. As we grow, we intend to continue to expand our international business activities.
 
Accordingly, we are subject to a variety of risks associated with the conduct of business outside the United States.  These risks include, but are not limited to:
 
·
political, social and economic instability;
 
·
the operational challenges of conducting our business in several geographic regions around the world, especially in the face of different business practices, social norms and legal standards that differ those to which we are accustomed and held to as a publicly traded company in the United States, particularly with respect to the protection and enforcement of intellectual property rights and the conduct of business generally;

·
natural disasters and public health emergencies;
 
·
nationalization of business and blocking of cash flows;

·
trade and travel restrictions;
 
·
the imposition of governmental controls and restrictions;

·
burdens of complying with a variety of foreign laws;
 
·
import and export license requirements and restrictions of the United States and each other country in which we operate;

·
unexpected changes in regulatory requirements;
 
·
foreign technical standards;

·
changes in taxation and tariffs;
 
·
difficulties in staffing and managing international operations;

·
fluctuations in currency exchange rates;
 
·
difficulties in collecting receivables from foreign entities or delayed revenue recognition;

·
expense and difficulties in protecting our intellectual property in foreign jurisdictions;
 
·
exposure to possible litigation or claims in foreign jurisdictions; and,

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

Also OEMs that design our semiconductors into their products sell them outside of the United States. This exposes us indirectly to foreign risks. Because sales of our products are denominated exclusively in United States dollars, relative increases in the value of the United States dollar will increase the foreign currency price equivalent of our products, which could lead to a change in their competitiveness in the marketplace. This in turn could lead to a reduction in our sales and profits.
 
 
 
 
 
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Our success depends on our investment of significant amount of resources in research and development.  We may have to invest more resources in research and development than anticipated, which could increase our operating expenses and negatively impact our operating results.

Our success depends on us investing significant amounts of resources into research and development.  Our research and development expenses as a percent of our total revenue were 30.1%, 28.9% and 45.3% in 2011, 2010 and 2009, respectively.  We expect to have to continue to invest heavily in research and development in the future in order to continue to innovate and come to market with new products in a timely manner and increase our revenue and profitability.  If we have to invest more resources in research and development than we anticipate, we could see an increase in our operating expenses which may negatively impact our operating results. Also, if we are unable to properly manage and effectively utilize our research and development resources, we could see adverse effects on our business, financial condition and operating results.
 
In addition, if  new competitors, technological advances by existing competitors, our entry into new markets, or other competitive factors require us to invest significantly greater resources than anticipated in our research and development efforts, our operating expenses would increase.  If we are required to invest significantly greater resources than anticipated in research and development efforts without a corresponding increase in revenue, our operating results could decline. Research and development expenses are likely to fluctuate from time to time to the extent we make periodic incremental investments in research and development and these investments may be independent of our level of revenue which could negatively impact our financial results. In order to remain competitive, we anticipate that we will continue to devote substantial resources to research and development, and we expect these expenses to increase in absolute dollars in the foreseeable future due to the increased complexity and the greater number of products under development.
 
The success of our business depends upon our ability to adequately protect our intellectual property.
 
            We rely on a combination of patent, copyright, trademark, mask work and trade secret laws, as well as nondisclosure agreements and other methods, to protect our confidential and proprietary technologies and information. Our success depends on our ability to adequately protect such intellectual property.  With respect to our patents, we have been issued patents and have a number of pending patent applications. However, we cannot assume that any pending patents applications will be issued or, if issued, that any claims allowed will protect our technology. In addition, we do not file patent applications on a worldwide basis, meaning we do not have patent protection in some jurisdictions. Additionally, it is possible that existing or future patents may be challenged, invalidated or circumvented. With respect to our copyright and trademark intellectual property, it may be possible for a third-party, including our licensees, to misappropriate such proprietary technology. It is possible that copyright, trademark and trade secret protection effective in the US may be unavailable or limited in foreign countries. Additionally, with respect to all of our intellectual property, it may be possible for a third-party to copy or otherwise obtain and use our products or technology without authorization, develop similar technology independently or design around our patents in the United States and in other jurisdictions. It is also possible that some of our existing or new licensing relationships will enable other parties to use our intellectual property to compete against us. Legal actions to enforce intellectual property rights tend to be lengthy and expensive and the outcome often is not predictable.
 
Despite our efforts and expenses, for the foregoing reasons and others, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business. In addition, practicality also limits our assertion of intellectual property rights. Assertion of intellectual property rights often results in counterclaims for perceived violations of the defendant’s intellectual property rights and/or antitrust claims. Certain parties after receipt of an assertion of infringement will cut off all commercial relationships with the party making the assertion, thus making assertions against suppliers, customers and key business partners risky. If we forgo making such claims, we may run the risk of creating legal and equitable defenses for an infringer.
 
 

 
 
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           We generally enter into confidentiality agreements with our employees, consultants and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, internal or external parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. Also, current or former employees may seek employment with our business partners, customers or competitors, and we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, current, departing or former employees or third parties could attempt to penetrate our computer systems and networks to misappropriate our proprietary information and technology or interrupt our business. Because the techniques used by computer hackers and others to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate, counter or ameliorate these techniques. As a result, our technologies and processes may be misappropriated, particularly in countries where laws may not protect our proprietary rights as fully as in the United States.
 
            Our products may contain technology provided to us by other parties such as contractors, suppliers or customers. We may have little or no ability to determine in advance whether such technology infringes the intellectual property rights of a third party. Our contractors, suppliers and licensors may not be required to indemnify us in the event that a claim of infringement is asserted against us, or they may be required to indemnify us only up to a maximum amount, above which we would be responsible for any further costs or damages. In addition, we may have little or no ability to correct errors in the technology provided by such contractors, suppliers and licensors, or to continue to develop new generations of such technology. Accordingly, we may be dependent on their ability and willingness to do so. In the event of a problem with such technology, or in the event that our rights to use such technology become impaired, we may be unable to ship our products containing such technology, and may be unable to replace the technology with a suitable alternative within the time frame needed by our customers.
 
Our participation in consortiums for the development and promotion of industry standards in our target markets, including the HDMI, MHL, SPMT and WirelessHD standards, requires us to license some of our intellectual property for free or under specified terms and conditions, which makes it easier for others to compete with us in such markets.
 
A key element of our business strategy includes participating in consortiums to establish industry standards in our target markets, promoting and enhancing specifications and developing and marketing products based on such specifications and future enhancements. We have and we will continue to participate in the consortiums that develop and promote the HDMI, MHL, SPMT and WirelessHD specifications. In connection with our participation in these consortiums, we make certain commitments regarding our intellectual property, in each case with the effect of making our intellectual property available to others, including our competitors, desiring to implement the specification in question.  For example, as a founder of the HDMI Consortium, we must license specific elements of our intellectual property to others for use in implementing the HDMI specification, including enhancements thereof, as long as we remain part of the consortium.  Also, as a promoter of the MHL specification, we must agree not to assert certain necessary patent claims against other members of the MHL Consortium, even if such members may infringed upon such claims in implementing the MHL specification. Additionally, in connection with our participation in the SPMT Consortium, we are required to license specific elements of our intellectual property on reasonable and non-discriminatory (RAND) terms to others desiring to implement the SPMT specification, including enhancements thereof so long as we continue to participate.

Accordingly, certain companies that implement these specifications in their products can use specific elements of our intellectual property to compete with us, in some cases, for free. Although in the case of the HDMI and MHL Consortiums, there are annual fees and royalties associated with the adopters’ use of the technology, there can be no assurance that our shares of such annual fees and royalties will adequately compensate us for having to license or refrain from asserting our intellectual property.
 
 
 
 
 
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           Through our wholly-owned subsidiary, HDMI Licensing, LLC, we act as agent of the HDMI specification and are responsible for promoting and administering the specification.  We receive all the license fees paid by adopters of the HDMI specification to cover the costs we incur to promote and administer the HDMI specification.  There can be no assurance that, going forward, we will continue to act as agent of the HDMI specification and/or receive all the license fees paid by HDMI adopters.  After an initial period during which we received all of the royalties paid by HDMI adopters, in 2007, the HDMI founders reallocated the royalties to reflect each founder’s relative contribution of intellectual property to the HDMI specification, and following this reallocation, our portion of HDMI royalties was reduced to approximately 62%.   In 2010, HDMI founders again reviewed the allocation of HDMI royalties and agreed on an allocation formula that reduced the portion of HDMI royalties received by us in 2011 to approximately 50%. We expect the HDMI founders to continue to review the allocation of HDMI royalties from time to time and we cannot provide any assurance regarding the portion of HDMI royalties received by us in the future. 
 
           Through our wholly-owned subsidiary, MHL, LLC, we act as agent of the MHL specification and are responsible for promoting and administering the specification.  As agent, we are entitled to receive license fees paid by adopters of the MHL specification sufficient to reimburse us the costs we incur to promote and administer the specification.  Given the limited number of MHL adopters to date, we do not believe that the license fees paid by such adopters will be sufficient to reimburse us for these costs and there can be no assurance that the license fees paid by MHL adopters will ever be sufficient to reimburse us the cost we incur as agent of the specification.
 
We intend to promote and continue to be involved and actively participate in other standard setting initiatives. For example, through our acquisition of SiBEAM, Inc. in May 2011, we achieved SiBEAM’s prior position as founder and chair of the WirelessHD Consortium.  Accordingly, we may likely license additional elements of our intellectual property to others for use in implementing, developing, promoting or adopting standards in our target markets, in certain circumstances at little or no cost. This may make it easier for others to compete with us in such markets. In addition, even if we receive license fees and/or royalties in connection with the licensing of our intellectual property, there can be no assurance that such license fees and/or royalties will compensate us adequately.
 
Our business may be adversely impacted as a result of the adoption of competing standards and technologies by the broader market.
 
The success of our business to date has depended on our participation in standard setting organizations, such as the HDMI and MHL Consortiums, and the widespread adoption and success of those standards. From time to time, competing standards have been established which negatively impact the success of existing standards or jeopardize the creation of new standards. DisplayPort is an example of a competing standard on a different technology base which has created an alternative high definition connectivity solution in the PC space. The DisplayPort standard has been adopted by many large PC manufacturers. While currently not as widely recognized as the HDMI standard, DisplayPort does represent a viable alternative to the HDMI or MHL technologies. If DisplayPort should gain broader adoption, especially with non-PC consumer electronics, our HDMI or MHL businesses could be negatively impacted and our revenues could be reduced.
 
 
 

 
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Our business and future business is dependent on the continued adoption and widespread implementation of the HDMI, MHL specifications and the new implementation and adoption of the WirelessHD specifications.
 
Our future success is largely dependent upon the continued adoption and widespread implementation of the HDMI, MHL and WirelessHD specifications. In 2011, more than 80% of our total revenue was derived from the sale of HDMI and MHL enabled products and the licensing of our HDMI and MHL technology. Our leadership in the market for HDMI and MHL-enabled products and intellectual property has been based on our ability to introduce first-to-market semiconductor and IP solutions to our customers and to continue to innovate within the standard. Therefore, our inability to be first to market with our HDMI and MHL-enabled products and intellectual property or to continue to drive innovation in the HDMI and MHL specifications could have an adverse impact on our business going forward.
 
With our acquisition of SiBEAM, Inc. in May 2011, we acquired 60 GHz wireless technology that we hope will be made widely available and adopted by the marketplace through the efforts of the WirelessHD Consortium and incorporated into certain of our future products.   As was and is the case with our HDMI and MHL products and intellectual property, our success with this technology will depend on our ability to introduce first-to-market, WirelessHD-enabled semiconductor and IP solutions to our customers and to continue to innovate within the WirelessHD standard. There can be no guarantee that this wireless technology will be adopted by the marketplace and our inability to do this could have an adverse impact on our business going forward.
 
In addition, the establishment and adoption by the markets we sell into of a competing digital interconnect technology could have an adverse impact on our ability to sell our products and license our intellectual property and therefore our revenues and business.
 
           As the agent for the HDMI specification, we derive revenue from the license fees paid by adopters, and as a founder we derive revenue from the royalties paid by the adopters of the HDMI technology. Any development that has the effect of lowering the number of adopters of the HDMI standard will negatively impact these license fees and royalties. The allocation of license fees and royalty revenue among the HDMI founders is reviewed and discussed by the founders from time to time. There can be no assurance that going forward we will continue to act as agent of the HDMI specification or to receive the share of HDMI license fees and royalties that we currently receive. If our share of these license fees and royalties is reduced, this decision will have a negative impact on our revenues. Refer to the previously discussed risk factor above which also discusses the sharing of HDMI royalty revenues among various founders.
 
We act as agent of the MHL specification and are responsible for promoting and administering the specification.  As agent, we are entitled to receive license fees paid by adopters of the MHL specification sufficient to reimburse us the costs we incur to promote and administer the specification.  Given the limited number of MHL adopters to date, we do not believe that the license fees paid by such adopters will be sufficient to reimburse us for these costs and there can be no assurance that the license fees paid by MHL adopters will ever be sufficient to reimburse us the cost we incur as agent of the specification.
 
