Silicon Image 10Q 2006 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


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

For the quarterly period ended March 31, 2006


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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):


Large Accelerated Filero		Accelerated Filerþ		Non-Accelerated Filero

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

As of April 28, 2006, there were 81,488,401 shares outstanding of the registrant’s Common Stock, $0.001 par value per share.

Silicon Image, Inc.
Quarterly Report on Form 10-Q
Three Months Ended
March 31, 2006

Table of Contents


Part I Financial Information (Unaudited)	3
Item 1 Financial Statements	3
Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005	3
Condensed Consolidated Statements of Income for the three months ended March 31, 2006 and 2005	4
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005	5
Notes to Condensed Consolidated Financial Statements	6
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3 Quantitative and Qualitative Disclosures About Market Risk	21
Item 4 Controls and Procedures	22
Part II Other Information	23
Item 1 Legal Proceedings	23
Item 1A Risk Factors	24
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3 Defaults Upon Senior Securities	40
Item 4 Submission of Matters to a Vote of Security Holders	40
Item 5 Other Information	40
Item 6 Exhibits	41
Signatures	42
EXHIBIT 31.01
EXHIBIT 31.02
EXHIBIT 32.01
EXHIBIT 32.02

Part I. Financial Information

Item 1. Financial Statements

Silicon Image, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)


	March 31,			December 31,
	2006			2005
	(unaudited)
Assets
Current Assets:
Cash and cash equivalents	$	71,093		$	77,877
Short-term investments		96,397			73,685
Accounts receivable, net of allowances for doubtful accounts of $216 at March 31, 2006 and $417 at December 31, 2005		37,339			30,141
Inventories		18,039			17,072
Prepaid expenses and other current assets		3,065			3,037

Total current assets		225,933			201,812

Property and equipment, net		9,518			9,613
Goodwill		13,021			13,021
Intangible assets, net		311			585
Other assets		7,900			7,990

Total assets	$	256,683		$	233,021

Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable	$	16,029		$	13,372
Accrued liabilities		11,826			13,952
Deferred license revenue		9,915			8,283
Debt obligations and capital leases		174			230
Deferred margin on sales to distributors		19,026			13,771

Current liabilities		56,970			49,608

Other long-term liabilities		6,927			6,867

Total liabilities		63,897			56,475

Commitments and contingencies (See Note 8)
Stockholders’ Equity:
Common stock, par value $0.001; shares authorized: 150,000,000; shares issued and outstanding: 81,437,980 – March 31, 2006 and 80,491,557 – December 31, 2005		81			80
Additional paid-in capital		314,429			307,149
Unearned stock compensation		—			(6,742	)
Accumulated deficit		(121,077	)		(123,429	)
Accumulated other comprehensive loss		(647	)		(512	)

Total stockholders’ equity		192,786			176,546

Total liabilities and stockholders’ equity	$	256,683		$	233,021

See accompanying Notes to Condensed Consolidated Financial Statements.

Silicon Image, Inc.

Condensed Consolidated Statements of Income

(in thousands, except per share amounts)
(unaudited)


	Three Months Ended March 31,
	2006		2005
Revenue:
Product	$	53,280	$	40,808
Development, licensing and royalties		5,819		3,512

Total revenue		59,099		44,320

Cost of revenue and operating expenses:
Cost of revenue (1)		25,348		15,505
Research and development (2)		15,566		8,122
Selling, general and administrative (3)		15,461		3,953
Amortization of intangible assets		274		274

Total cost of revenue and operating expenses		56,649		27,854

Income from operations		2,450		16,466
Interest income and other, net		1,538		498

Income before provision for income taxes		3,988		16,964
Provision for income taxes		1,636		331

Net income	$	2,352	$	16,633


Net income per share — basic	$	0.03	$	0.21

Net income per share — diluted	$	0.03	$	0.19

Weighted average shares — basic		80,986		78,307
Weighted average shares — diluted		85,398		83,963



(1) Includes stock compensation expense (benefit)	$	628	$	(1,196	)

(2) Includes stock compensation expense (benefit)		2,812		(4,438	)

(3) Includes stock compensation expense (benefit)		3,843		(3,693	)

See accompanying Notes to Condensed Consolidated Financial Statements.

Silicon Image, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)
(unaudited)


	Three Months Ended March 31,
	2006			2005
Cash flows from operating activities:
Net income	$	2,352		$	16,633
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		1,620			1,524
Amortization of intangible assets		274			274
Stock compensation expense (benefit)		7,283			(9,327	)
Excess tax benefits from employee stock transactions		(1,356	)		—
Amortization of investment premium		83			—
Changes in assets and liabilities:
Accounts receivable		(7,198	)		(2,663	)
Inventories		(967	)		1,782
Prepaid expenses and other assets		123			(304	)
Accounts payable		2,657			385
Accrued liabilities and deferred license revenue		861			(2,724	)
Deferred margin on sales to distributors		5,256			70

Cash provided by operating activities		10,988			5,650
Cash flows from investing activities:
Proceeds from sales and maturities of short-term investments		12,052			67
Purchases of short-term investments		(34,983	)		(16,541	)
Purchases of property and equipment		(1,525	)		(1,138	)

Cash used in investing activities		(24,456	)		(17,612	)
Cash flows from financing activities:
Proceeds from issuances of common stock, net		5,384			4,235
Excess tax benefit from employee stock transactions		1,356			—
Repayments of debt and capital lease obligations		(56	)		(54	)

Cash provided by financing activities		6,684			4,181

Net decrease in cash and cash equivalents		(6,784	)		(7,781	)
Cash and cash equivalents — beginning of period		77,877			23,280

Cash and cash equivalents — end of period	$	71,093		$	15,499


Supplemental cash flow information:
Cash payment for interest	$	4		$	2

Unrealized loss on investment security	$	(135	)	$	(1,807	)

Increase in restricted cash and related long-term liability associated with ongoing litigation	$	61		$	—

See accompanying Notes to Condensed Consolidated Financial Statements.

Silicon Image, Inc.

Notes to Condensed Consolidated Financial Statements

March 31, 2006

(unaudited)

1. Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Silicon Image, Inc. (the “Company”, “Silicon Image”, “we” or “our”) included herein have been prepared on a basis consistent with our December 31, 2005 audited financial statements and include all adjustments, consisting of normal recurring adjustments, necessary to fairly state the condensed consolidated balance sheets of Silicon Image and our subsidiaries as of March 31, 2006 and the related consolidated statements of income and cash flows for the three months ended March 31, 2006 and 2005. All significant intercompany accounts and transactions have been eliminated. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005. Results of income for the three months ended March 31, 2006 are not necessarily indicative of future operating results.

2. Recent Accounting Pronouncements

In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 154,Accounting Changes and Error Corrections(SFAS No. 154) which replaces APB Opinion No. 20 Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statement — An Amendment of APB Opinion No. 28. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principal unless it is not practicable. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Accordingly, we adopted SFAS No. 154 in the quarter ending March 31, 2006. Adoption of SFAS No. 154 did not have a material impact on our financial position, results of operations, or cash flows.

In September 2005, the Emerging Issues Task Force reached consensus on EITF Issue No. 04-13,Accounting for Purchases and Sales of Inventory with the Same Counterparty(Issue No. 04-13). In certain situations, a company may enter into nonmonetary transactions to sell inventory to another company in the same line of business from which it also purchases inventory. Under Issue No. 04-13, in general, an entity is required to treat sales and purchases of inventory between the entity and the same counterparty as one transaction for purposes of applying APB Opinion No. 29,Accounting for Nonmonetary Transactionswhen such transactions are entered into in contemplation of each other. When such transactions are legally contingent on each other, they are considered to have been entered into in contemplation of each other. The EITF also agreed on other factors that should be considered in determining whether transactions have been entered into in contemplation of each other. Issue No. 04-13 will be effective for all new arrangements entered into in reporting periods beginning after March 15, 2006. The Company’s adoption of the provisions of Issue No. 04-13 is not expected to impact its financial condition or results of operations.

In February of 2006, the FASB issued SFAS No. 155,Accounting for Certain Hybrid Instruments—An Amendment of FASB Statements No. 133 and No. 144(SFAS No. 155). SFAS No. 155 permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. It also clarifies which interest-only strips and principal-only strips are not subject to the requirements of FASB Statement No. 133, and establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. Furthermore, SFAS No. 155 clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and it amends FASB Statement No. 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of the first fiscal year beginning after September 15, 2006. The Company’s adoption of the provisions of SFAS No. 155 is not expected to impact its financial condition or results of operations.

3. Stock-Based Compensation

1999 Equity Incentive Plan (the “1999 Plan”)

In September 1995, the Board of Directors adopted the 1995 Equity Incentive Plan (the “1995 Plan), which provides for the granting of incentive stock options (ISOs) and non-qualified stock options (NSOs) to employees, directors and consultants. In

accordance with the 1995 Plan, the stated exercise price shall not be less than 100% and 85% of the fair market value of our common stock on the date of grant for ISOs and NSOs, respectively. In September 1998, the 1995 Plan was amended to allow ISOs to be exercised prior to vesting. We have the right to repurchase such shares at their original purchase price if the optionee is terminated from service prior to vesting. Such right expires as the options vest.

In October 1999, the 1999 Plan became the successor to the 1995 Plan and was changed to prohibit early exercise of stock options. The number of shares reserved for issuance under the 1999 Plan will be increased automatically on January 1 of each year by an amount equal to 5% of our total outstanding common shares as of the immediately preceding December 31.

In June and July 2001, in connection with the CMD and SCL acquisitions, we assumed all outstanding options and options available for issuance under the CMD 1999 Stock Incentive Plan and SCL 1999 Stock Option Plan. In April 2004, in connection with the TransWarp acquisition, we assumed all outstanding options and options available for issuance under the TransWarp Stock Option Plan. The terms of these Plans are very similar to those of the 1999 Plan. Our assumption of the CMD, SCL and TransWarp Plans and the outstanding options did not require the approval of, and was not approved by, our stockholders.

Options granted under all Plans are exercisable over periods not to exceed ten years and vest over periods ranging from one to five years and generally vest 25% annually. Some options provide for accelerated vesting if certain identified milestones are achieved.

Under our stock plans, we may grant options to purchase up to 5.3 millions shares of common stock.

