SIMG's Last Quarter Report
SIMG Beats 2Q; Unveils Data Networking Strategy
July 18, 2000 - 6:33am
Credit Suisse First Boston Corporation
Silicon Image (SIMG)
Summary
Silicon Image reported operating EPS of $0.05 for 2Q00,
soundly beating our estimate and consensus of $0.02, and
reporting profitable pro-forma operating income for the
first time.
SIMG's PanelLink brand continues to show good adoption
with design wins from Sony, Compaq and IBM. Large design
wins from its HDCP product (intro'd in 2Q00) look to
include Sony, Sharp and Echostar.
SIMG also unveiled its data networking/storage technology
that effectively brings a low cost fibre channel solution
to the desktop storage (e.g., HDD) bottleneck. A full demo
is expected in August.
Due to conservative guidance from management owing to
anticipated competition (that has yet to materialize,
again) and higher R&D from the DVDO acquisition and earlier
tape-outs for new products and customers, we are increasing
our 2000 EPS slightly to $0.11, while 2001 remains
unchanged at $0.26 - for now.
Silicon Image is a fabless semiconductor company that
develops and markets transmitters, receivers & controllers
under the PanelLink brand, addressing the dollar per
bandwidth concern initially in the digital display
market. PanelLink is the basis for the DDWG's DVI
standard.
Investment Summary
Silicon Image reported operating EPS of $0.05 for 2Q00,
soundly beating our estimate and consensus of $0.02.
Equally important, this was the first quarter SIMG was
profitable on a pro-forma operational basis
(ex-amortization of previous compensation expense).
Higher R&D expenses going forward reflect a high-class
problem: more customer wins, faster market adoption, and
earlier product releases. Revenue for the quarter was
$12.4 million, beating our $11.8 million estimate,
growing 23% sequentially. Better-than-expected mix of
products drove both the revenue and gross margin upside,
even with expected ASP erosion (which we estimate to be
5-7% in the quarter and going forward). Gross margin was
surprisingly strong, staying essentially flat with the
previous quarter at 63.4%, versus our expectation for a
sequential decline of 350 bps to 60%. R&D spending came
in lower than we had anticipated, but should kick up given
the company's acquisition of DVDO and several new product
tape-outs (for new customers). This type of higher R&D is
viewed as more of a high class problem: more customer
design wins, quicker market adoption, and earlier release
of new products are contributing to higher R&D - to fuel
higher revenue growth 6 months out. While operating
expenses are expected to increase, primarily as a result of
this aggressive R&D spending, SIMG should still be able to
capitalize on its first-to-market advantage thus slowing
any expected gross margin erosion.
Gross margins are expected to decline, owing to anticipated
(but still yet to be seen) competition and increased
materials costs. SIMG indicated that it would expect about
a 2-3% increase in wafer prices during 3Q, but had already
planned on that type of increase at the beginning of the
year. As we mentioned last Fall, we believe that within
two weeks after the Taiwanese earthquake, SIMG actually
received a letter from TSMC committing to a tripling of
SIMG's wafer needs - showing that SIMG is perceived as
long-term valued customer.
20/80/12 - Wind in the Sails of DVI Adoption
Management surprised us by not increasing forward guidance,
despite evidence that future prospects are better. Some of
the reasons why we believe the market indicators have
improved over the last quarter include:
Quicker Adoption of DVI
Competition Still not A Major Factor, But Modeled in Nevertheless.
HDCP and Data Network Products Introduced Early
One-third of flat panels shipped have PanelLink with penetration
expected to increase to two-thirds by end of year.
So far, SIMG's strategy seems to be well seeded, and is on
the cusp of showing full returns. The company estimates
that already one-third of the flat panels begin shipped are
using PanelLink, and 5% of total PCs. By the end of the
year, that penetration is expected to hit two-thirds and
10-15%, respectively. The significance of this is that in
prior technology adoptions (such as for AGP and USB), the
market has gone from 20% adoption of, to 75-80% penetration
within 12 months. Thus, we expect SIMG to hit a major
inflection point as the market approaches a 20% adoption
rate for DVI (both for the host and receiver markets).