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 PC 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 and Silicon Image have been parties to business cooperation agreements;
 
·
Intel and Silicon Image are parties to a patent cross-license;

·
Intel and Silicon Image worked together to develop HDCP;
 
·
an Intel subsidiary has the exclusive right to license HDCP, of which we are a licensee;

·
Intel and Silicon Image were two of the promoters of the DDWG;
 
·
we believe that Intel has the market presence to affect adoption of HDMI by either endorsing complementary technology or promulgating a competing standard, which could affect demand for our products;

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

·
Intel may enter into or continue relationships with our competitors that can put us at a relative disadvantage.
 
           Our cooperation and competition with Intel can lead to positive benefits, if managed effectively. If our relationship with Intel is not managed effectively, it could seriously harm our business, negatively affect our revenue and increase our operating expenses.
 
 
 
 
 
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We have granted Intel Corporation certain rights with respect to our intellectual property, which could allow Intel to develop products that compete with ours or otherwise reduce the value of our intellectual property.
 
           We entered into a patent cross-license agreement with Intel in which each of us granted the other a license to use the patents filed by the grantor prior to a specified date, except for identified types of products. We believe that the scope of our license to Intel excludes our current products and anticipated future products. Intel could, however, exercise its rights under this agreement to use our patents to develop and market other products that compete with ours, without payment to us. Additionally, Intel’s rights to our patents could reduce the value of our patents to any third-party who otherwise might be interested in acquiring rights to use our patents in such products. Finally, Intel could endorse competing products, including a competing digital interface, or develop its own proprietary digital interface. Any of these actions could substantially harm our business and results of operations.
 
New Releases of Microsoft Windows® and Apple Mac OS® operating systems may render our chips inoperable.
 
ICs targeted to PC, laptop, or notebook designs (whether running Microsoft Windows ®, Apple Mac OS® or Linux operating systems) often require device driver software to operate.  This software is difficult to produce and requires various certifications such as Microsoft’s Windows Hardware Quality Labs (WHQL) before being released.  Each new revision of an operating system may require a new software driver and associated testing/certification.  Failure to produce this software can have a negative impact on our relation with Microsoft and/or Apple and may damage our reputation as a quality supplier of SATA and HDMI products in the eyes of end consumers.
 
We may become engaged in intellectual property litigation that could be time-consuming, may be expensive to prosecute or defend and could adversely affect our ability to sell our product.
 
In recent years, there has been significant litigation in the United States and in other jurisdictions involving patents and other intellectual property rights. This litigation is particularly prevalent in the semiconductor industry, in which a number of companies aggressively use their patent portfolios to bring infringement claims. In addition, in recent years, there has been an increase in the filing of so-called “nuisance suits,” alleging infringement of intellectual property rights. These claims may be asserted as counterclaims in response to claims made by a company alleging infringement of intellectual property rights. These suits pressure defendants into entering settlement arrangements to quickly dispose of such suits, regardless of merit. In addition, as is common in the semiconductor industry, from time to time we have been notified that we may be infringing certain patents or other intellectual property rights of others. Responding to such claims, regardless of their merit, can be time consuming, result in costly litigation, divert management’s attention and resources and cause us to incur significant expenses. As each claim is evaluated, we may consider the desirability of entering into settlement or licensing agreements. No assurance can be given that settlements will occur or that licenses can be obtained on acceptable terms or that litigation will not occur. In the event there is a temporary or permanent injunction entered prohibiting us from marketing or selling certain of our products, or a successful claim of infringement against us requiring us to pay damages or royalties to a third-party and we fail to develop or license a substitute technology, our business, results of operations or financial condition could be materially adversely affected.
 
           Any potential intellectual property litigation against us or in which we become involved may be expensive and time-consuming and may divert our resources and the attention of our executives.  It could also force us to do one or more of the following:
 
·
stop selling products or using technology that contains the allegedly infringing intellectual property;
 
·
attempt to obtain a license to the relevant intellectual property, which license may not be available on reasonable terms or at all; and

·
attempt to redesign products that contain the allegedly infringing intellectual property.
    
 If we take any of these actions, we may be unable to manufacture and sell our products. We may be exposed to liability for monetary damages, the extent of which would be very difficult to accurately predict. In addition, we may be exposed to customer claims, for potential indemnity obligations and to customer dissatisfaction and a discontinuance of purchases of our products while the litigation is pending. Any of these consequences could substantially harm our business and results of operations.
 
 
 
 
 
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We have entered into and may again be required to enter into, patent or other intellectual property cross-licenses.
     
Many companies have significant patent portfolios or key specific patents, or other intellectual property in areas in which we compete. Many of these companies appear to have policies of imposing cross-licenses on other participants in their markets, which may include areas in which we compete. As a result, we have been required, either under pressure of litigation or by significant vendors or customers, to enter into cross licenses or non-assertion agreements relating to patents or other intellectual property. This permits the cross-licensee, or beneficiary of a non-assertion agreement, to use certain or all of our patents and/or certain other intellectual property for free to compete with us. Our results of operations could be adversely affected by the use of cross-license or beneficiary of a non-assertion agreement of all our patents and/or certain other intellectual property.

We indemnify certain of our customers against infringement.
 
We indemnify certain of our customers for any expenses or liabilities resulting from third-party claims of infringements of patent, trademark, trade secret, or copyright rights by the technology we license. Certain of these indemnification provisions are perpetual from execution of the agreement and, in some instances; the maximum amount of potential future indemnification is not limited. To date, we have not paid any such claims or been required to defend any lawsuits with respect to any claim. In the event that we were required to defend any lawsuits with respect to our indemnification obligations, or to pay any claim, our results of operations could be materially adversely affected.
 
We must attract and retain qualified personnel to be successful and competition for qualified personnel is increasing in our market.
 
Our success depends to a significant extent upon the continued contributions of our key management, technical and sales personnel, many of who would be difficult to replace. The loss of one or more of these employees could harm our business. We generally do not have employment contracts with our key employees. Our success also depends on our ability to identify, attract and retain qualified technical, sales, marketing, finance and managerial personnel. Competition for qualified personnel is particularly intense in our industry and in our locations throughout the world. This makes it difficult to retain our key personnel and to recruit highly qualified personnel. We have experienced and may continue to experience, difficulty in hiring and retaining candidates with appropriate qualifications. To be successful, we need to hire candidates with appropriate qualifications and retain our key executives and employees. Replacing departing executive officers and key employees can involve organizational disruption and uncertain timing.
 
           The volatility of our stock price has had an impact on our ability to offer competitive equity-based incentives to current and prospective employees, thereby affecting our ability to attract and retain highly qualified technical personnel. If these adverse conditions continue, we may not be able to hire or retain highly qualified employees in the future and this could harm our business. In addition, regulations adopted by The NASDAQ Stock Market requiring shareholder approval for all stock option plans, as well as regulations adopted 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. In addition, FASB ASC No. 718-10, Stock Compensation, requires us to record compensation expense for options granted to employees. 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 have experienced transitions in our management team, our board of directors in the past and may continue to do so in the future, which could result in disruptions in our operations and require additional costs.
 
We have experienced a number of transitions with respect to our board of directors and executive officers in the past and we may experience additional transitions in our board of directors and management in the future.  Any such future transitions could result in disruptions in our operations and require additional costs.
 
 
 

 
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If our internal control over financial reporting or disclosure controls and procedures are not effective, there may be errors in our financial statements that could require restatement or our filings may not be timely and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price.  While we have not identified any material weaknesses in the past three years, we cannot assure you that a material weakness will not be identified in the future.
 
           Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each year and to include a management report assessing the effectiveness of our internal control over financial reporting in each Annual Report on Form 10-K. Section 404 also requires our independent registered public accounting firm to report on, our internal control over financial reporting.
 
           Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because changes in conditions or deterioration in the degree of compliance with policies or procedures may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
           As a result, we cannot assure you that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding disclosure controls and the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause us to fail to timely meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.
 
 We have been and may continue to become the target of securities class action suits and derivative suits which could result in substantial costs and divert management attention and resources.
 
           Securities class action suits and derivative suits are often brought against companies, particularly technology companies, following periods of volatility in the market price of their securities. Defending against these suits, even if meritless, can result in substantial costs to us and could divert the attention of our management.
 
Our operations and the operations of our significant customers, third-party wafer foundry and third-party assembly and test subcontractors are located in areas susceptible to natural disasters, the occurrence of which could adversely impact our supply of product, revenues, gross margins and results of operations.
 
           Our operations are headquartered in the San Francisco Bay Area, which is susceptible to earthquakes. TSMC, our outside foundry that manufactures almost all of our semiconductor products, is located in Taiwan.  Siliconware Precision Industries Co. Ltd., or SPIL, Advanced Semiconductor Engineering, or ASE, and Amkor Taiwan are subcontractors located in Taiwan that assemble and test our semiconductor products.
 
 
 

 
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In addition, the operations of certain of our significant customers are located in Japan and Taiwan. For the years ended December 31, 2011, 2010 and 2009 customers and distributors located in Japan generated 19.7%, 29.9% and 27.1%,of our total revenue, respectively, and customers and distributors located in Taiwan generated 26.2%, 22.5% and 25.2% of our total revenue, respectively. 
 
Taiwan and Japan are susceptible to earthquakes, typhoons and other natural disasters.
 
Our supply of product, revenues, gross margins and results of operations generally would be adversely affected if any of the following were to occur:
 
·
an earthquake or other disaster in the San Francisco Bay Area or the Los Angeles area were to damage our facilities or disrupt the supply of water or electricity to our headquarters;
 
·
an earthquake, typhoon or other natural disaster in Taiwan were to damage the facilities or equipment of TSMC, SPIL, ASE or Amkor or were to result in shortages of water, electricity or transportation, which occurrences would limit the production capacity of our outside foundry and/or the ability of our third party contractors to provide assembly and test services;

·
an earthquake, typhoon or other natural disaster in Taiwan or Japan were to damage the facilities or equipment of our customers or distributors or were to result in shortages of water, electricity or transportation, which occurrences would result in reduced purchases of our products, adversely affecting our revenues, gross margins and results of operations; or
 
·
an earthquake, typhoon or other disaster in Taiwan or Japan were to disrupt the operations of suppliers to our Taiwanese or Japanese customers, outside foundries or our third party contractors providing assembly and test services, which in turn disrupted the operations of these customers, foundries or third party contractors, resulting in reduced purchases of our products or shortages in our product supply.
 
In March 2011, Japan experienced a 9.0-magnitude earthquake which triggered extremely destructive tsunami waves.  The earthquake and tsunami significantly impacted the Japanese people and the overall economy of Japan resulting to reduced consumer spending in Japan and supply chain issues, which adversely affected our revenues and results of operations in 2011. 
 
Terrorist attacks or war could lead to economic instability and adversely affect our operations, results of operations and stock price.
     
The United States has taken and continues to take, military action against terrorism and currently has troops in Afghanistan. In addition, the current tensions regarding nuclear arms in North Korea and Iran could escalate into armed hostilities or war. Acts of terrorism or armed hostilities may disrupt or result in instability in the general economy and financial markets and in consumer demand for the OEM’s products that incorporate our products. Disruptions and instability in the general economy could reduce demand for our products or disrupt the operations of our customers, suppliers, distributors and contractors, many of whom are located in Asia, which would in turn adversely affect our operations and results of operations. Disruptions and instability in financial markets could adversely affect our stock price. Armed hostilities or war in South Korea could disrupt the operations of the research and development contractors we utilize there, which would adversely affect our research and development capabilities and ability to timely develop and introduce new products and product improvements.
 
 Changes in environmental rules and regulations could increase our costs and reduce our revenue.
 
           Several jurisdictions have implemented rules that would require that certain products, including semiconductors, be made “green,” which means that the products need to be lead free and be free of certain banned substances. All of our products are available to customers in a green format. While we believe that we are generally in compliance with existing regulations, such environmental regulations are subject to change and the jurisdictions may impose additional regulations which could require us to incur costs to develop replacement products. These changes will require us to incur cost or may take time or may not always be economically or technically feasible, or may require disposal of non-compliant inventory. In addition, any requirement to dispose or abate previously sold products would require us to incur the costs of setting up and implementing such a program.
 
 
 

 
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Provisions of our charter documents and Delaware law could prevent or delay a change in control and may reduce the market price of our common stock.
 
           Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These provisions include:
 
·
authorizing the issuance of preferred stock without stockholder approval;
 
·
providing for a classified board of directors with staggered, three-year terms;

·
requiring advance notice of stockholder nominations for the board of directors;
 
·
providing the board of directors the opportunity to expand the number of directors without notice to stockholders;

·
prohibiting cumulative voting in the election of directors;

·
limiting the persons who may call special meetings of stockholders; and
 
·
prohibiting stockholder actions by written consent.
 
Provisions of Delaware law also may discourage delay or prevent someone from acquiring or merging with us.
 
The price of our stock fluctuates substantially and may continue to do so.
 