Non-plan options

There were no non-plan options granted during the three months ended March 31, 2006. All non-plan options generally have exercise prices equal to the fair market value on the date of grant and with vesting periods ranging from four to five years, and expire in ten years. Our non-plan option grants did not require the approval of, and were not approved by, our stockholders.

Our Employee Stock Purchase Plan (“ESPP”) provides that eligible employees may contribute up to 15% of their eligible earnings to purchase shares at the lower of 85% of the fair market value of the common stock on the date of commencement of the offering or on the last day of the six-month offering period. At March 31, 2006, there were 1.9 million shares of our common stock reserved for future issuance under the ESPP.

Adoption of SFAS No. 123(R)

Prior to 2006, our stock-based employee compensation plans were accounted for under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25 (APB 25),Accounting for Stock Issued to Employeesand related interpretations and provided the required pro forma disclosures as required by SFAS No. 123 (SFAS 123)Accounting for Stock-based Compensation. The ESPP qualified as a non-compensatory plan under APB 25, therefore, no compensation cost was recorded in relation to the discount offered to employees for purchases made under the ESPP.

Effective January 1, 2006, we adopted the fair value recognition provisions of the SFAS No. 123 (Revised 2004),Share-Based Payment, (SFAS No. 123(R)), requiring us to recognize expense related to the fair value of our stock-based compensation awards. We elected to use the modified prospective transition method as permitted by SFAS No. 123(R) and therefore have not restated our financial results for prior periods. Under this transition method, stock-based compensation expense for the three months ended March 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, as adjusted for estimated forfeitures. Stock-based compensation expense for all stock-based compensation awards granted subsequent to December 31, 2005 was based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). Under SFAS No. 123(R), the ESPP is considered a compensatory plan and we are required to recognize compensation cost for grants made under the ESPP. We recognize compensation expense on a straight-line basis for all share-based payment awards over the respective requisite service period of the awards.

Had we not adopted SFAS 123(R), our income before income taxes would have increased by $5.2 million and net income would have increased by $3.1 million for the three months ended March 31, 2006, respectively. Basic and diluted net income per share for the three months ended March 31, 2006 would have been $0.07 and $0.06, respectively. Cash provided by operating activities would have increased by $1.4 million and cash provided by financing activities would have decreased by $1.4 million related to excess tax benefits from employee stock transactions during the period had we not adopted SFAS 123R.

Determining Fair Value

Valuation and amortization method—We estimate the fair value of stock options granted using the Black-Scholes option valuation model and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

Expected Term—The expected term represents the period that our stock-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its stock-based awards.

Expected Volatility—Our computation of expected volatility for the quarter ended March 31, 2006 is based on historical volatility.

Risk-Free Interest Rate—The risk-free interest rate used in the Black-Scholes option valuation method is based on the implied yield currently available on U.S. Treasury zero-coupon issue with a remaining term equal to the expected term of the option.

Expected Dividend—The dividend yield reflects that we have not paid any dividends and have no intention to pay dividends in the foreseeable future.

In connection with the adoption of SFAS No. 123(R), we reassessed the valuation technique and related assumptions. The Company estimates the fair value of stock options using a Black-Scholes option valuation model, consistent with the provisions of SFAS No. 123(R), SEC SAB No. 107 and our prior period pro forma disclosures of net earnings, including stock-based compensation (determined under a fair value method as prescribed by SFAS No. 123). The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model and the straight-line attribution approach with the following weighted-average assumptions:


	Three Months Ended
	March 31, 2006			March 31, 2005
Employee stock option plans:
Expected life in years		5.0			5.0
Expected volatility		90.0	%		90.0	%
Risk-free interest rate		4.6	%		4.3	%
Expected dividends	none			none
Weighted average fair value	$	7.31		$	10.28

Employee Stock Purchase Plan:
Expected life in years		1.3			1.7
Expected volatility		57.0	%		85.0	%
Risk-free interest rate		4.7	%		3.8	%
Expected dividends	none			none
Weighted average fair value	$	4.75		$	4.75

The expected stock price volatility assumption was determined using the historical volatility of our common stock.

Stock Compensation Expense

The following table shows total stock-based compensation expense included in the Condensed Consolidated Statements of Income for the three months ended March 31, 2006 (in thousands):


Cost of sales	$	628
Research and development		2,812
Selling, general and administrative		3,843
Income tax effect		(2,986	)

	$	4,297

There was no stock-based compensation cost capitalized as part of inventory during the first quarter of 2006. As required by SFAS No. 123(R), management made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

At March 31, 2006, the total compensation cost related to unvested stock-based awards granted to employees under the stock option plans but not yet recognized was approximately $60.2 million, after estimated forfeitures. This cost will be recognized on a straight-line basis over an estimated weighted-average period of approximately 2.78 years and will be adjusted if necessary in subsequent periods if actual forfeitures differ from those estimates.

At March 31, 2006, the total compensation cost related to options to purchase common shares under the ESPP but not yet recognized was approximately $1.5 million. This cost will be recognized on a straight-line basis over a weighted-average period of approximately 1.25 years.

Prior to the adoption of SFAS No. 123(R), we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in our statement of cash flows. In accordance with SFAS No. 123(R), the cash flows resulting from excess tax benefits (tax benefits related to the excess of the tax deductions from employee’s exercises of stock options over the stock-based compensation cost recognized for those options) are classified as financing cash flows. During the three months ended March 31, 2006, we recorded $1.4 million of excess tax benefits as a financing cash inflow.

Stock Options and Awards Activity

The following is a summary of option activity for our Stock Option Plans (in thousands, except per share amounts):


						Weighted Average
						Remaining
				Weighted Average		Contractual		Aggregate Intrinsic
	Number of Shares			Exercise Price		Term in Years		Value
Outstanding at December 31, 2005		20,684		$	7.98
Granted		1,381			10.15
Exercised		(740	)		4.59
Forfeitures and cancellations		(217	)		10.07

Outstanding at March 31, 2006		21,108		$	8.21		6.95	$	66,264


Vested and expected to vest at March 31, 2006		20,149		$	8.11		0.61	$	65,085


Exercisable at March 31, 2006		11,183		$	6.74		5.60	$	49,426

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for the 14.8 million options that were in-the-money at March 31, 2006. The aggregate intrinsic value of options exercised under the Company’s stock option plans was $3.6 million, determined as of the date of option exercise during the three months ended March 31, 2006.

The Company settles employee stock option exercises with newly issued common shares.

Pro-forma Disclosures

The following table illustrates the effect on net income and net income per share as if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation during the three-month period ended March 31, 2005 (in thousands, except per share amounts):


Net income — as reported	$	16,633
Stock-based employee compensation benefit included in the determination of net income as reported		(10,266	)
Stock-based employee compensation expense determined under fair value based method for all awards, net of income taxes		(6,655	)

Pro forma net loss	$	(288	)

Earnings per share:
Basic — as reported	$	0.21
Basic — pro forma	$	0.00
Diluted — as reported	$	0.19
Diluted — pro forma	$	0.00

For purposes of this pro forma disclosure, the value of the options was estimated using a Black-Scholes option valuation model and recognized over the respective vesting periods of the awards.

4. Comprehensive income

The components of comprehensive income, net of related taxes, were as follows (in thousands):


	Three Months Ended March 31,
	2006			2005
Net income	$	2,352		$	16,633
Change in unrealized gain or loss on investments		(135	)		(1,807	)

Total comprehensive income	$	2,217		$	14,826

5. Net Income Per Share

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


	Three Months Ended March 31,
	2006			2005
Net income	$	2,352		$	16,633


Weighted average shares		80,988			78,560
Unvested common shares subject to repurchase		(2	)		(253	)

Weighted average shares — basic		80,986			78,307

Weighted average shares — diluted		85,398			83,963

Net income per share — basic	$	0.03		$	0.21
Net income per share — diluted	$	0.03		$	0.19

The following is a reconciliation of the weighted-average common shares used to calculate basic net income per share to the weighted-average common shares used to calculate diluted net income per shares (in thousands):


	Three Months Ended March 31,
	2006			2005
Weighted-average common shares for basic net income per share		80,986			78,307
Weighted-average dilutive stock options outstanding under the treasury stock method		4,409			5,392
Unvested common shares subject to repurchase		3			264

Total		85,398			83,963


6. Balance Sheet Components
	March 31,			December 31,
	2006			2005
			(in thousands)
Inventories:
Raw materials	$	3,752		$	3,123
Work in process		3,434			4,511
Finished goods		10,853			9,438

Total inventories	$	18,039		$	17,072


Property and equipment
Computers and software	$	17,114		$	16,669
Equipment		17,438			16,601
Furniture and fixtures		2,407			2,259

		36,959			35,529

Less: accumulated depreciation		(27,441	)		(25,916	)

Total property and equipment, net	$	9,518		$	9,613


Accrued liabilities:
Accrued payroll and related expenses	$	3,475		$	4,738
Restructuring accrual		—			25
Accrued legal fees		720			490
Warranty accrual		391			382
Bonus accrual		1,189			2,615
Other accrued liabilities		6,051			5,702

Total accrued liabilities	$	11,826		$	13,952


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

	March 31,			December 31,
	2006			2005
Balance at January 1	$	382		$	351
Provision for warranties issued during the period		14			273
Cash and other settlements made during the period		(5	)		(242	)

Balance	$	391		$	382

7. Asset impairment and restructuring activities

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

Severance related costs were determined based on the amount of pay people received that was not for services performed and by measuring the intrinsic value of stock options that were modified to the benefit of terminated employees. For those employees terminated in the three-month period ending March 31, 2003, the remaining service period from the communication date did not exceed 60 days.

Severance and benefits payments are complete. The following table presents the changes to our restructuring reserves for the three months ended March 31, 2006 and 2005 (in thousands):


	2006								2005
	Severance and		Leased						Severance and		Leased
	Benefits		Facilities			Total			Benefits		Facilities			Total
Balance as of January 1	$	—	$	25		$	25		$	32	$	1,004		$	1,036
Cash payments		—		(25	)		(25	)		—		(201	)		(201	)
Adjustment related to lease negotiation		—		—			—			—		—			—

Balance as of March 31	$	—	$	—		$	—		$	32	$	803		$	835

Effective December 2005, we renegotiated a lease for our Irvine, California facility, which was identified in our restructuring activities in 2001, that provided for early termination. We recorded an expense recovery of $220,000 to the restructuring accrual with an offsetting reduction of our operating expenses for the year ended December 31, 2005, resulting from this lease modification.