Like the consumer electronics market, this aggregate
addressable market is huge, with roughly 550-600 million
potential units forecasted in 2002 (by Dataquest).
Management noted that market adoption of its DVI technology
is gaining momentum. During the quarter, PanelLink
solutions were shipped to 9 of the top 10 PC OEMs and SIMG
shipped its ten millionth PanelLink chip, proof positive of
market acceptance of the company's technology. CRT revenue
commenced as ViewSonics began shipping PanelLink-based
displays. We expect Acer, NEC, and Compaq to ship volume
CRTs by year-end, too, with Sony right behind. Currently,
less than 5% of our modeled revenue for 2000 ($54 MM) is
from CRTs, so there is plenty of upside. SIMG also
reported design wins at companies such IBM (including an
all-in-one PC), Compaq, and Sony. Sony also joined the
DDWG (Digital Display Work Group) task force that oversees
the DVI standard, and represents the last of the holdouts
in giving full support to DVI, and its future prolifera-
tions such as HDCP.
Competition Welcomed, But Few Join In
As part of its guidance, SIMG continues to embed assumptions
that more competition will emerge and has already factored
in steps to proactively address this issue. The problem
is, that competition really has yet to emerge. Silicon
Image's PanelLink technology, the heart of the industry's
Digital Video Interface (DVI) standard, is based on an
open technology adoption that SIMG freely licenses to its
perspective vendors.
So far, we have been surprised by the limited number of
chip vendors who have viable solutions. So far, most of
the solutions have been on the transceiver side (not the
more difficult receiver side) enabling some premium ASPs
for SIMG. However, it also demonstrates that while many
companies have announced plans, they have found the actual
design implementation to be more of a challenge. Texas
Instruments was about 3 months late with its original DVI
1.0 version, and did not even have the receiver component
at Intel's Developer Forum. Actually, TXN used SIMG's
receiver with the clever marketing spin that it was showing
the "interoperability" of the DVI technology. ATI is also
the other major vendor, although we have seen initial
products from Genesis. Contrary to its press release at
the time it was acquired by Broadcom, industry contacts
indicate that Pivotal's prototype is a two-chip solution
(meaning it doesn't hit full DVI specs) and that Pivotal
has yet to even license the HDCP technology (even though
its free).
Meanwhile, SIMG is on its fourth and fifth generation of
PanelLink chips and has already shipped 10 million of
these units, plus unveiled real production chips of the
HDCP product. Thus, while SIMG continues to factor in
competitive issues, it has yet to materialize. That has not
stopped SIMG from aggressively cutting pricing to foster
more rapid adoption of DVI - better to have 25% of a big
market, than 40% of a smaller one.
HDCP Unveiled in 2Q00 and Already Getting Adoption
Momentum: Sony, Echostar Appear on Board; DVDO Acquisition
Closes SIMG formally unveiled its new HDCP (High-Bandwidth
Digital Content Protection) products during the quarter,
although significant revenue isn't expected until 2001.
Along those lines, we believe that the recent delay in
Sony's HDTV roll-out until 1Q01 will now include SIMG's
HDCP technology, although a formal announcement probably
won't occur until the Consumer Electronics Show (CES) next
January. On Friday, EETimes disclosed that Echostar will
announce their intention to include DVI with HDCP into
their next generation satellite set-top boxes. This would
be used as an alternative to the more costly IEEE 1394.
While no specific supplier was announced, the fact that
SIMG is the only vendor with actual HDCP silicon would
strongly argue that SIMG has the inside track.
SIMG also noted that adoption by the entertainment industry
is gaining further traction: Universal Studios is indicating
interest in supporting SIMG's HDCP for DVI and would join
the ranks of other industry giants Warner Bros., Disney,
and Fox Studios. In addition, during the quarter, JVC
announced that it would develop a digital player with HDCP
technology, and Sharp shipped its first products with HDCP
technology.
Just to remind investors, HDCP is an approved technology by
the Motion Pictures Association of America (MPAA) for
digital transmissions or video - to prevent unauthorized
copying. There is a current NSTC solution but is an
analog-based one, using software, and requiring a royalty
payment to Macronix.