   The stock market has experienced extreme price and volume fluctuations that have affected the market valuation of many technology companies, including Silicon Image. These factors, as well as general economic and political conditions, may materially and adversely affect the market price of our common stock in the future. The market price of our common stock has fluctuated significantly and may continue to fluctuate in response to a number of factors, including, but not limited to:
 
·
actual or anticipated changes in our operating results;
 
·
changes in expectations of our future financial performance;

·
changes in market valuations of comparable companies in our markets;
 
·
changes in market valuations or expectations of future financial performance of our vendors or customers;

·
changes in our key executives and technical personnel; and
 
·
announcements by us or our competitors of significant technical innovations, design wins, contracts, standards or acquisitions.
     
Due to these factors, the price of our stock may decline. In addition, the stock market experiences volatility that is often unrelated to the performance of particular companies. These market fluctuations may cause our stock price to decline regardless of our performance.
 
 
 
 
 
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Item 1B.  Unresolved Staff Comments
 
          None.

Item 2.  Properties
 
    Our current headquarters are located in Sunnyvale, California, consisting of approximately 128,154 square feet of space, which we lease through June 30, 2018. We also lease 25,227 square feet of space at two locations in China, which are being leased through July 23, 2013 and June 30, 2012. These facilities house our corporate offices, the majority of our engineering team, as well as a portion of our sales, marketing, operations and corporate services organizations.
  
           We had approximately 6,899 square feet of space in Irvine, California that is being leased through November 30, 2012, which we ceased to use in 2009. On December 19, 2011, we terminated the lease for this Irvine facility.

As a result of our acquisition of SiBEAM, Inc., we assumed a non-cancelable operating lease for 26,760 square feet at another location in Sunnyvale, California. The term of the lease agreement extends through September 2012.

In addition, we also lease facilities in Japan, Korea, Taiwan and India. We believe that our existing properties are in good condition and suitable for the conduct of our business.

Item 3.  Legal Proceedings
 
Information with respect to this item may be found in Note 9 in our notes to the consolidated financial statements included in Item 15(a) of this report.

Item 4.  Mine Safety Disclosures

Not applicable
 
    

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Our common shares have been traded on the NASDAQ Stock Market since our initial public offering on October 6, 1999. Our common shares trade under the symbol “SIMG”. Our shares are not listed on any other markets or exchanges. The following table shows the high and low closing prices for our common shares as reported by the NASDAQ Stock Market:
 

   
High
   
Low
 
Year Ended December 31, 2011
           
Fourth Quarter
  $ 6.93     $ 4.20  
Third Quarter
    7.22       4.55  
Second Quarter
    8.51       5.86  
First Quarter
    9.80       6.67  
                 
Year Ended December 31, 2010
               
Fourth Quarter
  $ 8.11     $ 4.51  
Third Quarter
    4.93       3.12  
Second Quarter
    3.97       3.00  
First Quarter
    3.15       2.29  
 
 

 
 
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As of February 23, 2012, we had approximately 92 holders of record of our common stock and the closing price of our common stock was $5.40. Because many of such shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.

Stock Performance Graph
 
 The following graph shows a comparison of cumulative total stockholder return, calculated on a dividend reinvested basis, for our common stock, the NASDAQ Composite Stock Market Index (US) and the S&P Information Technology Index. The graph assumes that $100 was invested in our common stock, the NASDAQ Composite Stock Market (US) and the S&P Information Technology Index from December 31, 2006 through December 31, 2011. No cash dividends have been declared on our common stock. Note that historic stock price performance is not necessarily indicative of future stock price performance.
 
GRAPHIC
 
Dividend Policy

We have never declared or paid cash dividends on shares of our capital stock. We intend to retain any future earnings to finance growth and do not anticipate paying cash dividends.
 
Securities Authorized for Issuance under Equity Compensation Plans

Information regarding securities authorized for issuance under equity compensation plans is incorporated by reference to our Proxy Statement for the 2012 Annual Meeting of Stockholders.
 
 

 
 
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Unregistered Securities Sold During the Year Ended December 31, 2011

We did not sell any unregistered securities during the year ended December 31, 2011.

Issuer Purchases of Equity Securities

In February 2007, our Board of Directors authorized a stock repurchase program under which we were authorized to purchase up to $100.0 million of common stock, on the open market, or in negotiated or block transactions, over a 36 month period.
 
In February 2008, our Board of Directors authorized an additional $100.0 million stock repurchase program, under which shares may be repurchased over a period of three years, to commence following completion of our accelerated stock repurchase plan (ASR) (see below). Purchases under this program may be increased, decreased or discontinued at any time without prior notice.
 
In February 2008, we entered into an ASR with Credit Suisse International (Credit Suisse), to purchase shares of common stock for an aggregate purchase price of approximately $62.0 million paid in February 2008.  We received 11.5 million shares under the agreement, based on a predetermined price, which was subject to an adjustment based on the volume weighted average price during the term of the ASR. In accordance with the ASR agreement, on June 25, 2008, we chose to settle the arrangement in cash (rather than shares) and made a final payment of approximately $6.2 million for the purchase of shares.  The ASR terminated on June 30, 2008 with final settlement taking place in July 2008, the settlement date. On the settlement date, Credit Suisse returned approximately $1.0 million based on the volume weighted average share price during the period. In accordance with the relevant accounting guidance, we reflected the 11.5 million shares repurchased and the $68.2 million paid to Credit Suisse as treasury stock and recorded the $1.0 million received as part of other income in the consolidated statement of income in the second and third quarters of 2008.
 
We had repurchased a total of 5.0 million shares at a total cost of $38.1 million under our original stock repurchase program announced on February 2007 and we had repurchased a total of approximately 11.5 million shares at a total cost of approximately $68.2 million under the new $100.0 million stock repurchase program approved by the Board of Directors in February 2008. We did not repurchase any common stock during the year ended December 31, 2011. The stock repurchase program expired in July 2011.
 
For securities authorized for issuance under equity compensation plans please See Note 10 in our notes to consolidated financial statements included in Item 15(a) of this report.
 
 
 

 
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Item 6.  Selected Financial Data
 
The following selected financial data should be read in connection with our consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. Historical results of operations are not necessarily indicative of future results.
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
   
(In thousands, except employees and per share data)
 
Statements of Operations Data:
                             
Revenue
  $ 221,009     $ 191,347     $ 150,589     $ 274,415     $ 320,503  
Cost of revenue (1)
    90,829       77,749       69,786       113,726       140,443  
Gross margin
    130,180       113,598       80,803       160,689       180,060  
% of revenue
    58.9 %     59.4 %     53.7 %     58.6 %     56.2 %
Research and development (2)
  $ 66,533     $ 55,313     $ 68,229     $ 84,819     $ 77,994  
% of revenue
    30.1 %     28.9 %     45.3 %     30.9 %     24.3 %
Selling, general and administrative (3)
  $ 55,277     $ 46,710     $ 55,000     $ 71,719     $ 70,340  
% of revenue
    25.0 %     24.4 %     36.5 %     26.1 %     21.9 %
Restructuring expense (4)
  $ 2,269     $ 3,259     $ 22,907     $ 5,858     $ -  
% of revenue
    1.0 %     1.7 %     15.2 %     2.1 %     -  
Amortization of intangible assets
  $ 1,585     $ 149     $ 4,478     $ 6,348     $ 3,549  
% of revenue
    0.7 %     0.1 %     3.0 %     2.3 %     1.1 %
Impairment of intangible assets
  $ 8,500     $ -     $ 28,296     $ -     $ -  
% of revenue
    3.8 %     -       18.8 %     -       -  
Impairment of goodwill
  $ -     $ -     $ 19,210     $ -     $ -  
% of revenue
    -       -       12.8 %     -       -  
Income (loss) from operations
  $ (3,984 )   $ 8,167     $ (117,317 )   $ (8,055 )   $ 28,155  
Net income (loss)
  $ (11,643 )   $ 8,182     $ (129,109 )   $ 10,063     $ 19,001  
Net income (loss) per share:
                                       
Basic
  $ (0.14 )   $ 0.11     $ (1.72 )   $ 0.13     $ 0.22  
Diluted
  $ (0.14 )   $ 0.10     $ (1.72 )   $ 0.13     $ 0.22  
Weighted average shares - basic
    80,603       76,957       74,912       75,570       85,557  
Weighted average shares - diluted
    80,603       78,277       74,912       76,626       87,388  
                                         
Consolidated Balance Sheet and Other Data as of Year End:
                                 
Cash and cash equivalents
  $ 37,125     $ 29,942     $ 29,756     $ 95,414     $ 137,822  
Short-term investments
  $ 124,301     $ 160,538     $ 120,866     $ 89,591     $ 111,889  
Working capital
  $ 161,923     $ 184,746     $ 163,482     $ 186,112     $ 223,688  
Total assets
  $ 266,073     $ 250,619     $ 225,438     $ 326,541     $ 412,948  
Other long-term liabilities
  $ 14,815     $ 13,356     $ 9,573     $ 8,064     $ 13,910  
Total stockholders' equity
  $ 204,516     $ 191,196     $ 171,519     $ 278,947     $ 313,847  
Regular full-time employees
    521       432       526       610       635  
                                         
(1) Includes stock-based compensation expense
  $ 670     $ 558     $ 986     $ 1,445     $ 1,597  
(2) Includes stock-based compensation expense
  $ 3,774     $ 2,631     $ 6,252     $ 7,134     $ 8,411  
(3) Includes stock-based compensation expense
  $ 5,076     $ 4,152     $ 10,863     $ 10,893     $ 9,442  
(4) Includes stock-based compensation expense
  $ -     $ -     $ -     $ 14     $ -  
 

 

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

Overview
 
Silicon Image is a leading provider of wireless and wired connectivity solutions that enable the reliable distribution and presentation of high-definition content for mobile, consumer electronics and PC markets. We deliver our technology via semiconductor and intellectual property products and services that are compliant with global industry standards and feature market leading Silicon Image innovations such as InstaPort™ and InstaPrevue™. Silicon Image’s products are deployed by the world’s leading electronics manufacturers in devices such as smart  phones, tablets, DTVs, Blu-ray Disc™ players, audio-video receivers, as well as desktop and notebook PCs. Silicon Image’s current growth is being driven by its mobile solutions supporting the latest mobile HD video connectivity standard, MHL™. Silicon Image has also driven the creation of the highly successful HDMI® and DVI™ industry standards. We have also established SPMT™, a memory interface standard for mobile devices and are actively involved with the standard for 60GHz wireless HD video/ audio – WirelessHD™. Via its wholly-owned subsidiary, Silicon Image offers manufacturers comprehensive product interoperability and standards compliance testing services from Simplay Labs, LLC.  Founded in 1995, we are headquartered in Sunnyvale, California, with regional engineering and sales offices in China, Japan, Korea, Taiwan and India.
 
 In May 2011, Silicon Image acquired SiBEAM, Inc., a provider of high-speed wireless communication products for uncompressed HD video in consumer electronics and personal computer applications, for $25.0 million in cash and Silicon Image stock.  With this acquisition, we became a promoter of the WirelessHD standard for transmitting HD content using 60GHz wireless technology.
 
Our mission is to create innovative HD connectivity solutions for mobile, CE, and PC markets to enhance the consumer experience.   Our “standards plus” business strategy is to grow the available market for our products and IP solutions through the development, introduction and promotion of market leading products which are based on industry standards but also include Silicon Image innovations that our customers value. We believe that our innovation around our core competencies, establishing industry standards and building strategic relationships, positions us to continue to drive change in the emerging world of high quality digital media storage, distribution and presentation.

Critical Accounting Policies
 
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and all known facts and circumstances that we believe are relevant. Actual results may differ materially from our estimates. We believe the accounting policies discussed below to be most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain.
 
Revenue Recognition
 
We recognize revenue when persuasive evidence of an arrangement exists, delivery or performance has occurred, the sales price is fixed or determinable and collectability is reasonably assured.
 
Revenue from products sold directly to end-users, or to distributors that are not entitled to price concessions and rights of return, is generally recognized when title and risk of loss has passed to the buyer which typically occurs upon shipment.
 
Revenue from products sold to distributors with agreements allowing for stock rotations is generally recognized upon shipment.  Reserves for stock rotations are estimated based primarily on historical experience and provided for at the time of shipment.
 
 

 
 
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                    For products sold to distributors with agreements allowing for price concessions and stock rotation rights/product returns, we recognize revenue based on when the distributor reports that it has sold the product to its customer. Our recognition of such distributor sell-through is based on point of sales reports received from the distributor which establishes a customer, quantity and final price. Revenue is not recognized upon our shipment of the product to the distributor, since, due to certain forms of price concessions, the sales price is not substantially fixed or determinable at the time of shipment. Price concessions are recorded when incurred, which is generally at the time the distributor sells the product to its customer. Additionally, these distributors have stock rotation rights permitting them to return products to us, up to a specified amount for a given period of time. When the distributor reports that it has sold product to its customer, our sales price to the distributor is fixed. Once we receive the point of sales reports from the distributor, we have satisfied all the requirements for revenue recognition with respect to the product reported as sold and any product returns/stock rotation and price concession rights that the distributor has under its distributor agreement with us lapsed at that time. Pursuant to our distributor agreements, older, end-of-life and certain other products are generally sold with no right of return and are not eligible for price concessions. For these products, revenue is recognized upon shipment and title transfer assuming all other revenue recognition criteria are met.