8. Commitments and Contingencies

Legal Proceedings

In 2001, we filed a suit in the U.S. District Court for the Eastern District of Virginia against Genesis Microchip Corp. and Genesis Microchip, Inc. (collectively, “Genesis”) for infringement of our U.S. patent number 5,905,769 (Case No.: CA-01-266-R). In 2002, we added a claim for infringement of our U.S. patent number 5,974,464. In December 2002, the parties entered into an agreement that apparently settled the case. The agreement was reflected in a Memorandum of Understanding (MOU), which contemplated, among other things, the execution of a more detailed “definitive agreement” by December 31, 2002. Disputes arose, however, regarding the interpretation of certain terms of the MOU, and the parties were unable to conclude a definitive agreement. The parties’ disputes were brought before the court, and on July 15, 2003, the court held that the MOU constituted a binding settlement agreement, and that our interpretation of the MOU was correct. Thereafter, the court ordered Genesis to make certain payments described in the MOU to the Court’s escrow account, and on December 19, 2003, the court entered judgment based on its July 15, 2003 ruling.

Genesis appealed the judgment to the U.S. Court of Appeals for the Federal Circuit on January 16, 2004. On January 28, 2005, the Federal Circuit dismissed Genesis’ appeal for lack of jurisdiction, holding that the judgment below was not final and appealable. Specifically, the Court of Appeals found that the parties’ agreement to settle the case, as embodied in the MOU, required that Genesis pay us, rather than the district court’s escrow account, certain of the payments described in the MOU.

asserting among other things that the district court erred in its interpretation of the MOU, that the MOU (as interpreted by the court) constitutes patent misuse, and that the district court erred in construing certain claim terms in the asserted patents. After a full briefing by the parties, oral argument was heard at the Federal Circuit on April 5, 2006 and on April 6, 2006 the Federal Circuit issued a per curiam ruling, affirming the district court’s decision in all regards. Genesis did not seek a rehearing by the Federal Circuit, and the Federal Circuit’s mandate issued on April 27, 2006. Genesis may still petition the United States Supreme Court to accept this case for review, but the Company believes that it is unlikely such a petition, if filed, would be granted.

We and certain of our officers and directors, together with certain investment banks, have been named as defendants in a securities class action suit filed against us on behalf of purchasers of our securities between October 5, 1999 and December 6, 2000. It is alleged that the prospectus related to our initial public offering was misleading because it failed to disclose that the underwriters of our initial public offering had solicited and received excessive commissions from certain investors in exchange for agreements by investors to buy our shares in the aftermarket for predetermined prices. Due to inherent uncertainties in litigation, we cannot accurately predict the outcome of this litigation; however, a proposed settlement has been negotiated and has received preliminary approval by the Court. This settlement will not require Silicon Image to pay any settlement amounts nor issue any securities. In the event that the settlement is not granted final approval, we believe that these claims are without merit and we intend to defend vigorously against them.

We and certain of our officers were named as defendants in a securities class action captioned “Curry v. Silicon Image, Inc., Steve Tirado, and Robert Gargus,” commenced on January 31, 2005. Plaintiffs filed the action on behalf of a putative class of shareholders who purchased Silicon Image stock between October 19, 2004 and January 24, 2005. The lawsuit alleged that Silicon Image and certain of our officers and directors made alleged misstatements of material facts and violated certain provisions of Sections 20(a) and 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 promulgated thereunder. On April 27, 2005, the Court issued an order appointing lead plaintiff and approving the selection of lead counsel. On July 27, 2005 plaintiffs filed a consolidated amended complaint (“CAC”). The CAC no longer named Mr. Gargus as an individual defendant, but added Dr. David Lee as an individual defendant. The CAC also expanded the class period from June 25, 2004 to April 22, 2005. Defendants filed a motion to dismiss the CAC on September 26, 2005. Plaintiffs subsequently received leave to file, and did file, a second consolidated amended complaint (“Second CAC”) on December 8, 2005. The Second CAC extends the end of the class period from April 22, 2005 to October 13, 2005 and adds additional factual allegations under the same causes of action against Silicon Image, Mr. Tirado and Dr. Lee. The complaint also adds a new plaintiff, James D. Smallwood. Defendants filed a motion to dismiss the Second CAC on February 9, 2006 and that motion is currently scheduled to be heard on June 9, 2006.

On January 14, 2005, we received a preliminary notification that the Securities and Exchange Commission had commenced a formal investigation involving trading in our securities. On February 14, 2005, through our legal counsel, we received a formal notification of that investigation and associated subpoenas. We are fully cooperating with the SEC in this matter.

In addition, 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.

We intend to defend such matters vigorously, and although adverse decisions or settlements may occur in one or more of such cases, the final resolution of these matters, individually or in the aggregate, is not expected to have a material adverse effect on our results of operations, financial position or cash flows.

Guarantees

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

9. Customer and Geographic Information

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


	Three Months Ended March 31,
	2006		2005
Taiwan	$	14,741	$	11,368
Japan		14,768		7,541
United States		12,816		12,158
Korea		5,420		4,694
Hong Kong		2,045		1,218
Other		9,309		7,341

Total revenue	$	59,099	$	44,320

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


	Three Months Ended March 31,
	2006		2005
Consumer Electronics(1)	$	35,392	$	21,232
Personal Computer(1)		13,306		11,105
Storage(1)		10,401		11,983

Total revenue	$	59,099	$	44,320

(1) Includes development, licensing and royalty revenue

For the three months ended March 31, 2006, three customers each generated 18.6%, 16.2%, and 10.2% of our revenue respectively. At March 31, 2006, one customer represented 25.3% of gross accounts receivable.

For the three months ended March 31, 2005, two customers each generated 18.2% and 10.3% of our revenue respectively. At March 31, 2005, two customers represented 12.9% and 11.5% of gross accounts receivable.

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

Cost of sales information by product line is not available. Accordingly, only revenue by product line is presented.

10. Provision for taxes

For the three months ended March 31, 2006, we recorded a provision for income taxes of $1.6 million. The effective tax rate for the three months ended March 31, 2006 is 41% and is based on our projected taxable income for 2006. The effective tax rate takes into account the fact that a portion of the expected benefit due to net operating loss carryforwards are the result of stock option transactions and therefore do not reduce the tax provision as this amount will be recorded as a credit to additional paid-in capital. The effective tax rate for the three months ended March 31, 2006 of 41.00% is comprised of 32.5% Federal, 5.0% State and 3.5% foreign.

We provided a valuation allowance of $52.3 million as of December 31, 2005 on 100% of the net deferred tax assets as management determined it was more likely than not that the deferred tax assets would not be realized. We continue to assess the recoverability of the deferred tax assets on an ongoing basis. If we subsequently conclude that it is more likely than not that the deferred tax assets will be recovered and, accordingly, reverse the valuation allowance, we expect that the effect of the reversal will principally be a credit to additional paid-in capital.

11. Gain on investment security

In October 2000, as consideration for the transfer of certain technology to Leadis Technology Inc. (Leadis), a development stage privately controlled entity, we received 300,000 shares of preferred stock and a warrant to purchase 75,000 shares of Leadis’ common stock. Initially, these equity instruments were recorded at a nominal value due to the early stage of Leadis’ development and other uncertainties as to the realization of this investment.

In June 2004, Leadis completed an initial public offering of its stock. In connection with the initial public offering, the preferred stock was converted into common stock on a 1:1 basis.

In February 2005, we sold approximately 23,600 shares of our investment in Leadis at prices ranging from $7.40 to $7.50. These shares related to the warrant shares and consequently in connection with this sale, we recorded a loss of approximately $119,000 for the three-month period ended March 31, 2005. During the three month period ended June 30, 2005, we sold the remainder of our holding in Leadis at prices ranging from $5.38 to $6.06, and recorded a net realized gain of approximately $1.4 million.

12. Subsequent event

On April 6, 2006, the Court of Appeals for the Federal Circuit issued a decision in our favor in our lawsuit against Genesis Microchip (See Note 8). In this decision, the Federal Circuit upheld the District Court’s findings of fact and conclusions of law in every respect, including the District Court’s conclusion that Genesis should pay a lump sum monetary settlement and royalties on all Genesis products that comply with the Digital Visual Interface (DVI) and High-Definition Multimedia Interface^{TM (}HDMI) standards. Genesis had until April 20, 2006 to petition the Federal Circuit to reconsider its April 6, 2006 decision, but did not file such a petition. Genesis did not seek a rehearing by the Federal Circuit, and the Federal Circuit’s mandate issued on April 27, 2006. Genesis may still petition the United States Supreme Court to accept this case for review, but the Company believes that it is unlikely such a petition, if filed, would be granted.

While the case was on appeal, Genesis was ordered to pay certain sums due to us into a segregated interest bearing account. By order of the trial court, our ability to take control of and use these funds was tied to the outcome of the appellate process. In light of the Federal Circuit’s mandate, we may now take control of the funds as early as May 11, 2006.

13. Related party transactions

On November 8, 2005, the Board of Directors of Silicon Image approved David Lee, Chairman of the Board of Directors of Simplay Labs, LLC, a wholly-owned subsidiary of Silicon Image, Inc., making an investment in and joining the Board of Directors of Synerchip Co., Ltd. (“Synerchip”). On November 21, 2005, Dr. Lee was appointed to the Board of Directors of Synerchip. Dr. Lee made a personal investment in the amount of $10,000 directly in Synerchip, and a limited partnership he controls made an investment in the amount of $500,000 in Synerchip. Sunplus Technology Co., Ltd. (“Sunplus”), a long-time customer and vendor of Silicon Image also has Board representation and an investment in Synerchip. Because of Sunplus’ representation on the Board of Directors of Synerchip and investment in Synerchip, Synerchip may be deemed an affiliate of Sunplus. On March 24, 2006, Dr. Lee resigned as an employee of Silicon Image and its related subsidiary Simplay Labs; therefore, Sunplus and Synerchip ceased as related parties to Silicon Image as of such date.

The related party transactions with Sunplus and Synerchip and its related subsidiaries and affiliates through March 24, 2006 are described below:

Silicon Image paid $363,000 and $160,000 to Sunplus for purchases of integrated semiconductors for the period ended March 24, 2006 and March 31, 2005, respectively.

Silicon Image paid $221,000 and $0 to Synerchip for purchases of integrated semiconductors for the period ended March 24, 2006 and March 31, 2005, respectively.