Thus, customers would pay more for a lower quality solution
if they want to hook up their DVDs, while not even able to
fully utilize the capabilities of their digital TVs. SIMG
allows open licensing of this technology, to further its
adoption, so there are no royalties. The consumer market
for digital content is a fast growing segment, and users
are only just beginning to realize the advantages of
digital content. By adding on HDCP to the current high
speed (10-Gbps), low cost DVI 1.0 standard, SIMG combines
both low cost digital capabilities and content protection
for high quality video transmissions into some of the large
consumer electronics markets -- set-top boxes, digital
CRTs, DVD players and HDTVs.
Along those lines, just after the end of the quarter, SIMG
closed on its acquisition of DVDO, a provider of digital
video processing technology for consumer electronics.
DVDO includes many of he same ex-Apple engineers that
used to work with many of SIMG's own engineers previously -
increasing our confidence that this merger will be highly
successful. The acquisition of DVDO will enable SIMG to
further its penetration into the consumer electronics
arena.
Unveils Networking/Storage Strategy; Acquires Zillion
SIMG unveiled its data storage initiative, a technology
that should enable SIMG to tap into and release the
interface bottleneck for internal storage devices (HDD,
etc.). Effectively this is equivalent to bringing a low
cost fibre channel interface to the desktop. The size of
this market could be enormous. Since SIMG has yet to
release all of the specifications of this technology, we
would describe it as a type of serial-based interface with
a "synchronization" that removes at least four of the
6 PLL components (Phase Locked Loop) and much of the
buffer/overflow memory that is currently used in these
storage systems. Thus SIMG's solutions would significantly
reduce cost while potentially improving performance
(reduced latency). This market is estimated to include
over 165 million addressable units.
SIMG also announced that it has acquired Zillion Technologies,
a developer of high-speed data storage transmission
technology. This acquisition is expected to provide SIMG
with high-level architecture engineering expertise.
Raising EPS estimates for 2000 to $0.11, 2001 unchanged
at $0.26.
Thanks to a higher revenue base reported for 2Q00, we have
bumped up our revenue estimates for both 2000 and 2001,
mostly offset by higher R&D expenses associated with the
new DVDO acquisition and tape-outs from both new products
and new customers that have occurred earlier than originally
expected. Forward guidance remained inline with previous
guidance for mid-teens sequential revenue growth for 3Q
and 4Q00. In several recent talks with management, we
believe that SIMG is giving conservative guidance in order
to easily beat future earnings reports. This effectively
allows the company to focus on its new design initiatives
(DVI, HDCP, and data storage) than on managing near-term
stock appreciation or second derivative perceptions about
upside guidance. Given this one step back-for three steps
forward trade-off, coupled with SIMG management's
conservative stance (think: RFMD meets Jack Gifford),
we are raising our 2000 EPS estimate slightly to $0.11
(formerly $0.10) while keeping our 2001 estimate of
unchanged at $0.26; but believe there is significant upside
to 2H00 and 2001.
Maintain BUY rating and Price Target of $95
Our investment thesis on SIMG remains intact: the industry
is moving rapidly to digital displays and OEMs are
adopting SIMG's innovative PanelLink solution for flat
panels, digital CRT, projectors, and consumer electronic
devices by year end. SIMG has already raised the bar by
introducing its HDCP technology and laying out its
preliminary networking/storage roadmap, with significant
revenue commencing in 2001. However, since there have been
no formal announcements, we have essentially no revenues
from either of these initiatives in our model - much in the
way that we originally had no CRT revenue in our 2000
model, when SIMG went public.
As a result, we reiterate our Buy on the shares and $95
price target, with plenty of upside expected into 2001.
That upside should materialize as the market transitions
more quickly digital and/or SIMG gains more market share
and dollar content per system. We believe that between
Intel's Developer Forum in August and CES next January,
there will be plenty of catalyst to SIMG stock in the form
of customer announcements and better visibility as to
market adoption. We recommend investors take a position in
SIMG before that period commences.
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