 From time to time we enter into “conversion agreements” for certain of our parts for certain identified end customers with our distributors who previously had the rights for price concessions and product returns. The “conversion agreement” converts the previously existing distributor relationship for these parts and identified customers into a sell in distributor relationship whereby the distributor does not have price protection rights. Revenue for such conversions is recorded at the time such conversion agreements are signed. 

             At the time of shipment to distributors, we record a trade receivable for the selling price since there is a legally enforceable right to payment, we relieve inventory for the carrying value of goods shipped since legal title has passed to the distributor and until revenue is recognized, we record the gross margin in “deferred margin on sale to distributors,” a component of current liabilities in our consolidated balance sheet. Deferred margin on the sale to distributor effectively represents the gross margin on the sale to the distributor. However, the amount of gross margin we recognize in future periods will be less than the originally recorded deferred margin on sales to distributor as a result of negotiated price concessions. We sell each item in our product price book to all of our distributors worldwide at a relatively uniform list price. However, distributors resell our products to end customers at a very broad range of individually negotiated price points based on customer, product, quantity, geography, competitive pricing and other factors. The majority of our distributors’ resales are priced at a discount from the list price. Often, under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed. Thus, a portion of the “deferred margin on the sale to distributor” balance represents a portion of distributors’ original purchase price that will be remitted back to the distributor in the future. The wide range and variability of negotiated price concessions granted to the distributors does not allow us to accurately estimate the portion of the balance in the deferred margin on the sale to distributors that will be remitted back to the distributors. In addition to the above, we also reduce the deferred margin by anticipated or determinable future price protections based on revised price lists, if any.
 
                   We derive revenue from the license of our IP. We enter into IP licensing agreements that generally provide licensees the right to incorporate our IP components in their products with terms and conditions that vary by licensee. Revenue earned under contracts with our licensees is classified as licensing revenue. Our IP licensing agreements generally include multiple elements, which may include one or more off-the-shelf and/or customized IP licenses bundled with support services covering a fixed period of time, usually one year. During 2010 and 2009, we followed the guidance in FASB ASC No. 605-25-25, Multiple-Element Arrangements Revenue Recognition, to determine whether there was more than one unit of accounting. To the extent that the deliverables were separable into multiple units of accounting, we allocated the total fee on such arrangements to the individual units of accounting using the residual method, if objective and reliable evidence of fair value did not exist for delivered elements. We then recognized revenue for each unit of accounting depending on the nature of the deliverable(s) comprising the unit of accounting in accordance with the revenue recognition criteria.
 
Beginning in the year ended December 31, 2011, for such multiple element IP licensing arrangements, we follow the guidance in FASB ASU No. 2009-13, Revenue Recognition (ASC Topic 605) - Multiple-Deliverable Revenue Arrangements, to determine whether there is more than one unit of accounting.
 
 

 
 
34

 
 

For multiple-element arrangements, we allocate revenue to all deliverables based on their relative selling prices. In such circumstances, we use a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (VSOE), (ii) third-party evidence of selling price (TPE), and (iii) best estimate of the selling price (ESP). VSOE generally exists only when we sell the deliverable separately and is the price actually charged by us for that deliverable. ESPs reflect our best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis. For the elements of IP licensing agreements we concluded that VSOE exists only for our support services based on periodic stand-alone renewals. For all other elements in IP licensing agreements, we concluded that no VSOE or TPE exists because these elements are almost never sold on a stand-alone basis by us or our competitors.

Our process for determining ESP for deliverables without VSOE or TPE considers multiple factors that may vary depending upon the unique facts and circumstances related to each deliverable. The key factors considered by us in developing the ESPs include prices charged by us for similar offerings, if any, our historical pricing practices, the nature and complexity of different technologies being licensed.

Amounts allocated to the delivered off-the-shelf IP licenses are recognized at the time of sale provided the other conditions for revenue recognition have been met. Amounts allocated to the customized IP licenses are recognized by percentage of completion or completed contract method depending on the nature of the customization project. Amounts allocated to the support services are deferred and recognized on a straight-line basis over the support period, usually one year.

Certain licensing agreements provide for royalty payments based on agreed upon royalty rates. Such rates can be fixed or variable depending on the terms of the agreement. The amount of revenue we recognize is determined based on a time period or on the agreed-upon royalty rate, extended by the number of units shipped by the customer. To determine the number of units shipped, we rely upon actual royalty reports from our customers when available and rely upon estimates in lieu of actual royalty reports when we have a sufficient history of receiving royalties from a specific customer for us to make an estimate based on available information from the licensee such as quantities held, manufactured and other information. These estimates for royalties necessarily involve the application of management judgment. As a result of our use of estimates, period-to-period numbers are “trued-up” in the following period to reflect actual units shipped. In cases where royalty reports and other information are not available to allow us to estimate royalty revenue, we recognize revenue only when royalty reports are received. We also perform compliance audits for our licenses and any additional royalties as a result of the compliance audits are generally recorded as revenue in the period when the compliance audits are settled.
 
                     For contracts related to licenses of our technology that involve significant modification, customization or engineering services, we recognize revenue in accordance with the provisions of FASB ASC No. 605-35-25, Construction-Type and Production-Type Contracts Revenue Recognition. Revenues derived from such license contracts are accounted for using the percentage-of-completion method.
 
                    We determine progress to completion based on input measures using labor-hours incurred by our engineers. The amount of revenue recognized is based on the total contract fees and the percentage of completion achieved. Estimates of total project requirements are based on prior experience of customization, delivery and acceptance of the same or similar technology and are reviewed and updated regularly by management. The estimates for labor-hours have not been significantly different as compared to actual labor-hours. If there is significant uncertainty about customer acceptance, or the time to complete the development or the deliverables by either party, we apply the completed contract method. The contract is considered substantially complete upon customer acceptance. If application of the percentage-of-completion method results in recognizable revenue prior to an invoicing event under a customer contract, we recognize the revenue and record an unbilled receivable assuming collectability is reasonably assured.  Amounts invoiced to our customers in excess of recognizable revenues are recorded as deferred revenue.
 
 
 

 
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Stock-based Compensation
 
We account for stock-based compensation in accordance with the provisions of FASB ASC No.  718-10-30, Stock Compensation Initial Measurement,  which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors including employee stock options, restricted stock units (RSUs), performance share awards and employee stock purchases under our Employee Stock Purchase Plan (ESPP) based on estimated fair values.  Following the provisions of FASB ASC No. 718-50-25, Employee Share Purchase Plans Recognition,  our ESPP is considered a compensatory plan, therefore, we are required to recognize compensation cost for grants made under the ESPP.   We estimate the fair value of stock options granted using the Black-Scholes-Merton (BSM) option-pricing model and a single option award approach. The BSM model requires various highly subjective assumptions including volatility, expected option life, and risk-free interest rate. Management estimates volatility for a given option grant by evaluating the historical volatility of the period immediately preceding the option grant date that is at least equal in length to the option’s expected term. Consideration is also given to unusual events (either historical or projected) or other factors that might suggest that historical volatility will not be a good indicator of future volatility. The expected life of an award is based on historical experience and on the terms and conditions of the stock awards granted to employees, as well as the potential effect from options that had not been exercised at the time. In accordance with FASB ASC No. 718-10-35, Subsequent Measurement of Stock Compensation, we generally recognize stock-based compensation expense, net of estimated forfeitures, on a ratable basis for all share-based payment awards over the requisite service periods of the awards, which is generally the vesting period or the remaining service (vesting) period.
 
The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and recognize expense only for those shares expected-to-vest. If our actual forfeiture rate is materially different from our estimate, our recorded stock-based compensation expense could be different.

Financial Instruments
 
Cash Equivalents and Marketable Securities

                   All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents. Our investments in debt and marketable equity securities have been classified and accounted for as available-for-sale. We determine the appropriate classification of such securities at the time of purchase and we reevaluate such classification as of each balance sheet date. We classify our marketable debt securities as short-term investments because of our intention to sell the securities within a relatively short period of time. Unrealized gains and losses on these investments are reported as a separate component of accumulated other comprehensive income (loss). The investments are adjusted for amortization of premiums and discounts to maturity and such amortization is included in interest income. We periodically assess whether our investments with unrealized loss positions are other than temporarily impaired. Other-than-temporary impairment charges exists when we have the intent to sell the security and we will more likely than not be required to sell the security before anticipated recovery or we do not expect to recover the entire amortized cost basis of the security. We determine other than temporary impairments based on the specific identification method and are reported in the consolidated statements of operations.
    
Derivative Financial Instruments
 
We account for our derivative instruments as either assets or liabilities and we carry them at fair value. Derivatives that are not defined as hedges must be adjusted to fair value through earnings. For derivative instruments that hedge the exposure to variability in expected future cash flows that are designated as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income in stockholders’ equity and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of the derivative gain (loss) is reported in each reporting period in other income (expense) on our consolidated statements of operations. To receive hedge accounting treatment, cash flow hedges must be highly effective in offsetting changes to expected future cash flows on hedged transactions.
 
 

 
 
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Fair Value Measurements
      
     We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. We define fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, which are required to be recorded at fair value, we consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk.
 
     The fair value measurement standard establishes a consistent framework for measuring fair value whereby inputs used in valuation techniques are assigned a hierarchical level.  The assignment to a level is based on whether the market participant assumptions used in determining fair value are obtained from independent sources (observable inputs) or reflect our own assumptions of market participant valuation (unobservable inputs).  Categorization within the fair value hierarchy is determined by the lowest level of input that is significant to the fair value measurement. The following are the hierarchical levels of inputs to measure fair value:
 
        Level 1
Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;
   
        Level 2
Quoted prices for identical assets and liabilities in markets that are inactive; quoted prices for similar assets and liabilities in active markets; or significant inputs that are observable, either directly or indirectly; or
   
        Level 3
Prices or valuations that require inputs that are both unobservable and significant to the fair value measurement.

     We consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and view an inactive market as one in which there are few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers.
 
         A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Allowance for Doubtful Accounts
 
           We review collectability of accounts receivable on an on-going basis and provide an allowance for amounts we estimate may not be collectible. During our review, we consider our historical experience, the age of the receivable balance, the credit-worthiness of the customer and the reason for the delinquency. Delinquent account balances are written-off after we have determined that the likelihood of collection is remote.

Inventories
 
           We record inventories at the lower of actual cost, determined on a first-in first-out (FIFO) basis, or market. Actual cost approximates standard cost, adjusted for variances between standard and actual. Standard costs are determined based on our estimate of material costs, manufacturing yields, costs to assemble, test and package our products and allocable indirect costs. We record differences between standard costs and actual costs as variances. These variances are analyzed and are either included on the consolidated balance sheet or the consolidated statements of operations in order to state the inventories at actual costs on a FIFO basis. Standard costs are re-evaluated quarterly.
 
 
 

 
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Provisions are recorded for excess and obsolete inventory and are estimated based on a comparison of the quantity and cost of inventory on hand to our forecast of customer demand. Customer demand is dependent on many factors and requires us to use significant judgment in our forecasting process. We also make assumptions regarding the rate at which new products will be accepted in the marketplace and at which customers will transition from older products to newer products. Generally, inventories in excess of six months forecasted demand are written down to zero (unless specific facts and circumstances warrant no write-down or a write-down to a different value) and the related provision is recorded as a cost of revenue. Once a provision is established, it is maintained until the product to which it relates is sold or otherwise disposed of, even if in subsequent periods we forecast demand for the product.
 
Long-Lived Assets Including Goodwill and Other Acquired Intangible Assets

           We review property and equipment, goodwill and other certain identifiable intangibles for impairment. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amounts to future undiscounted cash flows the assets are expected to generate. If property and equipment and certain identifiable intangibles are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds its fair market value. We do not amortize goodwill, rather such asset is required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired.

In 2009, we determined that our goodwill was impaired and recognized a total impairment charge of $19.2 million in our 2009 consolidated statement of operations under operating expenses, “Impairment of goodwill,” which reduced goodwill to zero as of December 31, 2009. Also, in 2009, we made an impairment evaluation of our intangible and other long-lived assets and determined that our investment in certain technology of Sunplus Technology Co., Ltd. (the “Sunplus IP”) was impaired and recognized an impairment charge of $28.3 million in our 2009 consolidated statement of operations under operating expenses, “Impairment of intangible assets,” which reduced the investment in Sunplus IP to zero as of December 31, 2009.

In the fourth quarter of 2011 and again subsequent to our year ended December 31, 2011, we assessed our advances to a third party for intellectual properties for impairment. We concluded that the intangible assets related to these advances were fully impaired as of December 31, 2011, and have written them off. This conclusion was based on our determination that certain of the technologies was no longer aligned with our product roadmap due to a change in strategic focus and therefore, would not be used. The remaining technologies were impaired due to an adverse change in the extent and manner in which the technology was expected to be utilized by a strategic customer, as well as the competitive environment in which the technology was intended for use. In connection with this assessment, we recognized an impairment charge of $8.5 million in our 2011 consolidated statement of operations under operating expenses, “Impairment of intangible assets.” There were no intangible asset impairment charges recorded in the year ended December 31, 2010. There were no goodwill impairment charges recorded in the years ended December 31, 2011 and 2010.