In March 2002, Silicon Image and Sunplus entered into a five-year Technology License Agreement pursuant to which Sunplus licensed certain LVDS receiver technology from Silicon Image. In connection with this agreement, Sunplus has paid $132,000 and $64,000 to Silicon Image in related royalty fees for the period ended March 24, 2006 and March 31, 2005, respectively.

In June 2003, Silicon Image and Sunplus entered into a three-year Strategic Relationship Agreement for joint manufacturing, marketing, selling and distribution of certain semiconductors. In connection with this agreement, Sunplus paid annual subscription fees to Silicon Image in the amounts of $50,000 for the period ended March 24, 2006 and March 31, 2005.

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

This report contains forward-looking statements within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933. These forward-looking statements involve a number of risks and uncertainties, including those identified in the section of this Form 10-Q entitled “Factors Affecting Future Results,” that may cause actual results to differ materially from those discussed in, or implied by, such forward-looking statements. Forward-looking statements within thisForm 10-Q are identified by words such as “believes,” “anticipates,” “expects,” “intends,” “estimates,” “may,” “will” and variations of such words and other similar expressions. However, these words are not the only means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances occurring subsequent to the filing of thisForm 10-Q with the SEC, including our Annual Report onForm 10-K for the fiscal year ended December 31, 2005. Our actual results could differ materially from those anticipated in, or implied by, forward-looking statements as a result of various factors, including the risks outlined elsewhere in this report. Readers are urged to carefully review and consider the various disclosures made by Silicon Image, Inc. in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risks and factors that may affect our business.

Overview

We are a leader in multi-gigabit semiconductor solutions for the secure transmission, storage and display of rich digital media. Our mission is to be the market leader in the secure storage, distribution and presentation of high definition content in the consumer environment. To ensure that rich digital content is available across devices, whether consumer electronics (CE), personal computers and displays (PC) or storage devices, they must be architected for content compatibility and interoperability. Our strategy entails establishing industry-standard, high-speed digital, secure interfaces and building market momentum and leadership through our first-to-market, standards-based semiconductor products.

In the CE market, our CE products offer a secure interface for transmission of digital video and audio to consumer devices, such as digital TVs, HDTVs, A/V receivers, set-top boxes (STBs) and DVD players. Leveraging our core technology and standards-setting expertise, we are a leading force in advancing the adoption of HDMI, the digital audio and video interface standard for the CE market. Introduced in 2003 by Silicon Image and several other leading CE companies, HDMI enables the distribution of uncompressed, high-definition video and multi-channel audio in a single, all-digital interface that dramatically improves quality and simplifies cabling. Our HDMI technology is marketed under the PanelLink brand and includes High-bandwidth Digital Content Protection (HDCP), which is supported by some Hollywood studios as the technology of choice for the secure distribution of premium content over uncompressed digital connections. In addition, our wholly-owned subsidiary Simplay Labs, LLC operates and markets the the Simplay HD^tm Testing Program, which is designed to educate retailers and consumers on the benefits of having the digital entertainment devices they sell and purchase tested for compliance with HD content delivery specifications including HDMI and HDCP. We shipped the first HDMI-compliant silicon to the market and currently remain the market leader for HDMI functionality, with more than 42 million units shipped to date. Products sold into the CE market have been increasing as a percentage of our total revenue and generated 54.0% of our total revenue for the three months ended March 31, 2006 compared to 43.9% of our total revenue for the three months ended March 31, 2005. Demand for our CE products will be driven primarily by the adoption rate of the HDMI standard within these product categories.

In the global PC market, we are a leader with our innovative PanelLink branded digital interconnect technology, which enables an all-digital connection between PC host systems, such as PC motherboards, graphics add-in boards and notebook PCs and digital displays such as LCD monitors, plasma displays and projectors. Products sold into the PC market generated 21.7% of our total revenue for the three months ended March 31, 2006 and 24.6% of our revenue for the three months ended March 31, 2005. Our PC business continues to see growth potential for DVI and HDMI on new PC systems. HDMI has been announced on several new notebooks, media PCs and graphics cards.

In the storage market, we have assumed a leadership role in Serial Advanced Technology Attachment (SATA), the high-bandwidth, point-to-point interface that is replacing Parallel ATA in desktop storage and making inroads in the enterprise arena. We are a leading supplier of discrete SATA devices. Our SATALinkÔ-branded solutions offer advanced features and capabilities such as native command queuing, port multiplier capability and Advanced Technology Attachment Packet Interface (ATAPI) support. We continue to supply high-performance, low-power fibre channel serializer/deserializers (SerDes) to leading switch manufacturers. In 2004, we shipped our first products based on the SteelVineÔ storage architecture that is expected to serve the storage needs of the of the home consumer and CE markets with a system- on-a-chip implementation that includes a high-speed switch, a custom designed dual instruction RISC (reduced instruction set computer) micro-processor, firmware and the SATA interface, among other features.

Products sold into the storage market, as a percentage of our total revenue, generated 14.4% of our total revenue for the three months ended March 31, 2006 and 23.5% of our total revenue for the three months ended March 31, 2005. Demand for our storage semiconductor products is dependent upon the rate at which interface technology transitions from parallel to serial, market acceptance of our SteelVineÔ architecture, and the extent to which SATA functionality is integrated into chipsets and controllers offered by other companies, which would make our discrete devices unnecessary where we have not already licensed our technology.

Further leveraging our IP portfolio, we broaden market adoption of the HDMI, DVI and SATA interfaces by licensing our proven IP cores to companies interested in promoting products complementary to our own. Licensing, in addition to creating revenue and return on engineering investment in market segments we choose not to address, creates products complementary to our own that expand the markets for our products and help to improve industry wide interoperability. Licensing contracts are complex and depend upon many factors including completion of milestones, allocation of values to delivered items, and customer acceptances. Although we attempt to make these factors predictable, many of these factors require significant judgment. Revenue from development for licensees, licensing and royalties accounted for 9.8% of our total revenue for the three months ended March 31, 2006 and 7.9% of our total revenue for the three months ended March 31, 2005. License revenue has been uneven and unpredictable over time, and is expected to continue to be uneven and unpredictable for the foreseeable future, resulting in considerable fluctuation in the amount of revenue recognized in a particular quarter.

Commitments, 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 58.4% of our revenue for the three months ended March 31, 2006 and 49.2% of our revenue for the three months ended March 31, 2005. Additionally, the percentage of revenue generated through distributors tends to be significant, since many original equipment manufacturers (OEM’s) rely upon third party manufacturers or distributors to provide purchasing and inventory management functions. For the three months ended March 31, 2006, 59.0% of our revenue was generated through distributors, compared to 48.1% for the comparable period of 2005. Our licensing revenue is not generated through distributors, and to the extent licensing revenue increases faster than product revenue, we would expect a decrease in the percentage of our total revenue generated through distributors.

A significant portion of our revenue is generated from products sold overseas. Sales to customers in Asia, including distributors, generated 71.7% of our revenue in the three months ended March 31, 2006, and 68.4% for the three months ended March 31, 2005. The reason for the geographical concentration in Asia is that most of our products are part of flat panel TV’s, graphic cards and motherboards, the majority of which are manufactured in Asia. The percentage of our revenue derived from any country is dependent upon where our end customers choose to manufacture their products. Accordingly, variability in our geographic revenue is not necessarily indicative of any geographic trends, but rather is the combined effect of new design wins and changes in customer manufacturing locations. All revenue to date has been denominated in U.S. dollars.

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and all known facts and circumstances that we believe are relevant. Actual results may differ materially from our estimates. We believe the following accounting policies 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. Our critical accounting estimates include those regarding (1) revenue recognition, (2) allowance for doubtful accounts receivable, (3) inventories, (4) goodwill and intangible assets, (5) deferred tax assets, (6) accrued liabilities, (7) stock-based compensation expense, and (8) legal matters. For a discussion of the critical accounting estimates, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2005.

Results of Operations

REVENUE


	Three months ended March 31,
	2006		2005		Change
	(dollars in thousands)
Product revenue	$	53,280	$	40,808		30.6	%
Development, licensing and royalty revenue		5,819		3,512		65.7	%

Total revenue	$	59,099	$	44,320		33.3	%


	Three months ended March 31,
	2006		2005		Change
	(dollars in thousands)
Consumer Electronics (1)	$	35,392	$	21,232		66.7	%
Personal Computers (1)		13,306		11,105		19.8	%
Storage (1)		10,401		11,983		-13.2	%

Total revenue	$	59,099	$	44,320		33.3	%

(1) Includes development, licensing and royalty revenue

Total revenue was $59.1 million for the three months ended March 31, 2006, representing an increase of 33.3% relative to the comparable period of 2005. The increased revenue in Consumer Electronics and Personal Computers was partially offset by lower sales of our Storage products. The increase in Consumer Electronics revenue was due to continued strong demand for our HDMI receivers for use in various devices including high definition plasma and LCD televisions as well as an increase in our transmitters used in DVD, AV receivers and STB's. The increase in Personal Computers revenue reflects strong demand for our transmitters used in PC motherboard as well as our receivers used in flat panel displays. The primary reason for the decrease in Storage revenue was a decrease in sales of our SATA products and the continued phase out of Parallel ATA products partially offset by an increase in storage licenses. Development, licensing and royalty revenues increased as a result of higher royalty revenues and higher licensing fees when compared to the prior year quarter. Our development, licensing and royalty revenues are subject fluctuations due to timing of development and licensing deliverables, as well as fluctuations in the shipments of royalty based products by our customers.

COST OF REVENUE AND GROSS PROFIT


	Three months ended March 31,
	2006			2005			Change
	(dollars in thousands)
Cost of revenue (1)	$	25,348		$	15,505		$	9,843
Product gross profit (excluding licensing revenue)		27,932			25,303			2,629
Product gross profit margin		52.4	%		62.0	%
Total gross profit	$	33,751		$	28,815		$	4,936
Total gross profit margin		57.1	%		65.0	%


(1) Includes stock compensation expense (benefit)		$	628			$	(1,196	)

Cost of revenue consists primarily of costs incurred to manufacture, assemble and test our products, as well as other related overhead costs including stock compensation expense (benefit). Cost of revenue was $25.3 million for the three months ended March 31, 2006. Cost of revenue was $15.5 million for the three months ended March 31, 2005. The $9.8 million increase in the three months ended March 31, 2006 over the comparable period of 2005 was primarily due to the product mix of our revenue. Stock compensation benefit was $628,000 in the first three months of 2006 compared to a stock compensation (benefit) of $(1.2) million in the first three months of 2005.

