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Tuesday, June 26, 2007

Bearish on Zilog

Today MarketWatch wrote that Zilog Inc. (ZILG) cut its fiscal first-quarter sales outlook, saying it would be 11% to 13% lower than the fourth quarter's $19.1 million. Based on fiscal fourth-quarter results, the San Jose semiconductor company is expecting fiscal first-quarter sales in the range of $16.6 million to $17 million. The company also said it still expects to post a quarterly loss of 16 cents to 18 cents a share.

This will make it six quarters in a row that Zilog has lost money. And yet, as of earlier this month, it had tripled in value since its low point of about $2 back in March of 2006.

Founded in 1974, Zilog is a supplier of 8-bit microcontrollers. A microcontroller is a computer-on-a-chip that is optimized to control electronic devices such as motors, remote controllers and user interfaces on appliances and various other gadgets. Microcontrollers are essentially a small PC on a chip and typically include a central processing unit, different kinds of memory and various peripheral capabilities such as network connections, timers, Analog-to-DigitalConverters (ADCs) and Digital-to-Analog Converters (DACs). These products enable a range of consumer and industrial electronics manufacturers to control the functions and performance of their products. Zilog has been a pioneer in this space, creating the original Z80 core processing unit many years ago. Its MCUs are certainly the workhorses underlying many products we interact with every day from TV remote controls to Palm Pilots.

Zilog's products are ubiquitous and necessary but they operate at the lower end of the technology spectrum. Compare the 8-bit MCU with today's 64-bit multi-core processors from Intel and AMD and you can see that Zilog has become a niche player, relegated to less complex uses. This is an area where margins are thin and volume is paramount. They are like the Wal-mart of the microprocessor sector.

There is some hope on the horizon, however. Zilog has been moving into the 32-bit MCU segment known as ARM-9 and is pursuing an application specific product strategy that will allow the company to target markets that are higher up the food chain in terms of profit margin and unit volume potential. And in February of this year Zilog named Darin Billerbeck as their new President and CEO. Billerbeck is a 14-year Intel veteran and was formerly Intel's Vice President and GM of their Flash Product Group. This was looked on as a positive development for the company and Zilog's stock price began rising.

Nevertheless, with a PEG ratio over 9 and a chart that is breaking down, there is no surprise Zilog is also flashing a strong TradeRadar SELL signal (see below).

Zilog chart - SELL signal

With the stock dropping to $5.34 today and no support in sight until the $4.50 level, look for ZILG to pull back at least another 18%. Will it be cheap enough to be a buy at that point? I don't think so. The expected loss for the upcoming quarter will only be marginally less than the previous quarter's $0.21 loss. We need to see Zilog get a lot closer to profitability before we would step in as buyers. The opportunity over the next few quarters appears to be on the short side.

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