We amortize our intangible assets with definite lives over their estimated useful lives and we review these assets for impairment whenever events or changes in circumstances indicate that the assets may be impaired.

 Investment in an Unconsolidated Affiliate

In July 2011, we purchased a 17.5% equity ownership interest in a privately-held company for $7.5 million in cash. We use the equity method to account for this investment since the privately-held company is a limited liability company and our ownership interest is greater than 5%. Equity method investment is recorded at original cost and adjusted periodically to recognize (1) our proportionate share of the privately-held company’s net income or loss after the date of investment, adjusted for any difference between our investment and underlying equity in net assets of the privately-held company at the date of investment, (2) additional contributions made and dividends or distributions received, and (3) impairment loss resulting from adjustment to net realizable value. We eliminate all intercompany transactions in accounting for our equity method investment. During the year ended December 31, 2011, we recorded $1.0 million in “Equity in net loss of an unconsolidated affiliate” on the consolidated statements of operations, representing 17.5% of our proportionate share of the privately-held company’s net loss.
 
 

 
 
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We assess the potential impairment of the equity method investment by considering available evidence such as ability to meet expense forecasts, history of operating results, negative or positive earnings and cash flow outlook, and the financial condition and prospects for the privately-held company’s business segment that might indicate a loss in value. We did not recognize any impairment loss on investment in an unconsolidated affiliate during the year ended December 31, 2011.

 Income Taxes

We account for income taxes in accordance with the FASB ASC No. 740 (ASC 740), Accounting for Income Taxes. We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, tax benefits and deductions and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. Significant changes to these estimates may result in an increase or decrease to our tax provision in the subsequent period when such a change in estimate occurs.
     
We use an asset and liability approach for accounting of deferred income taxes, which requires recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements, but have not been reflected in our taxable income. Estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain deferred income tax assets, which arise from temporary differences and carry-forwards. Deferred income tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled. We regularly assess the likelihood that our deferred income tax assets will be realized based on the realization criteria set forth in ASC No. 740. To the extent that we believe any amounts are not more likely than not to be realized, we record a valuation allowance to reduce our deferred income tax assets. In the event we determine that all or part of the net deferred tax assets are not realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period such determination is made. Similarly, if we subsequently realize deferred income tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in an adjustment to earnings in the period such determination is made. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize and measure potential liabilities based upon criteria set forth in ASC 740. Based upon these criteria, we estimate whether, and the extent to which, additional taxes will be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities may result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. If our estimate of tax liabilities is less than the amount ultimately assessed, a further charge to expense would result.
 
Significant judgment is required in determining any valuation allowance recorded against deferred income tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred income tax assets that could be realized, we will adjust our valuation allowance with a corresponding effect to the provision for income taxes in the period in which such determination is made.
 
Significant judgment is also required in evaluating our uncertain tax positions under ASC 740 and determining our provision for income taxes. Although we believe our reserves for uncertain tax positions are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different from the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made.  The provision for income taxes includes the effect of reserves for uncertain tax positions and any changes to the reserves that are considered appropriate, as well as the related net interest and penalties, if applicable.
 
 

 
 
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Restructuring Expenses
 
We record provisions for workforce reduction costs and exit costs when they are probable and estimable. Severance paid under ongoing benefit arrangements is recorded in accordance with FASB ASC No. 712-10-25, Nonretirement Postemployment Benefits Recognition. One-time termination benefits and contract settlement and lease costs are recorded in accordance with FASB ASC No. 420-10-25, Exit or Disposal Cost Obligations Recognition. At each reporting date, we evaluate our accruals related to workforce reduction charges, contract settlement and lease costs to ensure that these accruals are still appropriate. Restructuring expense accruals related to future lease commitments on exited facilities include estimates, primarily related to sublease income over the lease terms and other costs for vacated properties. Increases or decreases to the accruals for changes in estimates are classified as restructuring expenses in the consolidated statements of operations.
 
Loss Contingencies  
 
We are subject to the possibility of various loss contingencies arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset, or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We record a charge equal to the minimum estimated liability for litigation costs or a loss contingency only when both of the following conditions are met: (i) information available prior to issuance of our consolidated financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated and no point within the range of probable loss is more likely than other points within the range. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.
 
From time to time, we are involved in disputes, litigation, and other legal actions. We are aggressively defending our current litigation matters. However, there are many uncertainties associated with any litigation and these actions or other third-party claims against us may cause us to incur costly litigation and/or substantial settlement charges. In addition, the resolution of any future intellectual property litigation may require us to make royalty payments, which could adversely affect gross margins in future periods. If any of those events were to occur, our business, financial condition, results of operations, and cash flows could be adversely affected. The actual liability in any such matters may be materially different from our estimates, which could result in the need to adjust our liability and record additional expenses.

 Guarantees, Indemnifications and Warranty Liabilities
 
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.
 
                   At the time of revenue recognition, we provide an accrual for estimated costs (included in accrued liabilities in the accompanying consolidated balance sheets) to be incurred pursuant to our warranty obligation. Our estimate is based primarily on historical experience.

Contingencies and Concentrations
 
                   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 61.4%, 58.3% and 44.2% of our total revenue in 2011, 2010 and 2009, respectively. The percentage of revenue generated through distributors tends to be significant, since many OEMs rely upon third-party manufacturers or distributors to provide purchasing and inventory management functions. In 2011, 50.1% of our total revenue was generated through distributors, compared to 61.1% and 59.2% in 2010 and 2009, respectively. Samsung Electronics accounted for 23.4%, 17.0% and 7.5% of our total revenue in 2011, 2010 and 2009, respectively. Edom Technology comprised 13.8%, 9.0% and 5.9% of our total revenue in 2011, 2010 and 2009, respectively. Weikeng generated 10.2%, 9.9% and 10.3% of our total revenue in 2011, 2010 and 2009, respectively. Microtek Corporation comprised 7.9%, 11.0% and 11.9% of our total revenue in 2011, 2010 and 2009, respectively. Innotech Corporation comprised 6.2%, 11.3% and 7.3% of our total revenue in 2011, 2010 and 2009, respectively.
 
 
 

 
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We have been named as defendants in a number of judicial and administrative proceedings incidental to our business and may be named again from time to time, 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, financial position or cash flows.
 
A significant portion of our revenue is generated from products sold overseas. Sales (including licensing) to customers in Asia, including distributors, generated 60.8%, 73.6% and 67.3% of our total revenue in 2011, 2010 and 2009, respectively. The reason for our geographical concentration in Asia is that most of our products are incorporated into flat panel displays, graphic cards, motherboards and cell phones, 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. Primarily all revenue to date has been denominated in U.S. dollars.

Recent Accounting Pronouncements
 
In September 2011, Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-08, Testing Goodwill for Impairment (Accounting Standards Codification (ASC) Topic 350). Under the amendments in this ASU, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any. Under the amendments in this ASU, an entity has also the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. The amendments are effective for annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted.

In June 2011, FASB issued ASU No. 2011-05, Comprehensive Income (ASC Topic 220). This ASU provides the guidance on the presentation of comprehensive income, which eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. The guidance allows two presentation alternatives: (1) present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income; or (2) in two separate, but consecutive, statements of net income and other comprehensive income. This guidance is effective as of the beginning of a fiscal year that begins after December 15, 2011. Early adoption is permitted, but full retrospective application is required under both presentation alternatives.

In May 2011, FASB issued ASU No. 2011-04, Fair Value Measurements (ASC Topic 820). This ASU provides additional guidance on fair value disclosures. This guidance contains certain updates to the measurement guidance as well as enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for “Level 3” measurements including enhanced disclosure for: (1) the valuation processes used by the reporting entity; and (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any. This guidance is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. This guidance will be effective for us on January 1, 2012. Other than requiring additional disclosures on our “Level 3” disclosures, the adoption of this new guidance will not have a material impact on our consolidated financial statements.

 

 
 
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Annual Results of Operations
 
Revenue by product line was as follows:
 
   
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Mobile
  $ 65,789       525.1 %   $ 10,525       292.3 %   $ 2,683  
Consumer Electronics
    87,922       -25.6 %     118,192       21.2 %     97,502  
Personal Computers
    20,523       -14.9 %     24,124       7.3 %     22,483  
Total product revenue
  $ 174,234       14.0 %   $ 152,841       24.6 %   $ 122,668  
Percentage of total revenue
    78.8 %             79.9 %             81.5 %
Licensing revenue
  $ 46,775       21.5 %   $ 38,506       37.9 %   $ 27,921  
Percentage of total revenue
    21.2 %             20.1 %             18.5 %
Total revenue
  $ 221,009       15.5 %   $ 191,347       27.1 %   $ 150,589  
 
     Our consolidated total revenue for the year ended December 31, 2011 was $221.0 million, an increase of $29.7 million, or 15.5%, from the year ended December 31, 2010. The increase in product revenue was primarily due to increased demand for our mobile products. Revenue from our mobile products during the year ended December 31, 2011 increased by $55.3 million or 525.1% compared to the same period in 2010. The increase in our mobile products was primarily due to the successful launch of our newest MHL transmitter product. This product was introduced in the latter part of fiscal year 2010. Since then, we have seen increased shipments quarter after quarter for this product. The revenue growth in our mobile market was partially offset by the decrease in revenue in our CE market. Revenue from our CE market for the year ended December 31, 2011 decreased by $30.3 million compared to the CE revenue generated in the same period in 2010. The decrease in our CE revenue was primarily due to global macro-economic pressures that drove consumers to purchase lower priced CE products, and the 9.0 magnitude earthquake and subsequent tsunami that hit Japan in March 2011, which has affected both demand in Japan and the global supply chain for CE products.  High-end DTVs with the latest features and capabilities (the market segment where we typically deliver our latest CE innovations) have been particularly affected by this trend.  The earthquake in Japan had a two-fold impact.  First, it reduced demand for higher-end TVs in the domestic Japanese market. Secondly, as a result of damage to the production facilities, the brands shifted a portion of their TV production to original design manufacturers (ODMs) outside of Japan which typically supply the lower-end to mid-range DTV market. Our revenue from Japan for the year ended December 31, 2011 was 19.7% as compared to 29.9% for the same periods in 2010. Our revenues from Korea and Taiwan for the year ended December 31, 2011 was higher as compared to the same period in 2010 due to higher shipments.

From time to time we enter into “conversion agreements” for certain of our parts for certain identified end customers with our distributors who previously had the rights for price concessions and product returns. The “conversion agreement” converts the previously existing distributor relationship for these parts and identified customers into a sell in distributor relationship whereby the distributor does not have price protection rights. Revenue for such conversions is recorded at the time such conversion agreements are signed.  For the years ended December 31, 2011 and 2009, we recorded $1.6 million and $2.8 million, respectively, in revenue under such arrangement. There were no such conversions in 2010.
 
Our licensing activity is complementary to our product sales and helps us to monetize our intellectual property and accelerate market adoption curves associated with our technology.  IP licensing continues to represent an important part of our overall business.  Revenue from licensing accounted for 21.2% and 20.1% of our total revenue for the years ended December 31, 2011 and 2010, respectively. Licensing revenue during the year ended December 31, 2011 increased by $8.3 million or 21.5% when compared to the same period in 2010. This was primarily due to increase in new IP licenses granted by us during 2011 of approximately $4.8 million, increase in HDMI licensing and royalties of $2.2 million and increase in royalties and other activities of 1.0 million. HDMI LLC revenue was higher by $2.2 million mainly due to increase in HDMI product shipment activity reported by adopters in 2011 as compared to 2010. Royalty revenues recorded from the completion of certain licensing audit during the year ended December 31, 2011 decreased by $0.3 million as compared to 2010.

 Our consolidated total revenue for the year ended December 31, 2010 was $191.3 million, an increase of $40.8 million, or 27.1%, from the year ended December 31, 2009. The significant increase in revenue was primarily due to increased demand for our CE products and the increase in our licensing revenue. Revenue from our CE products and licensing during the year ended December 31, 2010 increased by $20.7 million or 21.2% and $10.6 million or 37.9%, respectively, compared to the same period in 2009. The increase in our CE products was primarily due to an increase in unit product shipments. Our unit shipments for CE during the year ended December 31, 2010 increased by 38.5%, compared to the same period in 2009. The higher unit shipments in our CE product line were primarily driven by increased demand for our port processors from the DTV market. The increase in our mobile products was primarily due to the new products we introduced in 2010. The impact of the 38.5% increase in unit shipments to our CE revenue was partially offset by a 7.7% decrease in the average selling price of our CE products.