Total gross profit was $33.8 million for the three months ended March 31, 2006 an increase of $4.9 million from $28.8 million in the same period of 2005. Gross profit margin was 57.1% for the three months ended March 31, 2006 compared to 65.0% in the same period of 2005. The primary reason for the decrease in the gross profit margin was the mix of products sold which were slightly lower margin products than in the first quarter of 2005. Furthermore, the $1.8 million increase in stock compensation expense was also a contributing factor to the reduction in the gross profit margin.

OPERATING EXPENSES


	Three months ended March 31,
	2006			2005			Change
	(dollars in thousands)
Research and development (1)	$	15,566		$	8,122			91.7	%
Percentage of total revenue		26.3	%		18.3	%
Selling, general and administrative (2)	$	15,461		$	3,953			291.1	%
Percentage of total revenue		26.2	%		8.9	%
Amortization of intangible assets	$	274		$	274			0.0	%
Interest income and other, net		1,538			498			208.8	%


(1) Includes stock compensation expense (benefit)	$	2,812	$	(4,438	)

(2) Includes stock compensation expense (benefit)		3,843		(3,693	)

Research and Development (R&D).R&D expense consists primarily of employee compensation, including stock compensation expense (benefit), and other related costs, 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 was $15.6 million and $8.1 million for the three months ended March 31, 2006 and 2005, respectively. R&D expense for the three months ended March 31, 2006, included a stock compensation expense of $2.8 million compared to a stock compensation (benefit) of $(4.4) million for the same period in 2005. Offsetting the benefit from stock compensation in R&D expense for the three months ended March 2005 was higher compensation expense resulting from increased staffing, and higher prototype expense reflecting increased R&D activity.

Selling, General and Administrative (SG&A). SG&A expense consists primarily of employee compensation, including stock compensation expense (benefit), sales commissions, professional fees, and marketing and promotional expenses. SG&A expense was $15.5 million and $4.0 million for the three months ended March 31, 2006 and 2005, respectively. The increase in SG&A expense for the three months ended March 31, 2006, resulted primarily from stock compensation expense of $3.8 million compared to a stock compensation benefit of $(3.7) million for the same period in 2005 and an increase in headcount and outside consultants.

Amortization of Intangible Assets.Amortization of intangible assets was $274,000 for the three months ended March 31, 2006 and 2005 pursuant to our acquisition of Transwarp Networks, Inc. during the second quarter of 2003.

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

Severance and benefits payments are substantially complete. Furthermore, in December 2005 we renegotiated a lease for our Irvine, California facility, which was identified in our restructuring activities. This renegotiation provided for early termination. Accordingly, we recorded an expense recovery to the restructuring accrual with an offsetting reduction of our our operating expenses

for the year ended December 31, 2005. The following table presents restructuring activity for the three months ended March 31, 2006 and 2005 (in thousands):


	2006								2005
	Severance and		Leased						Severance and		Leased
	Benefits		Facilities			Total			Benefits		Facilities			Total
Balance as of January 1	$	—	$	25		$	25		$	32	$	1,004		$	1,036
Cash payments		—		(25	)		(25	)		—		(201	)		(201	)
Adjustment related to lease negotiation		—		—			—			—		—			—

Balance as of March 31	$	—	$	—		$	—		$	32	$	803		$	835

Interest Income and other, net.The net amount of interest income and other, which principally includes interest income and interest expense, was $1.5 million for the three months ended March 31, 2006 compared to $498,000 for the three months ended March 31, 2005. This increase was primarily due to higher interest income resulting from larger cash and investment balances and higher interest rates in the periods ended March 31, 2006 than in the comparable period of 2005.

Loss on investment security.During the three months ended March 31, 2005, we recorded a net loss of $119,000 from the partial sale our holdings in Leadis Technology, Inc (Leadis). These holdings related to equity we acquired in a transaction with Leadis in 2001. As of June 30, 2005, we no longer had an equity interest in Leadis.

Provision for taxes.

LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION


	March 31,			March 31,
	2006			2005			Change
	(dollars in thousands)
Total cash, cash equivalents and short term investments	$	167,490		$	100,407		$	67,083


Cash provided by operating activities	$	10,988		$	5,650		$	5,338
Cash provided by used in investing activities		(24,456	)		(17,612	)		(6,844	)
Cash provided by financing activities		6,684			4,181			2,503

Net increase (decrease) in cash and cash equivalents	$	(6,784	)	$	(7,781	)	$	997

Cash, Cash Equivalents and Investments

Cash, cash equivalents and short-term investments were $167.5 million at March 31, 2006, an increase of $67.1 million from $100.4 million at March 31, 2005.

Operating Activities

We generated $11.0 million in cash from operating activities in the three months ended March 31, 2006 as compared to $5.7 million in the same period of 2005. The major components of operating cash flow were the increased deferred margin on distributor sales, and the non-cash expenses such as depreciation, amortization and stock compensation expense, partially offset by the increase in accounts receivable and the decrease in accrued expenses.

Investing and Financing Activities

We used $24.5 million in cash in our investing activities in the three months ended March 31, 2006 as compared to $17.6 million used in the same period of 2005. This use of cash resulted primarily from our purchases, net of the sale and maturity, of short term investments and our investment in property and equipment. We generated $ 6.7 million in our financing activities in the three months ended March 31, 2006 principally from the proceeds from the exercise of stock options, proceeds from sales of shares under our employee stock purchase plan, and the tax benefit related to employee stock transactions. We generated $4.2 million from financing activities in the first three months of 2005, primarily due to the issuance of common stock. We expect to continue to invest in property and equipment in the ordinary course of business.

Debt and Lease Obligations

During the three months ended March 31, 2003, we borrowed $383,000 to finance certain capital equipment. This term loan bore interest at 5% and required monthly payments through its maturity in February 2005. During the three-months ended March 31, 2005, this remaining balance on this loan was repaid in full.

In January 2005, we acquired certain capital equipment under a debt arrangement which was paid in full as of March 31, 2006.

Future minimum payments for our operating leases, debt and inventory related purchase obligations outstanding at March 31, 2006 are as follows (in thousands):


Contractual obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Debt obligations	$	174	$	174	$	—	$	—	$	—
Operating lease obligations		10,408		3,432		4,995		1,981		—
Inventory purchase obligations		17,852		17,852		—		—		—
Minimum royalty obligation		175		100		75		—		—

Total contractual obligations	$	28,609	$	21,558	$	5,070	$	1,981	$	—

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 12 months. 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 development, licensing and royalty revenue, investments in inventory 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. To the extent existing resources and cash from operations are insufficient to support our activities, we may need to raise additional funds through public or private equity or debt financing. These funds may not be available, or if available, we may not be able to obtain them on terms favorable to us.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

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

Foreign Currency Exchange Risk

All of our sales are denominated in U.S. dollars, and substantially all of our expenses are incurred in U.S. dollars, thus limiting our exposure to foreign currency exchange risk. We currently do not enter into forward exchange contracts to hedge exposures denominated in foreign currencies and do not use derivative financial instruments for trading or speculative purposes. The effect of an immediate 10% change in foreign currency exchange rates should not have a material effect on our future operating results or cash flows; however, a long term change in foreign currency rates would likely result in increased wafer, packaging, assembly or testing costs.

Item 4. Controls and Procedures

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 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 Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC’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.

For the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(b) of the Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as a result of the material weakness in internal control over financial reporting in the tax accounting area discussed below, our disclosure controls and procedures as of the end of the period covered by this report were not effective.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal controls over financial reporting during the first quarter of our 2006 fiscal year that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting (as such term is defined under Rule 13a-15(f) of the Exchange Act), except as set forth below.

As of December 31, 2005, management identified a material weakness in our internal control over financial reporting which resulted from the failure to maintain effective controls over the accounting for income taxes. Specifically, the controls we designed to correctly compute the excess tax benefit related to stock options exercised did not operate effectively. This also resulted in us recording a material adjustment in the 2005 financial statements that affected the provision for income taxes and stockholders’ equity. This control deficiency results in more than a remote likelihood that a material misstatement of annual or interim financial statements would not be prevented or detected. Accordingly, management determined that this control deficiency constitutes a material weakness.

Management and the Audit Committee intend to remediate the material weakness concerning income taxes described above, and have begun to implement the following actions during the first quarter of our 2006 fiscal year:

	1.		Perform an extensive reconciliation of our income tax accounts.

	2.		Utilize outside consultants to assist management in the analysis of complex tax accounting and disclosure matters.

	3.		Assess our staffing in the accounting and finance areas to ensure we have adequate technical tax expertise.

Part II. Other Information

Item 1. Legal Proceedings

The case was remanded to the district court, where the parties subsequently agreed to a stipulated order whereby the funds held by the district court were transferred to Silicon Image, under restrictions, until appeals are exhausted. On July 19, 2005 the court sent $6.8 million to Silicon Image, which we have deposited in a segregated account, as required by court order. These restricted funds are included with long-term liabilities in the accompanying consolidated balance sheets as of December 31, 2005 and March 31, 2006. These funds and the related interest earned of $0.1 million were restricted as of March 31, 2006. Pursuant to the district court’s order, the Company shall not be entitled to withdraw, encumber or take control of the funds until ten business days after issuance of a mandate from the Federal Circuit. On July 22, 2005, based on the stipulated order, the court dismissed the case with prejudice. Genesis filed a renewed appeal to the Federal Circuit, asserting among other things that the district court erred in its interpretation of the MOU, that the MOU (as interpreted by the court) constitutes patent misuse, and that the district court erred in construing certain claim terms in the asserted patents. After a full briefing by the parties, oral argument was heard at the Federal Circuit on April 5, 2006 and on April 6, 2006 the Federal Circuit issued a per curiam ruling, affirming the district court’s decision in all regards. Genesis did not seek a rehearing by the Federal Circuit, and the Federal Circuit’s mandate issued on April 27, 2006. Genesis may still petition the United States Supreme Court to accept this case for review, but the Company believes that it is unlikely such a petition, if filed, would be granted.

We and certain of our officers were named as defendants in a securities class action captioned “Curry v. Silicon Image, Inc., Steve Tirado, and Robert Gargus,” commenced on January 31, 2005. Plaintiffs filed the action on behalf of a putative class of shareholders who purchased Silicon Image stock between October 19, 2004 and January 24, 2005. The lawsuit alleged that we and certain of our officers and directors made alleged misstatements of material facts and violated certain provisions of Sections 20(a) and 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. On April 27, 2005, the Court issued an order appointing lead plaintiff and approving the selection of lead counsel. On July 27, 2005, plaintiffs filed a consolidated amended complaint (“CAC”). The CAC no longer named Mr. Gargus as an individual defendant, but added Dr. David Lee as an individual defendant. The CAC also expanded the class period from June 25, 2004 to April 22, 2005. Defendants filed a motion to dismiss the CAC on September 26, 2005. Plaintiffs subsequently received leave to file, and did file, a second consolidated amended complaint (“Second CAC”) on December 8, 2005. The Second CAC extends the end of the class period from April 22, 2005 to October 13, 2005 and adds additional factual allegations under the same causes of action against us, Mr. Tirado and Dr. Lee. The complaint also adds a new plaintiff, James D. Smallwood. Defendants filed a motion to dismiss the Second CAC on February 9, 2006 and that motion is currently scheduled to be heard on June 9, 2006.

In addition, 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. We intend to defend such matters vigorously, and although adverse decisions or settlements may occur in one or more of such cases, the final resolution of these matters, individually or in the aggregate, is not expected to have a material adverse effect on our results of operations or financial position.

Item 1A. Risk Factors

You should carefully consider the following risk factors, in addition to those identified in our Annual Report on Form 10-K for the year ended December 31, 2005, together with all other information contained or incorporated by reference in this filing, before you decide to purchase shares of our common stock. These factors could cause our future results to differ materially from those expressed in or implied by forward-looking statements made by us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.

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

The revenue and income potential of our business and the markets we serve are early in their lifecycle and are difficult to predict. The DVI specification, which is based on technology developed by us and used in many of our products, was first published in April 1999. We completed our first generation of CE and storage IC products in mid-to-late 2001. The preliminary SATA specification was first published in August 2001. The HDMI specification was first released in December 2002. Our SteelVine^TM storage architecture was first released in September 2004. 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 have a history of losses and may not sustain profitability.

For the three months ended March 31, 2006, we had net income of $2.4 million. For the year ended December 31, 2005, we generated net income of $49.5 million. However, prior to 2005, we incurred net losses in each fiscal year since our inception, including net losses of $0.3 million and $12.8 million for the years ended December 31, 2004 and 2003, respectively. Accordingly, we may not sustain profitability.

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

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

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

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

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

• competitive pressures, such as the ability of competitors to successfully introduce products that are more cost-effective or that offer greater functionality than our products, including integration into their products of 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 of our products, which are influenced by competition and technological advancements, among other factors;

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

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

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

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

• the nature and extent of litigation activities, particularly relating to our patent infringement suit against Genesis Microchip and any subsequent legal proceedings related to the matters raised in that suit, and a class action lawsuit against us that was initiated in early 2005.

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

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

• our ability to manage product introductions and transitions, develop necessary sales and marketing channels, and manage other matters necessary to enter new market segments;

• our ability to successfully manage our business in multiple markets such as PC, storage and CE, which may involve additional research and development, marketing or other costs and expenses;

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

• our ability to engineer 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.

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

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

Part of our business strategy is to license certain of our technology to companies that address markets in which we do not want to directly participate. We signed our first license contract in December 2001 and have limited experience marketing and selling our technology on a licensing basis. There can be no assurance that additional companies will be interested in licensing our technology on

commercially favorable terms or at all. We also cannot ensure that companies who license our technology will introduce and sell products incorporating our technology, will accurately report royalties owed to us, will pay agreed upon royalties, will honor agreed upon market restrictions, will not infringe upon or misappropriate our intellectual property and will maintain the confidentiality of our proprietary information. Licensing contracts are complex and depend upon many factors including completion of milestones, allocation of values to delivered items, and customer acceptances. Many of these factors require significant judgments. Licensing revenue could fluctuate significantly from period to period because it is heavily dependent on a few key deals being completed in a particular period, the timing of which is difficult to predict and may not match our expectations. Because of its high margin content, licensing revenue can have a disproportionate impact on gross profit and profitability. Also, generating revenue from licensing arrangements is a lengthy and complex process that may last beyond the period in which efforts begin, and once an agreement is in place, the timing of revenue recognition may be dependent on customer acceptance of deliverables, achievement of milestones, our ability to track and report progress on contracts, customer commercialization of the licensed technology, and other factors. Licensing that occurs in connection with actual or contemplated litigation is subject to risk that the adversarial nature of the transaction will induce non-compliance or non-payment. The accounting rules associated with recognizing revenue from licensing transactions are increasingly complex and subject to interpretation. Due to these factors, the amount of license revenue recognized in any period may differ significantly from our expectations.

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

The CE, PC and storage markets in which we operate are intensely competitive. These markets are characterized by rapid technological change, evolving standards, short product life cycles and declining selling prices. We expect competition for many of our products to increase, as industry standards become widely adopted and as new competitors enter our markets.

Our products face competition from companies selling similar discrete products, and from companies selling products such as chipsets with integrated functionality. Our competitors include semiconductor companies that focus on the display, CE or storage markets, as well as major diversified semiconductor companies, and we expect that new competitors will enter our markets. Current or potential customers, including our own licensees, may also develop solutions that could compete with us, including solutions that integrate the functionality of our products into their solutions. In addition, potential OEM customers may have internal semiconductor capabilities, and may develop their own solutions for use in their products rather than purchasing them from companies such as us. Some of our competitors have already established supplier or joint development relationships with current or potential customers and may be able to leverage their existing relationships to discourage these customers from purchasing products from us or persuade them to replace our 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, as a result, they may be able to adapt more quickly to new or emerging technologies and customer requirements, or devote greater resources to the promotion and sale of their products. In particular, well-established semiconductor companies, such as Analog Devices, Intel, National Semiconductor and Texas Instruments, and CE manufacturers, such as Hitachi, Matsushita, Philips, Sony, Thomson and Toshiba, may compete against us in the future. 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.

Our success depends in part on demand for our new SteelVine storage products.

Our growth depends in part on market acceptance of our new product offerings based on our SteelVine architecture. These products may not achieve the desired level of market acceptance in the anticipated timeframes. We anticipate that the products based upon our SteelVine architecture will be sold into markets where we have limited experience. Furthermore, there is no established market for these products. There can be no assurance that we will be able to successfully market and sell the products based upon the SteelVine architecture and failure to do so would adversely affect our business.

Our success depends in part on the success of our new integrated HDMI DTV products.

Our future growth depends in part on the success of our highly integrated Digital TV System On a Chip solutions currently sampling in the market and which may or may not contribute significantly to our overall CE revenue. These products are subject to

significant competition from established companies that have been selling these kinds of products for longer periods of time than Silicon Image.

Demand for our CE products is dependent on the adoption and widespread use of the HDMI specification.

Our success in the CE market is largely dependent upon the rapid and widespread adoption of the HDMI specification, which combines high-definition video and multi-channel audio in one digital interface and uses our patented underlying transition minimized differential signaling (TMDS ®) technology, and optionally Intel’s HDCP technology, as the basis for the interface. Version 1.0 of the specification was published for adoption in December 2002, Version 1.1 of the specification was published for adoption in May 2004, and Versions 1.2 and 1.2a were published for adoption in August and December 2005, respectively. We cannot predict the rate at which manufacturers will adopt the HDMI specification. Adoption of the HDMI specification may be affected by the availability of consumer products, such as DVD players and televisions, and of computer components that implement this new interface. Other competing specifications may also emerge that could adversely affect the acceptance of the HDMI specification. Delays in the widespread adoption of the HDMI specification could reduce acceptance of our products, limit or reduce our revenue growth and increase our losses.

We believe that the adoption of our CE products may be affected in part by U.S. and international regulations relating to digital television, cable, satellite and over-the-air digital transmissions, specifically regulations relating to the transition from analog to digital television. The Federal Communications Commission (FCC) has adopted rules governing the transition from analog to digital television, which include rules governing the requirements for television sets sold in the United States designed to speed the transition to digital television. The FCC has delayed such requirements and timetables for phasing in digital television in the past. We cannot predict whether the FCC will further delay its rules relating to the digital television requirements and timetables. In the event that additional regulatory activities, either in the United States or internationally, delay or postpone the transition to digital television beyond the anticipated time frame, that could reduce the demand for our CE products.

In addition, we believe that the rate of HDMI adoption may be accelerated by FCC rules and European Information Communications and Consumer Electronics Technology Industry Associations (EICTA) and Cable & Satellite Broadcasting Association of Asia (CASBAA) recommendations discussed in the “Promotion of Industry Standards” section above. However, in the case of the FCC, we cannot predict whether these rules will be amended prior to completion of the phase-in dates or that such phase-in dates will not be delayed. In addition, we cannot guarantee that the FCC will not in the future reverse these rules or adopt rules requiring or supporting different interface technologies, either of which would adversely affect our business. In the case of the EICTA and CASBAA recommendations, we cannot predict the rate at which manufacturers will implement the HDMI-related recommendations in their products.

Transmission of audio and video from source devices (such as a DVD player or STB) to sink devices (such as an HDTV) over HDMI with HDCP represents a combination of new technologies working in concert. Cable and satellite system operators are just beginning to require transmissions of digital video with HDCP between source and sink devices in consumer homes, and DVD players incorporating this technology have only recently come to market. Complexities with these technologies and the variability in implementations between manufacturers may cause some of these products to work incorrectly, or for the transmissions to not occur correctly, or for certain products not to be interoperable. Also, the user experience associated with audiovisual transmissions over HDMI with HDCP is unproven, and users may reject products incorporating these technologies or they may require more customer support than expected. Delays or difficulties in integration of these technologies into products or failure of products incorporating this technology to achieve market acceptance could have an adverse effect on our business.

Our success depends in part on strategic relationships.

We have entered into strategic partnerships with third parties. For example, we have entered into a relationship with Sunplus which includes licensing and development agreements. Under these agreements, Sunplus licenses our technology and we and Sunplus jointly develop products.