Revenue from licensing accounted for 20.1% and 18.5% of our total revenue for the years ended December 31, 2010 and 2009, respectively. Licensing revenue during the year ended December 31, 2010 increased by $10.6 million or 37.9% when compared to the same period in 2009. The significantly higher licensing revenue during the year ended December 31, 2010 compared to the licensing revenue during the same period in 2009 was primarily due to the increase in licensing activities in 2010 and to the $7.1 million additional royalties we recorded during the year ended December 31, 2010 as a result of the completion of certain licensing audit activities during that year.   
 
 

 
 
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COST OF REVENUE AND GROSS MARGIN
 
   
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Cost of product revenue (1)
  $ 90,035       16.2 %   $ 77,480       13.0 %   $ 68,574  
Product gross profit
    84,199       11.7 %     75,361       39.3 %     54,094  
Product gross profit margin
    48.3 %             49.3 %             44.1 %
                                         
(1) Includes stock-based compensation expense
  $ 670             $ 558             $ 986  
                                         
Cost of licensing revenue
  $ 794       195.2 %   $ 269       -77.8 %   $ 1,212  
Licensing gross profit
    45,981       20.3 %     38,237       43.2 %     26,709  
Licensing gross profit margin
    98.3 %             99.3 %             95.7 %
                                         
Total cost of revenue
  $ 90,829       16.8 %   $ 77,749       11.4 %   $ 69,786  
Total gross profit
    130,180       14.6 %     113,598       40.6 %     80,803  
Total gross profit margin
    58.9 %             59.4 %             53.7 %

Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, and costs to license our technology which involves modification, customization or engineering services, as well as other overhead costs relating to the aforementioned costs including stock-based compensation expense. Our overall gross profit, as a percentage of revenue, was 58.9% for the year ended December 31, 2011 and 59.4% for the year ended December 31, 2010.  Total cost of revenue for the year ended December 31, 2011 increased by $13.1 million or 16.8%, when compared to the total cost of revenue in the same period in 2010. The increase in the total cost of revenue was primarily due to the growth in revenue volume during the same comparative periods. 

Product gross profit margin for the year ended December 31, 2011 was 48.3%, compared to 49.3% for the year ended December 31, 2010. The 1.0% decrease in product gross profit margin during the year ended December 31, 2011 compared to the same period in 2010 was primarily attributable to the decrease in average selling price per unit from $1.45 during year ended December 31, 2010 to $1.23 during the year ended December 30, 2011, partially offset by decrease in wafer, testing and assembly cost in 2011 than in 2010 and better overhead absorption due to the increase in volume.
 
Our licensing gross profit margin for the year ended December 31, 2011 was 98.3%, compared to 99.3% for the year ended December 31, 2010.  Licensing gross margin during the year ended December 31, 2011 decreased by 1.0%, compared to the same period in 2010 primarily due to higher mix of IP customization projects during the year ended December 31, 2011 compared to the same period in 2010.

Overall gross profit, as a percentage of revenue, was 59.4% for the year ended December 31, 2010 and 53.7% for the year ended December 31, 2009.  Total cost of revenue for the year ended December 31, 2010 increased by $8.0 million or 11.4%, when compared to the total cost of revenue in the same period in 2009. The increase in the total cost of revenue was primarily due to the growth in revenue volume during the same comparative periods. 
 
Product gross profit margin for the year ended December 31, 2010 was 49.3%, compared to 44.1% for the year ended December 31, 2009. The 5.2% increase in product gross profit margin during the year ended December 31, 2010 compared to the same period in 2009 was primarily attributable to the 5.3% increase in the gross profit margin due to the wafer, testing and assembly cost reductions in 2010 and  4.0% increase in the gross profit margin  due to better yields, better overhead absorption resulting from our higher revenue volume in 2010 than in 2009 and lower stock-based compensation expense, partially offset by the 4.1% decrease in the gross profit margin due to the decrease in the average selling price.
 
Our licensing gross profit margin for the year ended December 31, 2010 was 99.3%, compared to 95.7% for the year ended December 31, 2009.  Licensing gross margin during the year ended December 31, 2010 increased by 3.6%, compared to the same period in 2009 primarily due to higher revenue and lower mix of IP customization projects during the year ended December 31, 2010 compared to the same period in 2009.
 

 

 
43

 


 
OPERATING EXPENSES
 
Research and development
 
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Research and development(1)
  $ 66,533       20.3 %   $ 55,313       -18.9 %   $ 68,229  
Percentage of total revenue
    30.1 %             28.9 %             45.3 %
(1) Includes stock-based  compensation expense
    3,774               2,631               6,252  

Research and development (R&D).  R&D expense consists primarily of employee compensation and benefits, fees for independent contractors, the cost of software tools used for designing and testing our products and costs associated with prototype materials. R&D expense for the year ended December 31, 2011 increased by $11.2 million or 20.3%, compared to the R&D expense incurred in the same period in 2010.  This increase was primarily attributable to the increase in compensation related expenses as a result of the two acquisitions that we completed in 2011, increase in project related expenses and increase in stock-based compensation expense. R&D expense for the year ended December 31, 2011 included stock-based compensation expense of $3.8 million, as compared to $2.6 million for the year ended December 31, 2010. Our R&D head count as of December 31, 2011 was 257 employees as compared to 207 employees as of December 31, 2010 due to the acquisitions of SiBEAM and ABT.

R&D expense decreased by $12.9 million or 18.9% for the year ended December 31, 2010 as compared to the comparable period in 2009, primarily due to the decrease in stock-based compensation expense, reduced expenses due to the restructuring programs implemented in 2009 by closing two R&D sites in Germany and expense management controls implemented internally, partially offset by additional expenses incurred as a result of increasing our R&D presence in Asia in 2010, increase in bonus expense driven by the better overall company performance.
 

Selling, general and administrative
 
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Selling, general and administrative (1)
  $ 55,277       18.3 %   $ 46,710       -15.1 %   $ 55,000  
Percentage of total revenue
    25.0 %             24.4 %             36.5 %
(1) Includes stock-based  compensation expense
    5,076               4,152               10,863  
  
Selling, general and administrative (SG&A). SG&A expense consists primarily of compensation, including stock-based compensation expense, sales commissions, professional fees, and marketing and promotional expenses. SG&A expense during the year ended December 31, 2011 was $55.3 million or 18.3% higher than the SG&A expense incurred in the same period in 2010 primarily due to the increase in compensation related expenses of approximately $2.7 million, additional marketing activities of approximately $2.8 million, stock-based compensation expense of approximately $0.9 million and transaction expenses of approximately $1.0 million in relation to the two business acquisitions that we completed during the year ended December 31, 2011. Our SG&A head count as of December 31, 2011 was 187 employees as compared to 156 employees as of December 31, 2010.

SG&A expense during the year ended December 31, 2010 was $8.3 million or 15.1% lower than the SG&A expense incurred in the same period in 2009 primarily due to the nonrecurring charges that we incurred in 2009.  In 2009, we incurred approximately $2.0 million in professional fees associated with a potential strategic acquisition which we evaluated but decided not to pursue, $1.2 million compensation expense related to the compensation package provided to our former Chief Executive Officer upon his resignation in September 2009 and $2.8 million stock-based compensation expense cumulative adjustment pertaining to the errors we identified with respect to the stock-based compensation expense calculated by our third-party software.  Not considering the impact of these 2009 nonrecurring charges, SG&A expense for the year ended December 31, 2010 would have been $2.3 million lower than what was incurred in the same period in 2009, which was primarily attributable to the lower compensation related expenses resulting from the restructuring programs implemented in 2009. The increase in bonus of $1.9 million in 2010 compared to 2009 driven by the better overall company performance partially offset the decrease in SG&A expense in 2010 compared to 2009.
 
 

 
 
44

 


 
Restructuring
 
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Restructuring expense
  $ 2,269       -30.4 %   $ 3,259       -85.8 %   $ 22,907  
Percentage of total revenue
    1.0 %             1.7 %             15.2 %

 Restructuring.  The total restructuring expense for the year ended December 31, 2011 consisted primarily of $0.9 million related to severance benefits and exit costs we incurred as a result of SiBEAM acquisition, $0.4 million related to our storage business restructuring, $0.3 million relating to operating lease termination costs and $0.7 million related to severance benefits for the headcount reduction in the fourth quarter of 2011.

The total restructuring expense for the year ended December 31, 2010 consisted primarily of $2.0 million related to contract termination cost, a charge of $0.9 million relating to operating lease termination costs and a charge of $0.3 million related to retirement of certain fixed assets. During 2010, we were in the process of transitioning certain R&D work from Europe to Asia and as a result of this transition, we decided to cease using the services of certain European engineers which resulted in an accrual of future costs of $2.0 million payable under the related contract without any future economic benefit to us. We recorded such future costs as restructuring expense in 2010.

In 2009, we announced restructuring plans to realign and focus our resources on our core competencies and in order to better align our revenues and expenses. The restructuring expense for the year ended December 31, 2009, consisted primarily of $22.1 million of employee severance and benefit arrangements related to the closure in 2009 of our two R&D sites in Germany, a charge of $0.6 million relating to retirement of certain assets and a charge of $0.2 million relating to operating lease termination costs.
   

Amortization of intangible assets
 
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Amortization of intangible assets
  $ 1,585       963.8 %   $ 149       -96.7 %   $ 4,478  
Percentage of total revenue
    0.7 %             0.1 %             3.0 %
  
Amortization of intangible assets.  The increase in the amortization of intangible assets for the year ended December 31, 2011 as compared to the same period in 2010 was primarily due to amortization of the intangible assets acquired from the two acquisitions completed during 2011.

Amortization of intangible assets was $0.1 million for the year ended December 31, 2010, as compared to $4.5 million in 2009.  The significant sequential decrease in the amortization of intangible assets was primarily due to the complete amortization of acquired intangible assets and write-off in 2009 of the investment in an intellectual property. Please see related discussion in Impairment of Intangible Assets below.
  
Impairment of intangible assets
 
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Impairment of intangible assets
  $ 8,500       N/A     $ -       N/A     $ 28,296  
Percentage of total revenue
    3.8 %             0.0 %             18.8 %

Impairment of intangible assets.  In the fourth quarter of 2011 and again subsequent to our year ended December 31, 2011, we assessed our advances to a third party for intellectual properties for impairment. We concluded that the intangible assets related to these advances were fully impaired as of December 31, 2011, and have written them off. This conclusion was based on our determination that certain of the technologies was no longer aligned with our product roadmap due to a change in strategic focus and therefore, would not be used. The remaining technologies were impaired due to an adverse change in the extent and manner in which the technology was expected to be utilized by a strategic customer, as well as the competitive environment in which the technology was intended for use. In connection with this assessment, we recognized an impairment charge of $8.5 million in 2011.
 
 In 2009, we determined that, in light of certain changes to our product strategy, the intellectual property licensed from Sunplus Technology Co., Ltd in February 2007 (the “Sunplus IP”) no longer aligned with our product roadmap and therefore would not be used. In connection with the decision to discontinue the use of the Sunplus IP, we wrote-off the unamortized balance of the investment in Sunplus IP of $28.3 million and recognized a pre-tax impairment charge of $28.3 million in 2009.
 
 


 
45

 
 

Impairment of Goodwill.  There was no impairment of goodwill in 2011 and 2010. In 2009, we assessed goodwill for impairment and noted indicators of impairment including a sustained and significant decline in our stock price, depressed market conditions and declining industry trends. In 2009, our stock price had been in a period of sustained decline and the business climate had deteriorated substantially in light of the economic crisis. Based on the result of the impairment analysis that we performed, we determined that the goodwill was impaired. As such, we wrote off the entire goodwill balance and recognized goodwill impairment charge of approximately $19.2 million in 2009.
 
Interest income and others, net
 
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Interest income
  $ 1,920       -17.8 %   $ 2,335       -18.8 %   $ 2,874  
Reversal of a subsidiary's accumulated currency translation adjustment
    (132 )     -109.7 %     1,366       N/A       -  
Other income (expense), net
    130       268.8 %     (77 )     -158.8 %     131  
Total
  $ 1,918       -47.1 %   $ 3,624       20.6 %   $ 3,005  
Percentage of total revenue
    0.9 %             1.9 %             2.0 %

Interest income and other, net.  Interest income and others, net in 2011, consisted primarily of interest income of $1.9 million from our short-term investments. In 2010, we transferred the accumulated foreign currency translation adjustment of our wholly owned subsidiary in Germany whose facilities and offices had been substantially liquidated during 2010, to income.

Interest income for the year ended December 31, 2011 decreased by 17.8% compared to the same period in 2010 primarily due to the decrease in our short-term investments as a result of the cash used in business acquisitions. Interest income for the year ended December 31, 2010 decreased by 18.8% compared to the same period in 2009 primarily due to the decline in interest rates as a result of macro-economic conditions.
 

Provision for income taxes
 
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Provision for income taxes
  $ 8,583       137.8 %   $ 3,609       -75.6 %   $ 14,797  
Percentage of total revenue
    3.9 %             1.9 %             9.8 %
 
Provision for income taxes.  For the year ended December 31, 2011, we recorded an income tax provision of $8.6 million, compared to income tax provision of $3.6 million and $14.8 million in 2010 and 2009, respectively. Our effective income tax rate was (415.4%) in 2011. In 2011, the primary reconciling items between our effective tax rate and the U.S. statutory tax rate of 35% included approximately $8.9 million of income tax expense primarily due to foreign withholding taxes and foreign income inclusions.  In addition, we provided approximately $8.2 million for an increase to the valuation allowance to offset deferred tax assets which are not more likely than not to be realized and approximately $1.0 million for stock based compensation.   The primary benefit provided was for approximately $6.8 million related to the use of foreign tax credits and R&D tax credits.