While these strategic partnerships are designed to drive revenue growth and adoption of our technologies and industry standards promulgated by us and also reduce our research and development expenses, there is no guarantee that these strategic partnerships will be successful. Negotiating and performing under these strategic partnerships involves significant time and expense; we may not realize anticipated increases in revenue, standards adoption or cost savings; and these strategic partnerships may make it easier for the third parties to compete with us; any of which may have a negative effect our business and results of operations.

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

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

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

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

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

Historically, a relatively small number of customers and distributors have generated a significant portion of our revenue. For the three months ended March 31, 2006, shipments to World Peace International, Microtek, and Weikeng Industrial, all of whom are distributors, generated 18.6%, 16.2% and 10.2% of our revenue. For the three months ended March 31, 2005, shipments to World Peace International generated 18.2% of our revenue, and shipments to Microtek generated 10.3% of our revenue. In addition, an end-customer may buy through multiple distributors, contract manufacturers, and/or directly, which could create an even greater concentration. We cannot be certain that customers and key distributors that have accounted for significant revenue in past periods, individually or as a group, will continue to sell our products and generate revenue. As a result of this concentration of our customers, our results of operations could be negatively affected if any of the following occurs:

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

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

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

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

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

Many original equipment manufacturers rely on third-party manufacturers or distributors to provide inventory management and purchasing functions. Distributors generated 59.0% and 48.1% of our revenue for the three months ended March 31, 2006 and March 31, 2005, 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 and manage the level of inventory of our products at each distributor;

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

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

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 retail 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.

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

The development of new products is highly complex, and we have experienced delays, some of which exceeded one year, in the development and introduction of new products on several occasions in the past. We have recently introduced new storage products for the consumer and small to medium-sized business markets and we expect to introduce new CE, storage and PC products in the future. As our products integrate new, more advanced functions, they become more complex and increasingly difficult to design, manufacture and debug. Successful product development and introduction depends on a number of factors, including, but not limited to:

• accurate prediction of market requirements and evolving standards, including enhancements or modifications to existing standards such as DVI, HDCP, SATA I and SATA II, and HDMI;

• identification of customer 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;

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

• competitors’ and customers’ integration of the functionality of our products into their products, which puts pressure on us to continue to develop and introduce new products with new functionality;

• timely completion and introduction of new product designs;

• management of product life cycles;

• use of leading-edge foundry processes and achievement of high manufacturing yields and low cost testing;

• market acceptance of new products; and

• market acceptance of new architectures like SteelVine^TM.

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

complexity of our products may result in the introduction of products that contain defects or that do not perform as expected, which would harm our relationships with customers and our ability to achieve market acceptance of our new products. There can be no assurance that we will be able to achieve design wins for our planned new products, that we will be able to complete development of these products when anticipated, or that these products can be manufactured in commercial volumes at acceptable yields, or that any design wins will produce any revenue. Failure to develop and introduce new products, successfully and in a timely manner, may adversely affect our results of operations.

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

Our growth depends upon market growth and our ability to enhance our existing products and introduce new products on a timely basis. One of the ways we develop new products and enter new markets is through acquisitions. In 2001, we completed the acquisitions of CMD and SCL. In April 2003, we acquired Transwarp Networks, Inc. (TWN). We may acquire additional companies or technologies. Acquisitions involve numerous risks, including, but not limited to, the following:

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

• disruption of our ongoing business;

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

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

• inability to commercialize acquired technology; and

• the need to take impairment charges or write-downs with respect to acquired assets.

No assurance can be given 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. Failure to manage growth effectively and to successfully integrate acquisitions made by us could materially harm our business and operating results.

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

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. Production capacity for fabricated semiconductors is subject to allocation, whereby not all of our production requirements would be met. This may impact our ability to meet demand and could also increase our production costs. Cyclicality has also accelerated decreases in average selling prices per unit. We may experience fluctuations in our future financial results because of changes in industry-wide conditions.

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

We do not own or operate a semiconductor fabrication facility. We rely on third party semiconductor manufacturing companies overseas to produce the vast majority 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, assembly and test facilities involves a number of significant risks, including, but not limited to:

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

• lack of guaranteed production capacity or product supply;

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

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

In addition, our semiconductor products are assembled and tested by several independent subcontractors. We do not have a long-term supply agreement with all of our subcontractors, and instead obtain production services on a purchase order basis. Our outside sub-contractors have no obligation to supply products to us for any specific period of time, in any specific quantity or at any specific price, except as set forth in a particular purchase order. Our requirements represent a small portion of the total production capacity of our outside foundries, assembly and test facilities and our sub-contractors may reallocate capacity to other customers even during periods of high demand for our products. These foundries may allocate or move production of our products to different foundries under their control, even in different locations, which may be time consuming, costly, and difficult, have an adverse affect on quality, yields, and costs, and require us and/or our customers to re-qualify the products, which could open up design wins to competition and result in the loss of design wins and design-ins. If our subcontractors are unable or unwilling to continue manufacturing our products in the required volumes, at acceptable quality, yields and costs, and in a timely manner, our business will be substantially harmed. As a result, we would have to identify and qualify substitute contractors, which would be time-consuming, costly and difficult. This qualification process may also require significant effort by our customers, and may lead to re-qualification of parts, opening up design wins to competition, and loss of design wins and design-ins. Any of these circumstances could substantially harm our business. In addition, if competition for foundry, assembly and test capacity increases, our product costs may increase and we may be required to pay significant amounts or make significant purchase commitments to secure access to production services.

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

The manufacture of semiconductors is a complex process, and it is often difficult for semiconductor foundries to achieve acceptable product yields. Product yields depend on both our product design and the manufacturing process technology unique to the semiconductor foundry. Since low yields may result from either design or process difficulties, identifying 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.

We face foreign business, political and economic risks because a majority of our products and our customers’ products are manufactured and sold outside of the United States.

A substantial portion of our business is conducted outside of the United States. 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. 78.3% and 72.6% of our revenue were generated for the three months ended March 31, 2006 and March 31, 2005, respectively, from customers and distributors located outside of the United States, primarily in Asia.

We anticipate that sales outside of the United States will continue to account for a substantial portion of our revenue in future periods. Accordingly, we are subject to international risks, including, but not limited to:

• difficulties in managing from afar;

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

• less developed infrastructures in newly industrializing countries;

• susceptibility of foreign areas to terrorist attacks;

• susceptibility to interruptions of travel, including those due to international tensions (including the war in and occupation of Iraq), medical issues such as the SARS and Avian Flu epidemics (particularly affecting the Asian markets we serve), and the financial instability and bankruptcy of major air carriers;

• bias against foreign, especially American, companies;

• difficulties in collecting accounts receivable;

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

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

• exposure to possible litigation or claims in foreign jurisdictions; and

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

These risks could adversely affect our business and our results of operations. In addition, original equipment manufacturers that design our semiconductors into their products sell them outside of the United States. This exposes us indirectly to foreign risks. Because sales of our products are denominated exclusively in United States dollars, relative increases in the value of the United States dollar will increase the foreign currency price equivalent of our products, which could lead to a change in the competitive nature of these products in the marketplace. This in turn could lead to a reduction in sales and profits.

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

We rely on a combination of patent, copyright, trademark, mask work and trade secret laws, as well as nondisclosure agreements and other methods, to protect our proprietary technologies. We have been issued patents and have a number of pending patent applications. However, we cannot assure you that any patents will be issued as a result of any applications or, if issued, that any claims allowed will protect our technology. In addition, we do not file patent applications on a worldwide basis, meaning we do not have patent protection in some jurisdictions. It may be possible for a third-party, including our licensees, to misappropriate our copyrighted material or trademarks. It is possible that existing or future patents may be challenged, invalidated or circumvented and effective patent, copyright, trademark and trade secret protection may be unavailable or limited in foreign countries. It may be possible for a third-party to copy or otherwise obtain and use our products or technology without authorization, develop similar technology independently or design around our patents in the United States and in other jurisdictions. It is also possible that some of our existing or new licensing relationships will enable other parties to use our intellectual property to compete against us. Legal actions to enforce intellectual property rights tend to be lengthy and expensive, and the outcome often is not predictable. As a result, despite our efforts and expenses, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business. In addition, practicality also limits our assertion of intellectual property rights. Patent litigation is expensive and its results are often unpredictable. Assertion of intellectual property rights often results in counterclaims for perceived violations of the defendant’s intellectual property rights and/or antitrust claims. Certain parties after receipt of an assertion of infringement will cut off all commercial relationships with the party making the assertion, thus making assertions against suppliers, customers, and key business partners risky. If we forgo making such claims, we may run the risk of creating legal and equitable defenses for an infringer.

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

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

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

• we may license additional intellectual property for free as the DDWG promotes enhancements to the DVI specification.

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

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

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

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

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

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

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

Our success depends on managing our relationship with Intel.

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

• Intel 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;

• Intel and Silicon Image are two of the promoters of the Unified Display Interface Working Group;

• Intel is a promoter of the SATA working group, of which we are a contributor;

• Intel is a supplier to us and a customer for our products;

• we believe that Intel has the market presence to drive adoption of SATA by making them widely available in its chipsets and motherboards, which could affect demand for our products;

• 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 potentially integrate the functionality of our products, including Fibre Channel, SATA, DVI, or HDMI into its own chips and chipsets, thereby displacing demand for some of our products;

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

• Intel’s technology, including its 845G chipset, may lower barriers to entry for other parties who may enter the market and compete with us; and

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

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

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

We 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.

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. We and certain of our officers and directors, together with certain investment banks, have been named as defendants in a securities class action suit filed against us on behalf of purchasers of our securities between October 5, 1999 and December 6, 2000. It is alleged that the prospectus related to our initial public offering was misleading because it failed to disclose that the underwriters of our initial public offering had solicited and received excessive commissions from certain investors in exchange for agreements by investors to buy our shares in the aftermarket for predetermined prices. Due to inherent uncertainties in litigation, we cannot accurately predict the outcome of this litigation; however, a proposed settlement has been negotiated and has received preliminary approval by the Court. This settlement will not require Silicon Image to pay any settlement amounts nor issue any securities. In the event that the settlement is not granted final approval, we believe that these claims are without merit and we intend to defend vigorously against them.