For the year ended December 31, 2010, we recorded an income tax provision of $3.6 million, compared to income tax provision of $14.8 million in 2009 and income tax benefit of $11.9 million in 2008. Our effective income tax rate was 30.6% in 2010. In 2010, the difference between the expense for income taxes and the income tax expense determined by applying the statutory federal income tax rate of 35% was due primarily to foreign withholding taxes and changes in the valuation allowance.

For the year ended December 31, 2009, we recorded an income tax provision of $14.8 million, compared to income tax benefit of $11.9 million in 2008. Our effective income tax rate was (13%) in 2009. In 2009, the difference between the expense for income taxes and the income tax benefit determined by applying the statutory federal income tax rate of 35% was due primarily to the following items: (1) $43.0 million of  tax expense related to a valuation allowance being recorded to offset deferred taxes recorded on the balance sheet, (2) $3.8 million of expense associated with the geographic and tax jurisdictional mix of earnings within our global business structure, (3) $7.6 million of tax expense associated with stock-based compensation expense being reversed for tax purposes, (4) $5.3 million expense of foreign unbenefited  losses, and (5) $3.8 million tax expense associated with non-deductible goodwill write-off for book purposes.  Offsetting these expenses are benefits of: (1) $5.6 million related to a worthless stock deduction for investment in our German subsidiary, and (2) $3.2 million related to federal and state research and development tax credits generated during 2009.
 
 

 
 
46

 
 

Liquidity and Capital Resources
 
   
2011
   
Change
   
2010
   
Change
   
2009
 
   
(Dollars in thousands)
 
Cash and cash equivalents
  $ 37,125     $ 7,183     $ 29,942     $ 186     $ 29,756  
Short term investments
    124,301       (36,237 )     160,538       39,672       120,866  
Total cash, cash equivalents and short term investments
  $ 161,426     $ (29,054 )   $ 190,480     $ 39,858     $ 150,622  
Percentage of total assets
    60.7 %             76.0 %             66.8 %
                                         
Total current assets
  $ 208,665     $ (22,148 )   $ 230,813     $ 22,985     $ 207,828  
Total current liabilities
    (46,742 )     (675 )     (46,067 )     (1,721 )     (44,346 )
Working capital
  $ 161,923     $ (22,823 )   $ 184,746     $ 21,264     $ 163,482  

            At December 31, 2011, we had $161.9 million of working capital including $161.4 million of cash, cash equivalents and short-term investments. Cash and cash equivalents and short-term investments decreased by $29.1 million from $190.5 million in 2010 to $161.4 million in 2011 primarily due to $15.9 million cash considerations for the two recent acquisitions that we completed during the year ended December 31, 2011, $2.2 million cash used to satisfy certain liabilities assumed in connection with the business acquisitions previously mentioned, $7.5 million cash used for an investment in an unconsolidated affiliate, $7.2 million cash used for advances for intellectual properties, net of repayments of secured notes and $7.8  million cash used for capital expenditures, partially offset by net cash provided by operations during the year ended December 31, 2011 and  proceeds from stock option exercises and purchases under our employee stock purchase program totaling to approximately $6.2 million. As of December 31, 2011, $1.2 million of the $37.1 million of cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we may be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to indefinitely reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.
 
The significant components of our working capital are cash and cash equivalents, short-term investments, accounts receivable, inventories, deferred income taxes  and prepaid expenses and other current assets, reduced by accounts payable, accrued and other current liabilities, deferred license revenue and deferred margin on sales to distributors.

Working capital at December 31, 2011 decreased by approximately $22.8 million compared to the working capital at December 31, 2010 primarily due to $22.1 million net decrease in operating assets and by $0.7 million net increase in operating liabilities. The $22.1 million net decrease in operating assets was primarily due to the previously mentioned $29.1 million decrease in total cash and cash equivalents and short-term investments, partially offset by $2.8 million increase in prepaid expenses and other assets and $4.4 million increase in accounts receivable. The increase in prepaid expenses and other current assets was primarily due to income tax receivables, advances toward hiring fees for 75 engineers in India which was completed in 2012 and the prepayment for additional software licenses. The increase in accounts receivable was primarily due to the increase in billings over collections during the year ended December 31, 2011. The $0.7 million increase in operating liabilities was mainly due to $4.8 million increase in accrued and other current liabilities, partially offset by $5.7 million and $1.5 million decrease in deferred margin on sales to distributors and deferred license revenue, respectively. The increase in accrued and other current liabilities was mainly due to increase in payroll related expenses, increase in accrued royalties, increase in accrued product rebate and other current liabilities assumed from business acquisitions. The decrease in deferred margin on sales to distributors was primarily due to lower ending inventory at our distributors as of December 31, 2011 compared to the  ending inventory as at December 31, 2010 and the decrease in deferred license revenue was primarily due to the increase in license revenue recognized during the year ended December 31, 2011.
 
 
 

 
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We believe that our current cash, cash equivalents and short-term investment balances together with income derived from sales of our products and licensing will be sufficient to meet our liquidity requirements for at least the next twelve months.
    
At December 31, 2010, we had $184.7 million of working capital including $190.5 million of cash, cash equivalents and short-term investments. Cash and cash equivalents and short-term investments increased by $39.9 million from $150.6 million in 2009 to $190.5 million in 2010 primarily due to net income tax refunds totaling to approximately $18.1 million, proceeds from stock option exercises and purchases under our employee stock purchase program totaling to approximately $5.6 million, and increased cash collections of receivables, partially offset by the $17.4 million cash used to pay our restructuring liability.

Working capital at December 31, 2010 increased by approximately $21.3 million when compared to the working capital at December 31, 2009 primarily due to the $23.0 million increase in operating assets, partially offset by the $1.7 million increase in operating liabilities. The $23.0 million increase in operating assets was primarily related to the $39.9 million increase in total cash, cash equivalents and short-term investments and $2.5 million increase in inventories, partially offset by the $21.0 million decrease in prepaid expenses and other current assets. The $2.5 million increase in inventories was primarily due to the increasing demand for our products while the $21.4 million decrease in prepaid expenses and other current assets was primarily attributed to the net income tax refunds. The $1.7 million increase in operating liabilities was primarily due to the $10.5 million increase in deferred margin on sales to distributors and $1.1 million increase in deferred license revenue, partially offset by the $8.1 million decrease in accrued and other current liabilities. The $10.5 million increase in deferred margin on sales to distributors was mainly due to the increasing activities with our distributors driven by the increasing demand for our products while the $8.1 million decrease in accrued and other current liabilities was mainly attributable to the payment of the restructuring liability, primarily related to the severance and termination benefits.

Summary of Cash Flows. The table below summarizes the cash and cash equivalents provided by (used in) in our operating, investing and financing activities.
 
   
2011
   
2010
   
2009
 
   
(Dollars in thousands)
 
Cash provided by (used in) operating activities
  $ 7,458     $ 46,494     $ (29,664 )
Cash used in investing activities
    (4,762 )     (50,725 )     (38,066 )
Cash provided by financing activities
    4,501       3,954       1,354  
Effect of exchange rate changes on cash and cash equivalents
    (14 )     463       718  
  Net  increase (decrease) in cash and cash equivalents
  $ 7,183     $ 186     $ (65,658 )

Operating Activities
 
The $7.5 million cash generated from our operating activities during the year ended December 31, 2011 was primarily due to $30.2 million in net favorable non-cash adjustments to net loss, a decrease in inventories and an increase in accrued and other liabilities, partially offset by the increase in operating assets, such as accounts receivable and prepaid expenses and other current assets and the decrease in operating liabilities, such as deferred margin on sales to distributors and deferred license revenue.
 
 
 

 
48

 
 

The favorable adjustments to net loss were primarily comprised of depreciation and amortization of $8.0 million, stock based compensation of $9.5 million, amortization of investment premium of $2.6 million, impairment of intangible assets of $8.5 million and $1.0 million of non-cash equity in net loss of our unconsolidated affiliate. Inventory excluding inventory acquired from acquisition decreased by $1.7 million primarily due to our tighter inventory management and increase in product shipment. Accrued and other liabilities increased by $4.8 million primarily due to an increase in bonus accrual, an increase in accrued payroll and other payroll related expenses and increase in the share of the HDMI founders payable as a result of increased royalties in the year ended December 31, 2011 compared to the same period in 2010, partially offset by a decrease in restructuring accrual due to payments of severance benefits and the termination of operating lease agreement during the year ended December 31, 2011.  The increase in accounts receivable was primarily due to the increase in billings over collections during the year ended December 31, 2011. The increase in prepaid expenses and other current assets was primarily due to income tax receivable, advances toward hiring fees of 75 engineers in India and prepayment for additional software licenses. The decrease in deferred margin on sales to distributors was primarily due to lower ending inventory at our distributors as of December 31, 2011 than the  ending inventory as at December 31, 2010 and the decrease in deferred license revenue was primarily due to the decrease in license revenue recognized during the year ended December 31, 2011.

The $46.5 million cash generated from our operating activities during the year ended December 31, 2010 was primarily due to net income, a decrease in prepaid expenses and other assets and an increase in operating liabilities, such as deferred license revenue and deferred margin on sales to distributors, partially offset by the increases in net accounts receivable and inventories and by the decrease in accrued and other liabilities.
 
Prepaid expenses and other assets decreased by approximately $21.4 million primarily due to net income tax refunds during the year ended December 31, 2010. Deferred margin on sales to distributors increased by $10.5 million, which was attributable to the increasing activities with our distributors driven by the increasing demand for our products. Deferred license revenue increased by $2.6 million primarily due to the new licensing agreements we entered into during the year ended December 31, 2010. Accrued and other liabilities decreased by $8.1 million primarily due to the $15.5 million net decrease in the balance of restructuring liability due to payments of severance benefits during the year ended December 31, 2010, partially offset by the increases in other accrued liabilities, such as accrued payroll and related expenses, which increased by $3.9 million, and royalties payable, which increased by $3.0 million. The increase in accrued payroll and related expenses was attributable mainly to the bonus and sales commission accruals, which was a direct result of the significant increase in revenues during the year ended December 31, 2010 compared to the same period in 2009. The increase in royalties payable was mainly due to the increase in the share of the HDMI founders as a result of increased royalties in 2010 compared to 2009.
 
The $29.7 million cash used in operating activities during the year ended December 31, 2009 was primarily due to the cash used for working capital as a result of the increase in operating assets, such as accounts receivable and prepaid expenses and other current assets and decrease in deferred margin on sales to distributors, partially offset by the decrease in inventories and the increase in operating liabilities, such as accounts payable and accrued liabilities and other current liabilities.
    
Investing Activities
 
The $4.8 million cash used in our investing activities during the year ended December 31, 2011 was due primarily to $15.9 million cash used in connection with our business acquisitions, $7.5 million cash used to make an investment in an unconsolidated affiliate, $7.2 million cash used for advances for intellectual properties, net of repayments of secured notes and $7.8 million net investment in property and equipment, partially offset by $33.7 million net proceeds from the sales and maturities of short-term investments. During the year ended December 31, 2011, we sold $147.0 million and purchased $113.3 million worth of short-term investments.

The $50.7 million cash used in investing activities during the year ended December 31, 2010 was due primarily to net purchases of short-term investments of approximately $42.8 million, net investment in property and equipment of approximately $4.7 million and other investing activities amounting to approximately $3.2 million. During the year ended December 31, 2010, we purchased $166.9 million and sold $124.1 million short-term investments.
 
 

 
 
49

 

 
   
The $38.1 million cash used in investing activities during the year ended December 31, 2009 was due primarily to net purchases of short-term investments of approximately $34.0 million and net investment in property and equipment of approximately $4.1 million. During the year ended December 31, 2009, we purchased $165.1 million and sold $131.1 million short-term investments.
      
We held no direct investments in auction rate securities, collateralized debt obligations, structured investment vehicles or mortgage-backed securities. We are not a capital-intensive business. Our purchases of property and equipment in 2011, 2010 and 2009 related mainly to testing equipment, leasehold improvements and information technology infrastructure.

Financing Activities
 
The $4.5 million cash generated from our financing activities during the year ended December 31, 2011 was primarily due to the proceeds from issuances of common stock of approximately $6.2 million and to the excess tax benefits from employee stock-based transactions of approximately $2.1 million, partially offset by $3.3 million cash used to repurchase restricted stock units for minimum statutory income tax withholding and $0.5 million cash used to pay a line of credit assumed from business acquisition.

The $4.0 million net cash generated from our financing activities during the year ended December 31, 2010 was primarily due to the proceeds from stock option exercises and purchases under our employee stock purchase program totaling approximately $5.6 million and to the excess tax benefits from employee stock-based transactions of approximately $0.8 million,  partially offset by payments to vendor of financed purchases of software and intangibles of approximately $1.2 million and cash used to repurchase restricted stock units for income tax withholding of approximately $1.2 million.
    