We and certain of our officers were named as defendants in a securities class action captioned “Curry v. Silicon Image, Inc., Steve Tirado, and Robert Gargus,” commenced on January 31, 2005. Plaintiffs filed the action on behalf of a putative class of shareholders who purchased Silicon Image stock between October 19, 2004 and January 24, 2005. The lawsuit alleged that we and certain of our officers and directors made alleged misstatements of material facts and violated certain provisions of Sections 20(a) and 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. On April 27, 2005, the Court issued an order appointing lead plaintiff and approving the selection of lead counsel. On July 27, 2005, plaintiffs filed a consolidated amended complaint (“CAC”). The CAC no longer named Mr. Gargus as an individual defendant, but added Dr. David Lee as an individual defendant. The CAC also expanded the class period from June 25, 2004 to April 22, 2005. Defendants filed a motion to dismiss the CAC on September 26, 2005. Plaintiffs subsequently received leave to file, and did file, a second consolidated amended complaint (“Second CAC”) on December 8, 2005. The Second CAC extends the end of the class period from April 22, 2005 to October 13, 2005 and adds additional factual allegations under the same causes of action against us, Mr. Tirado and Dr. Lee. The complaint also adds a new plaintiff, James D.

Smallwood. Defendants filed a motion to dismiss the Second CAC on February 9, 2006 and that motion is currently scheduled to be heard on June 9, 2006.

We are currently engaged in intellectual property litigation that is time-consuming and expensive to prosecute. We may become engaged in additional intellectual property litigation that could be time-consuming, 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 could also force us to do one or more of the following:

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

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

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

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

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

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

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

Our success depends to a significant extent upon the continued contributions of our key management, technical and sales personnel, many of who would be difficult to replace. The loss of one or more of these employees could harm our business. Although we have entered into a limited number of employment contracts with certain executive officers, we generally do not have employment contracts with our key employees. We do not have key person life insurance for any of our key personnel. Our success also depends on our ability to identify, attract and retain qualified technical, sales, marketing, finance and managerial personnel. Competition for qualified personnel is particularly intense in our industry and in our location. This makes it difficult to retain our key personnel and to recruit highly qualified personnel. We have experienced, and may continue to experience, difficulty in hiring and retaining candidates with appropriate qualifications. To be successful, we need to hire candidates with appropriate qualifications and retain our key executives and employees. 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 National 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, SFAS No. 123R, Share Based Payments, 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 use contractors to provide services to us, which often involves contractual complexity, tax and employment law compliance, and being subject to audits and other governmental actions. We have been audited for our contracting policies in the past, and may be in the future. Burdening our ability to freely use contractors to provide services to us may increase the expense of obtaining such services, and/or require us to discontinue using contractors and attempt to find, interview, and hire employees to provide similar services. Such potential employees may not be available in a reasonable time, or at all, or may not be hired without undue cost.

We have experienced transitions in our management team, our board of directors and our registered public accounting firm in the past and may continue to do so in the future.

We have experienced a number of transitions with respect to our board of directors, executive officers and our independent registered public accounting firm in recent quarters, including the following:

We have experienced transitions in our management team, our board of directors and our independent registered public accounting firm in the past and may continue to do so in the future.

We have experienced a number of transitions with respect to our board of directors, executive officers, and our independent registered public accounting firm in recent quarters, including the following:

• In January 2005, Steve Laub (who replaced David Lee in November 2004) resigned from the positions of chief executive officer and president and from the board of directors, Steve Tirado was appointed as chief executive officer and president and to the board as well, and Chris Paisley was appointed chairman of the board of directors.

• In February 2005, Jaime Garcia-Meza was appointed as vice president of our storage business.

• In April 2005, Robert C. Gargus retired from the position of chief financial officer and Darrel Slack was appointed as his successor.

• In April 2005, four of our then independent outside directors, David Courtney (chairman of the audit committee), Keith McAuliffe, Chris Paisley (chairman of the board) and Richard Sanquini, resigned from our board of directors and board committees.

• In April 2005, Darrel Slack, our then chief financial officer, was elected to our board of directors.

• In May 2005, Masood Jabbar and Peter Hanelt were elected to our board of directors.

• In June 2005, David Lee did not stand for re-election as a director at our annual meeting of stockholders, and accordingly, Dr. Lee resigned from our board of directors.

• In June 2005, PricewaterhouseCoopers LLP resigned as our independent registered public accounting firm. In July 2005, we appointed Deloitte & Touche LLP as our new independent registered public accounting firm.

• In August 2005, Darrel Slack began a personal leave of absence.

• In August 2005, Dale Brown resigned from the positions of chief accounting officer and corporate controller.

• In August 2005, Robert Freeman was appointed as interim chief financial officer and chief accounting officer .

• In September 2005, Darrel Slack resigned from the position of chief financial officer and from our board of directors and the board of directors of HDMI Licensing, LLC, our wholly-owned subsidiary.

• In October 2005, William George was elected to our board of directors.

• In October 2005, Robert Bagheri resigned from the position of executive vice president of operations.

• In October 2005, John LeMoncheck, then vice president, consumer electronics and PC/display, left Silicon Image.

• In October 2005, John Shin was appointed as interim vice president, consumer electronics and PC/display businesses and served in that position until February 2006. Mr Shin serves as vice president of engineering, and has held that position since October 2003.

• In November 2005, Robert Freeman’s position changed from interim chief financial officer to chief financial officer.

• In December 2005, William Raduchel was elected to our board of directors.

• In January 2006, Dale Zimmerman was appointed as our vice president of worldwide marketing.

• In February 2006, John Hodge was elected to our board of directors.

Such past and future transitions may continue to result in disruptions in our operations and require additional costs.

Industry cycles may strain our management and resources.

Cycles of growth and contraction in our industry may strain our management and resources. To manage these industry cycles effectively, we must:

• improve operational and financial systems;

• train and manage our employee base;

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

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

• adjust spending levels according to prevailing market conditions.

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

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

Our operations are headquartered in the San Francisco Bay Area, which is susceptible to earthquakes, and the operations of CMD, which we acquired, are based in the Los Angeles area, which is also susceptible to earthquakes. TSMC, the outside foundry that produces the majority of our semiconductor products, is located in Taiwan. Advanced Semiconductor Engineering, or ASE, one of the subcontractors that assemble and test our semiconductor products, is also located in Taiwan. For the three months ended March 31, 2006 and March 31, 2005, customers and distributors located in Taiwan generated 25% and 25% of our revenue, respectively. For the three months ended March 31, 2006 and March 31, 2005, customers and distributors located in Japan generated 25% and 17% of our revenue, respectively. Both Taiwan and Japan are susceptible to earthquakes, typhoons and other natural disasters.

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

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

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

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

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

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

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

addition, any requirement to dispose or abate previously sold products would require us to incur the costs of setting up and implementing such a program.

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

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

• authorizing the issuance of preferred stock without stockholder approval;

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

• 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;

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

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

• prohibiting stockholder actions by written consent.

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

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

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

• actual or anticipated changes in our operating results;

• changes in expectations of our future financial performance;

• changes in market valuations of comparable companies in our markets;

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

• changes in our key executives and technical personnel; and

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

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

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

The United States has taken, and continues to take, military action against terrorism and has engaged in war with Iraq and currently has an occupation force there and in Afghanistan. In addition, the current nuclear arms crises 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.

We indemnify certain of our licensing customers against infringement.

We indemnify certain of our licensing agreements 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.

If we are unable to successfully address the material weakness in our internal controls as described in Item 9A of our Annual Report onForm 10-K, our ability to report our financial results on a timely and accurate basis may be adversely affected.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we were required to furnish in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 a report by our management in our internal control over financial reporting. Such report must contain, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. Such report must also contain a statement that our auditors have issued an attestation report on management’s assessment of such internal controls. Management’s report was included in the Annual Report on Form 10-K under Item 9A.

As of December 31, 2005, management concluded that a material weakness exists as we did not maintain effective controls to correctly compute the excess tax benefit relating to stock options exercised, which resulted in us recording a material adjustment in the 2005 financial statements that affected the provision for income taxes and stockholders’ equity. Because of this material weakness, management concluded that we did not maintain effective internal control over financial reporting as of December 31, 2005. Management has identified the steps necessary to address the material weaknesses described above, and has begun to execute remediation plans, as discussed in Item 9A of the Annual Report on Form 10-K. If we are unable to successfully address the material weakness in our internal controls, our ability to report our financial results on a timely and accurate basis may be adversely affected. As a result, current and potential stockholders and other third parties could lose confidence in our financial reporting which could have a material adverse effect on our business, operating results and stock price.

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

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

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

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

(a) Exhibits


10.01		Silicon Image, Inc. Bonus Plan for Fiscal Year 2006 (incorporated by reference to Exhibit 10.01 to our Current Report on Form 8-K, filed February 17, 2006)

10.02		Silicon Image, Inc. Sales Incentive Plan for Vice President of Worldwide Sales for Fiscal Year 2006 (incorporated by reference to Exhibit 10.02 to our Current Report on Form 8-K filed February 7, 2006)

10.03*		Consulting Agreement between Dr. David D. Lee and the Registrant dated March 15, 2006 (incorporated by reference to Exhibit 10.03 to our Current Report on Form 8-K filed March 16, 2006)

31.01		Certification under Section 302 of the Sarbanes-Oxley Act of 2002

31.02		Certification under Section 302 of the Sarbanes-Oxley Act of 2002

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

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


*		Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.

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

Signatures

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


Dated: May 9, 2006		Silicon Image, Inc.

		/s/ Robert R Freeman

		Robert R Freeman
		Chief Financial Officer (Principal Financial Officer)

Exhibit Index


10.01		Silicon Image, Inc. Bonus Plan for Fiscal Year 2006 (incorporated by reference to Exhibit 10.01 to our Current Report on Form 8-K, filed February 17, 2006)

10.02		Silicon Image, Inc. Sales Incentive Plan for Vice President of Worldwide Sales for Fiscal Year 2006 (incorporated by reference to Exhibit 10.02 to our Current Report on Form 8-K filed February 7, 2006)

10.03*		Consulting Agreement between Dr. David D. Lee and the Registrant dated March 15, 2006 (incorporated by reference to Exhibit 10.03 to our Current Report on Form 8-K filed March 16, 2006)

31.01		Certification under Section 302 of the Sarbanes-Oxley Act of 2002

31.02		Certification under Section 302 of the Sarbanes-Oxley Act of 2002

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

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


*		Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.

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

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Litigous
Readability	H.S. freshman Good

Silicon Image (SIMG) Inactive 10-Q2006 Q1 Quarterly report

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