The $1.4 million net cash generated from our financing activities during the year ended December 31, 2009 was primarily due to the proceeds from stock option exercises and purchases under our employee stock purchase program of approximately $2.8 million, partially offset by payments to vendor of financed purchases of software and intangibles of approximately $1.2 million and cash used to repurchase restricted stock units for income tax withholding of approximately $0.3 million.
      
Cash Requirements and Commitments
 
In addition to our normal operating cash requirements, our principal future cash requirements will be to fund capital expenditures, share repurchases and any strategic acquisitions, in addition we have approximately $16.6 million in commitments for fiscal years including and beyond 2012 as disclosed in the contractual obligations section below.
 
 
 

 
50

 
Table of Contents
 
 
Contractual Obligations
      
Our contractual obligations as of December 31, 2011 were as follows (in thousands):

   
Payments Due In
 
   
Total
   
Less Than
1 Year
   
1-3 Years
   
3-5 Years
   
More Than
5 Years
 
Contractual Obligations:
                             
Operating lease obligations
  $ 11,802     $ 2,498     $ 3,401     $ 3,196     $ 2,707  
Hiring fees for engineers in India
    2,000       2,000       -       -       -  
    $ 13,802     $ 4,498     $ 3,401     $ 3,196     $ 2,707  
 
In July 2011, we entered into a call option agreement with a privately-held company whereby we have the option to acquire the privately-held company until January 5, 2013 at an agreed upon purchase price on certain terms and conditions.  We are obligated either (i) to purchase $2.0 million of the privately-held company’s secured convertible promissory notes (the “Notes”) or (ii) to acquire the privately-held company at $35.0 million plus earn-out payments on the agreed upon terms and conditions by April 15, 2012. If this call option is not exercised by July 31, 2012, we are obligated to purchase an additional $0.8 million of the privately-held company’s Notes.  Fair value of the call option mentioned above was approximately $3.0 million as of December 31, 2011.
 
In November 2011, we entered into an agreement with a third party R&D engineering services company in India with which we had contracted since 2009 whereby, we agreed to hire 75 engineers in India working for such consultant for a hiring fee of $3.0 million. Out of this total hiring fee, $1.0 million was paid as an advance in December 2011 upon the fulfillment of certain conditions of the agreement, which amount is reflected in “Prepaid and other current assets” in the consolidated balance sheets, and $2.0 million was paid in January 2012 upon closing. The deal closed in January 2012 at which time the 75 engineers became our employees.
 
The amounts above exclude liabilities under FASB ASC 740-10, “Income Taxes – Recognition section” amounting to approximately $26.6 million as of December 31, 2011 as we are unable to reasonably estimate the ultimate amount or timing of settlement. See Note 12, “Income Taxes,” in our notes to consolidated financial statements included in Item 15(a) of this report for further discussion.

Long-Term Liquidity
 
Based on our estimated cash flows, we believe our existing cash and short-term investments are sufficient to meet our capital and operating requirements for at least the next twelve months. We expect to continue to invest in property and equipment in the ordinary course of business. Our future operating and capital requirements depend on many factors, including the levels at which we generate product revenue and related margins, the extent to which we generate cash through stock option exercises and proceeds from sales of shares under our employee stock purchase plan, the timing and extent of licensing revenue, investments in inventory, property, plant and equipment and accounts receivable, the cost of securing access to adequate manufacturing capacity, our operating expenses, including legal and patent assertion costs and general economic conditions. In addition, cash may be required for future acquisitions should we choose to pursue any. While we believe that our current cash, cash equivalents and short-term investment balances together with income derived from sales of our products and licensing will be sufficient to meet our liquidity requirements in the foreseeable future, 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 when we need them, or if available, we may not be able to obtain them on terms favorable to us.
 
 
 

 
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Global credit and financial markets have experienced disruptions since mid-2008, including diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and uncertainty about economic stability. There can be no assurance that there will not be further deterioration in credit and financial markets and confidence in economic conditions.  These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. The current tightening of credit in financial markets may lead consumers and businesses to postpone spending, which may cause our customers to cancel, decrease or delay their existing and future orders with us. In addition, financial difficulties experienced by our suppliers or distributors could result in product delays, increased accounts receivable defaults and inventory challenges.

 Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk
 
The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including government and corporate securities and money market funds. These securities are classified as available for sale and consequently are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss). We also limit our exposure to interest rate and credit risk by establishing and monitoring clear policies and guidelines of our fixed income portfolios. The guidelines also establish credit quality standards, limits on exposure to any one issuer and limits on exposure to the type of instrument. Due to the limited duration and credit risk criteria established in our guidelines we do not expect the exposure to interest rate risk and credit risk to be material. If interest rates rise, the market value of our investments may decline, which could result in a realized loss if we are forced to sell an investment before its scheduled maturity. As of December 31, 2011, we had an investment portfolio of securities as reported in short-term investments, including those classified as cash equivalents of approximately $149.1 million. A sensitivity analysis was performed on our investment portfolio as of December 31, 2011. This sensitivity analysis was based on a modeling technique that measures the hypothetical market value changes that would result from a parallel shift in the yield curve of plus 50, 100, or 150 basis points over a twelve-month time horizon.

 
  0.5%       1.0%       1.5%  
  $ 483,000       $ 965,000       $ 1,448,000  


As of December 31, 2010, we had an investment portfolio of securities as reported in short-term investments, including those classified as cash equivalents of approximately $160.5 million. These securities are subject to interest rate fluctuations. The following represents the potential change to the value of our investments given a shift in the yield curve used in our sensitivity analysis.

 
0.5%
     
1.0%
     
1.5%
 
 
$ 656,000
   
 
$ 1,313,000
   
 
$ 1,969,000
 
    
Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of cash equivalents and short-term investments and accounts receivable. A majority of our cash and investments are maintained with a major financial institutions headquartered in the United States. As part of our cash and investment management processes, we perform periodic evaluations of the credit standing of the financial institutions and we have not sustained any credit losses from investments held at these financial institutions. The counterparties to the agreements relating to our investment securities consist of various major corporations and financial institutions of high credit standing.
 
We perform on-going credit evaluations of our customers’ financial condition and may require collateral, such as letters of credit, to secure accounts receivable if deemed necessary. We maintain an allowance for potentially uncollectible accounts receivable based on our assessment of collectability.
 
 
  

 
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Foreign Currency Exchange Risk

A majority of our revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, certain operating expenditures and capital purchases are incurred in or exposed to other currencies, primarily the Euro, the South Korean Won, Taiwan Dollar and the Chinese Yuan. Additionally, many of our foreign distributors price our products in the local currency of the countries in which they sell. Therefore, significant strengthening or weakening of the U.S. dollar relative to those foreign currencies could result in reduced demand or lower U.S. dollar prices or vice versa, for our products, which would negatively affect our operating results. Cash balances held in foreign countries are subject to local banking laws and may bear higher or lower risk than cash deposited in the United States. The following represents the potential impact of a change in the value of the U.S. dollar compared to the foreign currencies which we use in our operations.  The following represents the potential impact of a change in the value of the U.S. dollar compared to the Euro, British Pound, Japanese Yen, Chinese Yuan, Taiwan Dollar and Korean Won for the years ended December 31, 2011 and 2010.  This sensitivity analysis aggregates our annual activity in these currencies, translated to U.S. dollars, and applies a change in the U.S. dollar value of 5%, 7.5% and 10% (in thousands).


   
December 31, 2011
   
December 31, 2010
   
December 31, 2011
   
December 31, 2010
   
December 31, 2011
   
December 31, 2010
 
      5%       5%       7.50%       7.50%       10%       10%  
China (Yuan)
  $ 506     $ 295     $ 758     $ 443     $ 1,011     $ 590  
Japan (Yen)
    224       149       336       223       448       298  
Germany (Euro)
    -       444       -       667       -       889  
Others
    189       143       285       214       379       286  
Total
  $ 919     $ 1,031     $ 1,379     $ 1,547     $ 1,838     $ 2,063  
 
Derivative Instruments

 We have operations in the United States, Europe and Asia; however, a majority of our revenue, costs of sales, expense and capital purchasing activities are being transacted in U.S. Dollars. As a corporation with international as well as domestic operations, we are exposed to changes in foreign exchange rates. These exposures may change over time and could have a material adverse impact on our financial results. Periodically, we use foreign currency forward contracts to hedge certain forecasted foreign currency transactions relating to operating expenses.  We do not enter into derivatives for speculative or trading purposes. We use derivative instruments primarily to manage exposures to foreign currency fluctuations on forecasted cash flows and balances primarily denominated in Chinese Yuan. Our primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates. These derivatives are designated as cash flow hedges and have maturities of less than one year. The effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income and, upon occurrence of the forecasted transaction, is subsequently reclassified into the line item in the consolidated statements of operations to which the hedged transaction relates. We record any ineffectiveness of the hedging instruments in other income (expense) on our consolidated statements of operations.

Our derivatives expose us to credit and non performance risks to the extent that the counterparties may be unable to meet the terms of the agreement. We seek to mitigate such risks by limiting the counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.

As of December 31, 2011, the outstanding foreign exchange contracts had a total notional value of $3.6 million. See Note 11 in our notes to consolidated financial statements included in Item 15(a) of this report for more detailed discussions on derivative transactions.

Investment in an Unconsolidated Affiliate

On July 13, 2011, we purchased a 17.5% equity ownership interest in a privately-held company which develops and designs wireless video and audio semiconductor chips for $7.5 million in cash. The investment is recorded as part of “Other long-term assets” account in our consolidated balance sheet and we use the equity method to account for our investment in this entity as the privately-held company is a limited liability company and we have more than 5% ownership interest. During the year ended December 31, 2011, we recorded $1.0 million in “Equity in net loss of an unconsolidated affiliate” on the consolidated statements of operations, representing 17.5% of our proportionate share of the privately-held company’s net loss. This investment is inherently risky and we could lose our entire investment in this company. As of December 31, 2011, we did not record any impairment charge on this investment.

 
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Item 8.  Financial Statements and Supplementary Data
 
The Financial Statements and Supplemental Data required by this item are set forth at the pages indicated at Item 15(a).


Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
None.

Item 9A.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures
 
Management is required to evaluate our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Disclosure controls and procedures are controls and other procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures include components of our internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles in the U.S. To the extent that components of our internal control over financial reporting are included within our disclosure controls and procedures, they are included in the scope of our periodic controls evaluation.  Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) are effective at the reasonable assurance level to ensure that information required to be disclosed by us in the reports filed and submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
 
Management’s Report on Internal Control over Financial Reporting
 
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:

·  
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
 
·  
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
 
·  
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
 
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting.
 
Management conducted an assessment of our internal control over financial reporting as of December 31, 2011 based on the framework established by the Committee of Sponsoring Organization (COSO) of the Treadway Commission in Internal Control — Integrated Framework. Based on this assessment, management concluded that, as of December 31, 2011, our internal control over financial reporting was effective.
 
The effectiveness of our internal control over financial reporting as of December 31, 2011 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which appears herein.

Changes in Internal Control over Financial Reporting
 
                    There were no changes in our internal controls over financial reporting during the fourth quarter of our 2011 fiscal year that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
 

 
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Silicon Image, Inc.
 
We have audited the internal control over financial reporting of Silicon Image, Inc. and subsidiaries (the "Company") as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
 
A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and consolidated financial statement schedule as of and for the year ended December 31, 2011 of the Company and our report dated February 29, 2012 expressed an unqualified opinion on those consolidated financial statements and consolidated financial statement schedule.
 

 
/s/ DELOITTE & TOUCHE LLP
 
San Jose, California
February 29, 2012
 
 

 
 
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 Item 9B.  Other Information
 
Not applicable.
 

Item 10.  Directors, Executive Officers and Corporate Governance
 
The information required by this Item is herein incorporated by reference from Silicon Image’s Proxy Statement for its 2012 Annual Meeting of Stockholders.

Item 11.  Executive Compensation
 
The information required by this Item is herein incorporated by reference from Silicon Image’s Proxy Statement for its 2012 Annual Meeting of Stockholders.

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
The information required by this Item is herein incorporated by reference from Silicon Image’s Proxy Statement for its 2012 Annual Meeting of Stockholders.

Item 13.  Certain Relationships and Related Transactions and Director Independence
 
 The information required by this Item is herein incorporated by reference from Silicon Image’s Proxy Statement for its 2012 Annual Meeting of Stockholders.

Item 14.  Principal Accountant Fees and Services
 
The information required by this Item is herein incorporated by reference from Silicon Image’s Proxy Statement for its 2012 Annual Meeting of Stockholders.
 
 
 

 
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Item 15.  Exhibits and Financial Statement Schedules
 
    (a) The following documents are filed as a part of this Form:
 
    1. Financial Statements:
 
    
    2. Financial Statement Schedules
 
The following financial statement schedule of Silicon Image is filed as part of this Form 10-K: