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Article by DailyStocks_admin    (06-17-08 08:24 AM)

Filed with the SEC from May 22 to May 28:

Zilog (ZILG)
Riley Investment Management said it intends to nominate two candidates to serve as directors when ZILG's 2008 nominating window opens on June 8. Riley expressed "deep concern" over the company's strategic direction, and urged the board to move swiftly to maximize shareholder value through a sale of the company. Riley has been unhappy with Zilog's rejection of an acquisition offer from Universal Electronics (UEIC), which in January offered to buy Zilog for $4.50 a share. Riley Investment reported ownership of 1,061,357 shares (6.3%).

BUSINESS OVERVIEW

Our Business

We are a fabless semiconductor supplier of microprocessor and microcontroller semiconductor devices that we refer to as micrologic products. 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. A microcontroller typically includes a central processing unit, non-volatile program memory, random access memory for data storage and various peripheral capabilities. The microcontroller is offered as a complete solution because it incorporates application-specific software provided by the customer and may include specialized peripheral device controllers and internal or external non-volatile memory components to enable the storage and access of additional program software.

ZiLOG was founded in 1974 by Federico Faggin who co-invented the microprocessor. We design, develop, test and market a portfolio of these devices for a variety of applications used in consumer electronics, home appliances, security systems, point-of-sale terminals, personal computer peripherals, personal health and medical products.

We introduced our first products in the mid-1970's and have since established a globally recognized brand. We sell our devices directly to a diverse customer base of Original Equipment Manufacturers ("OEMs") for general purpose use or for use in application specific end markets. Additionally, we sell our devices to distributors who generally provide logistical and post sales support to these customers.

We continue to invest in the development of our 8 and 16-bit portfolio of products, including derivatives of our Z8 Encore!, Z8Encore!XP, Motor control and eZ80 Acclaim! product families. These devices are designed to incorporate reprogrammable flash memory and enhanced peripherals with features that may allow such functionality as power management, sensing secure transactions and connectivity.

Additionally, we now offer an integrated 32-bit ARM based microprocessor with secured transaction technology currently servicing the point-of-sale market.

Our Industry

Microcontroller devices have been incorporated into a wide variety of products in markets including consumer electronics, home appliances, security systems, point-of-sale terminals and personal computer peripherals, as well as industrial and automotive applications. Microcontrollers are generally segmented by word length, which is measured in bits ranging from 4-bit through 32-bit architectures. Although 4-bit microcontrollers are relatively inexpensive, they generally lack the minimum performance and features required for product differentiation and are typically used only to produce basic functionality in products. While traditional 16 and 32-bit architectures are typically higher performance, they can be too expensive for many high-volume embedded control applications, typically costing two to four times the cost of an 8-bit microcontroller. Manufacturers will choose the appropriate microcontroller based on cost, performance and functionality. Microcontrollers are used broadly in over 100 different market categories for specific and general purpose applications.

Analysts estimate the 8-bit market to be in excess of $4 billion per year with the fastest growing element of that market being embedded flash. We believe that 8-bit microcontrollers are generally perceived as the most cost-effective embedded control solution for high volume requirements. High-volume microcontrollers available today are Read Only Memory ("ROM") or One-Time Programmable ("OTP"), which typically require longer delays and greater costs in order to implement customer application code changes as compared to embedded flash with reprogrammable capabilities. ROM and OTP products generally result in longer lead times for delivery of such microcontrollers. In addition to delayed product introduction, these longer lead times can result in potential inventory obsolescence and disruptions to customers' factory production when changes in the application code are required by the customer. To address some of these issues, suppliers may offer OTP-based microcontrollers that can be configured by the customer in the customer's manufacturing line, thus minimizing lead-time and inventory risks if the customer's application code requires changes. Furthermore, flash memory offers the flexibility of in-product re-programmability. While these flash-based microcontrollers were initially expensive relative to ROM and OTP-based microcontrollers, manufacturing technology has evolved over the past years to the point where the premium for flash microcontrollers over ROM and OTP-based microcontrollers can be minimal.

Our Strategy

The key elements of our strategy are:

Deliver Complete Solutions to Our Customers

We are focused on providing advanced semiconductor solutions that assist our customers in adding functionality and enhancing the performance of their products.

Partner with Third Party Manufacturers to Leverage Scale

Our manufacturing strategy is to utilize third-party wafer foundries to manufacture our devices. We believe outsourcing the manufacturing process enables us to access advanced technologies and reduce our manufacturing costs. This strategy allows us to focus greater resources on product design, systems and software development and customer support. In line with this strategy, during 2002 and 2004 we closed our wafer manufacturing facilities in Nampa, Idaho, and migrated production of these products to our wafer foundry suppliers. Our new products are sourced from TSMC and UMC in Taiwan and our legacy products are sourced from X-FAB in Lubbock, Texas.

Products and Applications

We design, develop, and market a broad portfolio of micrologic semiconductor devices for embedded control and communication applications used in consumer electronics, home appliances, security systems, point-of-sale terminals, personal computer peripherals and industrial and automotive applications.

Our products offer our customers the ability to integrate peripheral functions (such as network connectivity, timers, serial communication, analog to digital conversion, infrared data transmission and display drivers) on our micrologic devices. These additional functions enhance the capabilities of the customer's end product, which can lower their overall systems costs. These peripherals incorporate functionality, which may otherwise be found in a separate chip, on the printed circuit board to which the micrologic device is attached.

We combine different microprocessors, memories and peripheral functions to create devices specifically tailored to meet the requirements of targeted vertical markets.

Customers, Sales and Marketing

Introduction

To market our products, we utilize a well-trained, direct and distribution sales force, a customer-centric website, technical documentation that includes product specifications and application notes, development tools and reference designs, sales promotional materials, targeted advertising and public relations activities, and involvement in key trade shows and technical conferences in North America, Europe and Asia. Our direct sales force and our sales representatives cover various geographic locations in the Americas, Europe and Asia.

Sales Process

Through direct sales and distributors we have developed relationships with customers, including large OEMs and end users. By collaborating with customers in an interactive product design and development process, we have been able to establish long-standing relationships, which help us solidify our customer base and define our next generation products.

We work closely with our customers in identifying opportunities for the customer to pursue end product designs using our devices. The customer's decision to design an end product using our devices is based upon technical and financial factors, including microprocessor performance, memory, peripheral options, pre-existing customer relationships, financial stability and pricing. Typically, a customer's product architects and design engineers will use our proprietary development tools over a period of many months, or longer, to design an end product and test the design using our devices before making a decision.

We classify a design win as the point at which the customer has placed orders to purchase a minimum of $1,000 of product. Once we have achieved a design win, we deliver a limited production of the device to our customer. Product prototypes are then created and tested. If the decision is made to produce the product for sale, we will receive a full production order. The entire cycle from design win to full production typically takes between 12 and 18 months, although it may take much longer. After a design win is achieved, our sales are generally made pursuant to short-term cancelable purchase orders that can be cancelled upon 30 to 60 days notice. As a result, design wins are not necessarily an accurate or reliable indication of future net sales.

Direct Sales Force

Our direct sales force focuses on the Americas, Europe and Asia. We have offices located in the metropolitan areas of San Jose, Seattle, Hong Kong, London, Munich, Seoul, Shanghai, Shenzhen (China), Singapore, Taipei and Toronto. The percentage of net sales derived directly from sales to OEMs is included in Table 1 below, including one OEM customer, SMK, which represented 15%, 10%, 12% and 12% of net sales for the twelve months ended March 31, 2007, twelve months ended March 31, 2006, three month transition period ended March 27, 2005 and the twelve months ended December 31, 2004, respectively. Additionally, from time to time we engage sales representative firms to further augment our own direct sales force.

We provide direct customer support through our field application engineers, who are located in our sales offices around the world and work directly with local customers in close consultation with our factory-based technical specialists. Field application engineers typically develop technology expertise in a market segment that is most prominent in their geographic areas. These engineers provide significant aid to the customer throughout the design process. Customer support is provided locally or through our new global support organization in Manila, Philippines.

Distribution Partners

We entered into a distributor agreement with Future Electronics effective October 23, 2002. This agreement provides that Future Electronics will be our exclusive full-service distributor within North America and will also serve as a non-exclusive distributor for the rest of the world. Either party may terminate the agreement upon 30 days prior written notice to the other party. Future Electronics is a private Canadian-based company with an extensive and well-integrated international distribution infrastructure. Their ability to cover a broad spectrum of market opportunities, especially in embedded flash-based products, continues to provide significant value and opportunities for our flash product portfolio. Future Electronics' value-added services to us have not increased our costs, and include a significant number of sales representatives focused on our business, seminars and workshops to train design engineers about our products, direct mail advertising, collateral materials and web site pages dedicated to our products. Net sales through our distribution channel are included in Table 1 above. During the twelve months ended March 31, 2007, twelve months ended March 31, 2006, three month transition period ended March 27, 2005, and the twelve months ended December 31, 2004, Future Electronics accounted for approximately 23%, 24%, 20% and 20% of net sales, respectively. Additionally, we use various distributors to support both our Asia and European markets. Distributors in these regions generally specialize based on the country serviced and have rights of return and/or price protection on unsold merchandise held by them. We have no exclusive arrangements in these regions and have distributor agreements for the supply and support of product sales to their customers.

Manufacturing and Sourcing

Our manufacturing strategy is to utilize third-party wafer foundries to manufacture our devices. We believe outsourcing manufacturing enables us to access advanced process technology and reduce our research and development and manufacturing costs. We source our wafer requirements from third-party foundries located in Taiwan and the United States. Wafers for our new products are supplied by TSMC and UMC and our legacy products are provided by X-FAB in Lubbock, Texas. Our assembly operations are performed by subcontractors located throughout Asia including Indonesia, Thailand and the Philippines, while a significant amount of our wafer probe and final product testing is conducted at our test and global support facility located in Manila, Philippines.

The SGS International Certification Services AG of Zurich, Switzerland granted an ISO 9001 certification to our Philippines test facility. ISO certifications reflect the stringent quality standards to which all of our products are manufactured. We believe that these certifications enhance the reputation and quality of our products.

Research and Development

Our research and development expenditures have been focused on the design and development of 8 and 16-bit embedded flash-based microcontrollers, including our Z8 Encore! Z8 Encore XP, Z8 Encore MC, ZNEO and eZ80 Acclaim! families of products. Additionally, we have focused our development resources on our Crimzon family of devices for the universal remote control market and our portfolio of 32-bit ARM based products.

Research and development expenditures were $20.5 million, $21.0 million, $5.2 million and $20.9 million for the twelve months ended March 31, 2007, twelve months ended March 31, 2006, the three month transition period ended March 27, 2005, and the twelve months ended December 31, 2004, representing 25%, 27%, 26% and 22% of net sales, respectively. During the twelve months ended March 31, 2007, twelve months ended March 31, 2006, the three month transition period ended March 27, 2005, and the twelve months ended December 31, 2004, our research and development expenditures were focused largely on our embedded flash products, including our family of flash-based microcontrollers, new devices and software features for our Crimzon line of consumer solution products concentrated in the infrared remote control market segment and our 32-bit ARM based family of products, which are initially focused on the secured transactions point-of-sale market.

Competition

The semiconductor industry is highly competitive and is characterized by price erosion and the rapid technological changes in many markets. The industry consists of major domestic and international semiconductor companies, many of which have substantially greater resources than we do with which to pursue engineering, manufacturing, marketing and distribution of their products. Emerging companies are also expected to increase their participation in the semiconductor market.

We compete on a global basis with other micrologic device manufacturers who target the same specific market segment. We believe the primary bases for competition include: price, technological sophistication, customer relationships, support tools, familiarity with micrologic architecture and existing customer investment in system software based on a particular architecture. In many instances, our competitors have similar competitive strengths to us and have significantly more resources than we do. Many of our competitors are much larger than we are, with broad product offerings in many sectors.

Our current and future products compete with, or may compete with, products offered by Atmel, Cypress Semiconductor, Freescale, Microchip, Samsung, Renasas, STMicroelectronics and Universal Electronics, Inc., among others.

Backlog

Our total backlog of cancelable customer orders was $10.0 million at March 31, 2007, $17.3 million at March 31, 2006, $13.0 million at March 27, 2005 and $13.6 million at December 31, 2004. Our sales are generally made pursuant to short-term cancelable purchase orders that are cancelable upon 30 to 60 days notice rather than long-term contracts. As a result, our backlog may not be an accurate measure of net sales or operating results for any period. Additionally, during times of economic downturn there tends to be excess capacity in the marketplace, driving shorter lead time expectations which often results in a higher percentage of book-ship (or turns) business in the period.

Patents and Licenses

We currently have 191 U.S. and non-U.S. patents as of March 31, 2007, which expire between fiscal years 2008 and 2026.

We employ a combination of patents, copyrights, mask-work rights, trademarks and trade secrets, as well as contractual restrictions, to protect the proprietary aspects of our business and devices. In addition to our own intellectual property, we license technologies and products from others, as necessary, to provide second sources for standard products or to obtain rights to cores, cells or other technology. We often enter into agreements to incorporate into our designs the intellectual property of third parties. Such agreements may impose certain obligations or limitations on our use or disclosure of, such intellectual property or the enforcement of our own intellectual property. We hold numerous U.S. and foreign patents and have additional U.S. and foreign patent applications pending. We also hold numerous mask works, copyrights to protect proprietary software employed in our devices and trademarks. We intend to continue investing in the protection of our intellectual property through the filing of patent applications and, if appropriate, the registration of copyrights, mask-works and trademarks. Nevertheless, we believe that our continued success depends primarily on the technological skills and innovative abilities of our personnel and our ability to rapidly commercialize product developments. Thus, we believe that the loss of any one of our patents or trade secrets would not materially affect our core business.

The extent and value of our intellectual property is necessarily uncertain. While we intend to protect our intellectual property rights vigorously, our efforts may not be successful. Despite our precautions, a third party may copy, or otherwise obtain, our devices or technology without authorization, requiring patent litigation to enforce our rights. Patent litigation is, by its nature, expensive and unpredictable. If litigated, one or more of our patents may be found invalid or unenforceable or to have claims of such narrow scope as to be of little economic value. Third parties may design around our patents. Third parties may independently develop technology similar to our trade secrets. In addition, the laws of some foreign countries where we have patent and trademark rights may not protect our intellectual property rights to the same extent as the laws of the United States. Additionally, our pending and future patent applications should not be relied upon as they may not issue as patents, and even if they do issue, such future patents may not be of sufficient scope or strength to provide meaningful economic or competitive value.

The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights, both defensive and offensive. From time to time we have received, and may in the future, receive communications from third parties asserting that a product offered by us, or an aspect of our business, infringes a patent held by the third party and/or require a license thereto. With respect to those third party communications that are currently pending but which have not yet been filed as a lawsuit, we believe, after having consulted with counsel, that either (i) we have meritorious defenses, (ii) based on license terms previously offered to us or typically available in the industry, we can obtain any necessary licenses on commercially reasonable terms, or (iii) we can modify our products to avoid such rights, but in any case, we may be sued and assessed damages for past infringement. Indeed, licenses may not be available on commercially reasonable terms, or at all. In addition, we have certain indemnification obligations to customers with respect to such claims of infringement of third party intellectual property rights by our devices. Should it become necessary to engage in litigation to defend against such assertions, such litigation could be expensive and time consuming. There can be no assurance that the ultimate resolution of these matters would not have a material adverse affect on our business.

On August 11, 2005, Microchip Technology, Inc. ("Microchip") filed a patent infringement claim against the Company in the U.S. District Court of Arizona (case number CV05-2406-PHX-MHM). Microchip alleges that the Company has infringed, and currently infringes, its patents numbered 5,847,450, 6,696,316 and 6,483,183. Microchip claims that unspecified products of the company, including the Z8 Encore! XP 4K Series of products, infringe these patents and is seeking preliminary and permanent injunctive relief, unspecified damages and costs, including attorneys' fees. We filed a response to the claims on September 15, 2005 generally denying the claims and challenging the validity of the patents. A hearing was scheduled for November 17, 2005. On January 10, 2006, the Company filed a request for patent re-examination with the U.S. PTO, which was granted in February and March 2006 for all 3 patents. On March 13, 2006, the Company was informed that its motion to stay with the Federal Court of Arizona was granted until such time as Microchip is informed of the outcome of the re-examinations. We do not believe it is feasible to predict or determine the outcome or resolution of this litigation at this time. We believe we have meritorious defenses and will defend ourselves against these claims vigorously. We may incur substantial expenses in our defense against these claims. In the event of a determination adverse to us, we may incur substantial monetary liabilities and be required to change our business practices. Either of these could have a material adverse effect on our financial position, results of operations and/or cash flows.

Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we may not be successful in defending ourselves against intellectual property claims. The cost of defending against patent infringement or other intellectual property litigation, in terms of management time and attention, legal fees and product delays, could be substantial, whatever the outcome. If any patent or other intellectual property claims against us are successful, we may be prohibited from using the technologies subject to these claims, and if we are unable to obtain a license on acceptable terms, license a substitute technology, or design new technology to avoid infringement, we could be prohibited from using or selling the infringing products or technologies and be required to pay substantial damages. Such a result could have a material adverse effect on our business. Conversely, we also enforce our intellectual property rights where appropriate, consistent with business considerations.

CEO BACKGROUND

Federico Faggin was appointed as a director upon effectiveness of our plan of reorganization on May 13, 2002 and became our Non-executive Chairman of the Board of Directors on February 15, 2007. Mr. Faggin is serving as Chief Executive Officer of Foveon, Inc., a developer of digital photography technology, since August 2003. Mr. Faggin co-founded Synaptics, a developer of custom-designed user interface solutions, and has served as the Chairman of the Board of Synaptics since January 1999. Mr. Faggin served as a director and the President and Chief Executive Officer of Synaptics from March 1987 to January 1999. Mr. Faggin also co-founded Cygnet Technologies, Inc. in 1982 and ZiLOG, Inc. in 1974. Mr. Faggin served as Department Manager in Research and Development at Intel Corporation from 1970 to 1974 and led the design and development of the world’s first microprocessor and more than 25 other integrated circuits. In 1968 Mr. Faggin, while employed by Fairchild Semiconductor, led the development of the original MOS Silicon Gate Technology and designed the world’s first commercial integrated circuit to use such technology. Mr. Faggin is also a director of a publicly-traded producer of fiber optic-based products, known as photonic processors; Foveon, Inc. Mr. Faggin is the recipient of many honors and awards, including the 1988 International Marconi Fellowship Award, the 1994 IEEE W. Wallace McDowell Award, and the 1997 Kyoto Prize. In addition, in 1996, Mr. Faggin was inducted into the National Inventor’s Hall of Fame for the co-invention of the microprocessor. Mr. Faggin holds a doctorate in physics, summa cum laude, from the University of Padua, Italy. Mr. Faggin also holds an honorary doctorate degree in computer science from the University of Milan, Italy. Mr. Faggin is a Group II director, subject to re-election at the Annual Meeting.

Darin G. Billerbeck was appointed President and Chief Executive Officer effective January 29, 2007. On February 15, 2007, the Board of Directors of ZiLOG, Inc. elected Darin G. Billerbeck as a member of the Board of Directors to serve until the 2007 Annual Meeting. Previously Mr. Billerbeck served at Intel as Vice President of the flash memory group and as General Manager of Intel’s flash products group from 1999 to December 2006. From 1998 to 1999, Mr. Billerbeck headed up design for Intel’s flash products group, responsible for flash architecture, design tools automation, software integration, tools validation, lab and strategic planning. From 1988 to 1999, Mr. Billerbeck was director of Intel’s manufacturing operations responsible for the technologies used in the sort, assembly, test and packaging of flash products. Prior to joining Intel, Mr. Billerbeck worked for Advanced Micro Devices from 1981 to 1988. Mr. Billerbeck received his bachelor’s degree in mechanical engineering from the University of California, Davis in 1981. Mr. Billerbeck is a nominee as a Group II Director at the Annual Meeting.

Richard L. Sanquini was elected as a director in August 2002. Mr. Sanquini presently is a consultant in the semiconductor industry. Mr. Sanquini had a twenty year career at National Semiconductor, where he managed key business units, including microprocessors and microcontrollers, served as chief technology officer, managed business development and intellectual property protection, and was Chairman of two joint ventures in China. Prior to National Semiconductor, he was the President and CEO of Information Storage Devices and General Manager and Director of the memory and microprocessor businesses at RCA. Mr. Sanquini is currently a member of the Board of Directors of Synaptics, LitePoint, FyreStorm and SiPort. Mr. Sanquini holds a bachelor’s degree in electrical engineering from the Milwaukee School of Engineering, Wisconsin. Mr. Sanquini is a Group I director, subject to re-election in 2009.

Robin A. Abrams has been a director of the Company since March 10, 2004. Ms. Abrams acted as interim Chief Executive Officer of ZiLOG Inc. from August 30, 2006 through January 29, 2007. On February 15, 2007, she was re-appointed to the Compensation Committee and Nominating Committees of the Board of Directors and appointed Chair of the Compensation Committee. From July 2004 until July 2006, Ms. Abrams served as a director and Chief Executive Officer of Firefly Mobile, Inc, a company with a range of products that address the mobile youth market. Prior to joining Firefly Mobile from September 2003 to July 2004, Ms. Abrams was President of Accenture (Connection to eBay), a company that provides strategy, management and customer service, where she also served as a consultant from May 2003 to September 2003. Ms. Abrams acted as President and Chief Executive Officer of BlueKite, a provider of bandwidth and optimization software for wireless operators, from May 2001 through January 2003. From July 1999 to March 2003, Ms. Abrams served as Chief Operating Officer of Ventro Corporation, a service provider of business-to-business marketplaces. Ms. Abrams served as the President of Palm Computing Inc. and a Senior Vice President of 3Com Corporation from February 1999 to June 1999. Ms. Abrams served as the President of VeriFone Inc., a secure payment systems company and a subsidiary of Hewlett-Packard, from March 1998 to February 1999, and as the Vice President of the Americas of VeriFone from February 1997 to March 1998. From June 1996 to February 1997, Ms. Abrams was the Senior Vice President of Apple Computer, Inc. and the President of Apple Americas, and from December 1994 to June 1996, Ms. Abrams served as the Vice President and General Manager of Apple Asia. Ms. Abrams currently serves on the Board of Directors of HCL Technologies, BEA Systems and Emotive Systems. Ms. Abrams holds a B.A. in political science and history and a J.D. from the University of Nebraska. Ms. Abrams is a Group I director, subject to re-election in 2009.

David G. Elkins has been a director of the Company since March 10, 2004 and currently chairs our Audit Committee. In 2003, Mr. Elkins retired as President and Co-CEO of Sterling Chemicals, Inc., a chemicals producing company with manufacturing facilities in the U.S. and Canada. Prior to joining Sterling Chemicals in 1998, Mr. Elkins was a senior partner in the law firm of Andrews Kurth LLP, where he specialized in corporate and business law, including mergers and acquisitions, securities law matters and corporate governance matters. Mr. Elkins currently serves as an independent director of Pliant Corporation, a leading producer of value-added film and flexible packaging products headquartered in Schaumburg, Illinois. Since 1996 Mr. Elkins has served as business representative and advisor for a large group of private investors in connection with substantial real estate holdings in Nevada and California. Mr. Elkins holds a J.D. degree from Southern Methodist University and a B.B.A. degree from The University of Texas at Arlington. Mr. Elkins is currently a Group III director, subject to re-election in 2008.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

Founded in 1974, we are a global supplier of 8-bit micrologic semiconductor devices. We design, develop and market various families of devices in this market segment. Using proprietary technology that we have developed over our 30-year operating history, we provide semiconductor integrated circuit devices that our customers design into their end products. Our devices often include related application software and typically combine a microprocessor with memory and various peripheral functions on a single device. Our products enable a broad range of consumer and industrial electronics manufacturers to control the functions and performance of their products. For example, some typical applications include devices that control the speed of a motor, infrared remote controls, security systems and battery chargers. In addition to our micrologic devices, we sell other integrated circuit devices that have a wide variety of uses, including the processing and transmission of information for communications and consumer electronics products. These devices include serial communication controllers, modems, IrDA transceivers, TV display controllers and personal computer peripheral controllers. Historically, we have also performed wafer fabrication foundry services for third parties, which were terminated in 2004.

During the December quarter of 2000, we began to experience declining sales. During the first half of calendar year 2001, James M. Thorburn joined the Company as Chief Executive Officer ("CEO") and Chairman of the Board of Directors to restructure our operations, financials and product portfolio with the goal of eliminating the debt that we had at that time, positioning the Company for growth and returning the Company to profitability. In 2002, we completed our recapitalization whereby we eliminated the debt and established the MOD III special purpose subsidiary as a result of our voluntary pre-packaged plan of reorganization under Chapter 11 of the United States Bankruptcy Code. Our fiscal 2007 financial results show progress towards profitability as we reduced our net loss by approximately $8 million as compared to fiscal 2006 on approximately $3 million of additional net sales. In August 2006, Mr. Thorburn resigned his position as CEO and Chairman of the Board of Directors.

In January 2007, under the leadership of our new CEO, Darin Billerbeck, we completed a comprehensive strategic plan update. One of the key actions resulting from this plan update was the decision to consolidate our engineering activities in order to better concentrate our core competencies and improve our product development cycle time while reducing our overall research and development spending. Our business model is structured around our fabless manufacturing approach and our market focus will be on those opportunities were we can best leverage our technology. We will continue to service the 8 and 16-bit markets where more complexity and greater value can be obtained by the customer. Our design and development resources are also focused on our universal remote control solutions and our broad based family of CRIMZON microcontrollers. Additionally, we are expanding our 32-bit ARM based portfolio of products to support secured transaction opportunities in the point of sale market and adjacent markets where these solutions have the greatest value and can be best leveraged.

Stock Repurchase Programs

2003 Stock Repurchases

On April 17, 2003, our Board of Directors approved a stock repurchase program under which we could repurchase up to 500,000 shares of our outstanding common stock at market value.

We generally had the right of first refusal to repurchase shares of common stock issued under our stock plan to certain employees, former employees and contractors, which expired on March 12, 2004. This right of first refusal became exercisable when the shares were offered for sale or upon termination of employment.

2004 Stock Repurchase Program

On July 29, 2004, our Board of Directors approved the 2004 stock repurchase program pursuant to which we could repurchase up to $5.0 million in market value of our outstanding shares of common stock. Pursuant to this program, during 2004 we purchased 572,100 shares of our common stock at a net aggregate cost of $4.4 million. No other purchases have occurred under this program.

Other Stock Repurchases

On November 17, 2004, our Board of Directors, in conjunction with the resignation of a former officer, Michael Burger, approved the repurchase of 92,735 shares of common stock from Mr. Burger at a fair market purchase price of $6.20 per share in consideration for the repayment of his loans payable to us totaling $0.6 million.

During fiscal 2006, the company repurchased 17,389 shares from former employees in consideration for the repayment of loans payable to us totaling less than $0.1 million.

During fiscal 2007 and during the three month transition period ended March 27, 2005, there were no stock repurchases.

Our net sales to OEM customers consist of gross product sales reduced by expected future sales returns and price allowances. To estimate sales returns and price allowances, we analyze historical returns and allowance activity to establish a baseline reserve level. We then evaluate whether there are any underlying product quality or other customer specific issues that require additional specific reserves above the baseline level. Because the reserve for sales returns and price allowances is based on our judgments and estimates, our reserves may not be adequate to cover actual sales returns and price allowances. If our reserves are not adequate, our net sales and accounts receivable could be materially adversely affected.

Our net sales to distributors that have rights of return and/or price protection allowances on unsold merchandise held by them are deferred until such products are resold by the distributors to end users of our devices. At the time that we recognize distributor re-sales as revenue, we record a reserve for estimated price adjustments that the distributors will reclaim from us on the merchandise they resold to end users. These reserves are recorded as a reduction to our net sales and a reduction to our accounts receivable. To estimate this distributor price adjustment reserve, we analyze our historical price adjustment payments, price adjustments taken by distributors but not yet processed by us and pending price adjustments that have been authorized by us but have not yet been claimed by our distributors. Because our distributor allowance reserve is based upon our judgments and estimates, such reserves may not be adequate to cover actual distributor price allowances. If our reserves are not adequate, our net sales and accounts receivable could be materially adversely affected.

Estimating Allowance for Doubtful Accounts

We maintain an allowance for losses we may incur as a result of our customers' inability to make required payments. Any increase in the allowance results in a corresponding increase in our selling, general and administrative expenses. In establishing this allowance, and then evaluating the adequacy of the allowance for doubtful accounts, we consider the aging of our accounts receivable, historical bad debts, customer concentrations, customer credit-worthiness and, to a lesser extent, current economic trends and changes in our customer payment terms. Historically, we have not experienced material bad debt write-offs. If the financial condition of one or more of our customers unexpectedly deteriorates, resulting in their inability to make payments, or if we otherwise underestimate the losses we will incur as a result of our customers' inability to pay us, we could be required to increase our allowance for doubtful accounts which, could materially adversely affect our operating results.

Estimating Write-Downs of Excess and Obsolete Inventories

Each inventory component, excluding raw materials, is assessed for excess or obsolescence by using an algorithm that we have established. This algorithm is based on historical trends, demand forecasts and inventory age. We review the result of this algorithm and generally reserve work-in-process inventories based upon aging and finished goods inventory quantities in excess of our current backlog or historical demand. In addition to analyzing the results of our reserve algorithm calculations, we also review known exposures, market conditions and other relevant factors to determine whether our inventory reserves are appropriate based on our best estimates. Reserves for excess and obsolete inventories are reflected as a reduction to inventory values in the accompanying consolidated balance sheets, and an increase in cost of sales in the accompanying consolidated statements of operations. If actual market conditions or customer demand patterns are less favorable than, or inconsistent with our assumptions, we may be required to take further write-downs of our inventory value, which could materially adversely impact our cost of sales and operating results.

Asset Impairments

We apply the provisions of SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" and SFAS 142, "Goodwill and Other Intangible Assets." We evaluate long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

* significant changes in the manner of our use of the acquired assets;

* decrease in our market value below our stockholder's equity book value;

* significant changes in the strategy for our overall business;

* significant negative industry or economic trends; and

* periods of operating or cash flow losses.

When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying value, the carrying value of the assets are reduced to their estimated fair value. The estimated fair value is usually determined based on an estimate of discounted future cash flows. Asset impairments are recorded as a reduction in the asset value in our consolidated balance sheets and as special charges in our consolidated statements of operations.

The intangible assets created by the adoption of fresh-start accounting on our emergence from bankruptcy in 2002, consist of existing technology and brand name, as well as excess enterprise value, or goodwill. The existing technology and brand name are being amortized based on a pattern-of-use method in proportion to the forecast discounted cash flows from such assets. The goodwill is not subject to amortization.

We evaluate existing technology and brand name whenever events and circumstances indicate that their fair value may be less than their carrying value. Additionally, goodwill is tested for impairment at least annually and more often if events and circumstances indicate that its fair value may be less than its carrying value. We performed the annual impairment test for goodwill in the fourth quarter of fiscal 2007, and we perform this test in the third quarter of each fiscal year unless the existence of triggering events indicates that an earlier review should be performed.

Adjustments to record impairment of long-lived assets or intangible assets could have a material adverse impact on our financial condition and results of operations in the period or periods in which such impairment is identified.

Results of Operations

We calculate each of these key metrics based on annual results of operations data and balance sheets data as of the end of the period indicated. Each of these key metrics is described below.

Days sales outstanding ("DSOs"), is a common metric used to analyze how quickly our customers pay us. This metric is influenced largely by the timing of our customer billings and collections. DSOs were 37 days at March 31, 2007, 44 days at March 31, 2006, 56 days at March 27, 2005 and 38 days at December 31, 2004. The March 31, 2007 DSOs reflects greater linearity of shipment and a higher mix of distribution customers that generally tend to pay faster than the average of our OEM customers.

Net sales to inventory ratio is a metric we use to analyze how quickly our investment in inventories is recovered by our sales. This metric may not be comparable to those other companies use to analyze inventory and is not the same as a typical inventory turns ratio. Our net sales to inventory ratio remained flat from March 31, 2006 to March 31, 2007, on higher sales, at 9 times annual sales, reflecting better alignment of supply and demand and improved lead times from our wafer foundry suppliers.

Weeks of inventory at distributors measures the level of inventories on hand at our distributors available for sale to their end customers, and as such, is relative to the level of sales we record for distribution sales. We do not recognize revenue on shipments to distributors who have rights of return and/or price protection on unsold merchandise held by them until our distributors resell our products to their end customers. We generally target 10 to 13 weeks of inventory in the distribution channel to allow these distributors to react to market demand and buffer the cycle time of reordering new product from us and awaiting delivery. As of March 31, 2007, our distributor inventory levels were at 12 weeks and were within our target range.

Current ratio represents current assets divided by current liabilities and is commonly used to assess a company's liquidity. The Company uses this ratio to make spending determinations on discretionary items.

Comparison of Financial Results

Fiscal Year Ended March 31, 2007 and March 31, 2006

Net Sales

Revenue from product sales to OEM customers is recognized upon title transfer, which generally occurs upon shipment, net of appropriate allowances for returns and warranty costs that are recorded at the time revenue is recognized. The Company recognizes revenue on sales to distributors who have rights of return and price protection on unsold merchandise held by them when products are resold by the distributors to end-users, or as we refer to it, on the sell through method of revenue recognition.

Net sales were $82.0 million in fiscal year 2007, as compared to net sales of $78.8 million in fiscal year 2006. Our net sales increase of $3.2 million or 4% includes an increase in overall Micrologic net sales of $7.3 million or 12%, partially offset by a decrease in net sales of our other devices. The increase in Micrologic net sales is driven by an increase of $6.0 million or 88% in embedded flash net sales, an increase of $3.8 million or 19% in our remote control business, partially offset by a decrease of $2.5 million or 8% in our non-flash net sales. The 88% increase in our embedded flash products reflects higher levels of sales in Z8Encore!, Z8Encore!XP and EZ80 Acclaim devices.

Net sales of our other devices decreased by $4.1 million or 22% reflecting a $2.9 million decrease in TV product net sales, a decrease of $0.8 million in serial communications controllers net sales and a decrease of $0.3 million in net sales of modem products, driven by a technology migration by our largest modem OEM customer from a hardware-driven solution to an internally developed software-operated modem. The TV and peripheral products have continued to decline as customers have migrated away from 8-bit analog devices to alternative solutions for digital TV.

Gross Margin

Our cost of sales primarily represents the cost of producing our products, including wafer fabrication, assembly and test expenditures. Cost of sales fluctuates depending on materials and services prices from our vendors, manufacturing efficiency and productivity of our test operation, product mix, and product yield performance.

Gross margin as a percent of net sales was 48% in fiscal year 2007 as compared to 42% in fiscal year 2006. Our gross margin improvement in fiscal 2007 reflects higher volumes on new products and lower associated supplier costs, as well as design and manufacturing improvements, resulting in lower unit costs. Gross margins on our flash products continue to improve as sales demand and volumes grow, allowing us to obtain lower wafer pricing from our suppliers.

We have focused on manufacturing cost controls, yield enhancements and price management and have continued to consolidate and streamline our manufacturing activities by closing our 8-inch MOD III wafer facility in January 2002 and our 5-inch MOD II wafer facility in July 2004. We operate with a fully fabless model and outsource all of our wafer manufacturing needs from foundries in the United States and Taiwan. We have the flexibility to use lower geometry fab processes from our suppliers for design, allowing us to reduce the physical size of our flash products, which has allowed us to improve our gross margins on these products.

We have continued to multi-source our product assembly activities with several Asian suppliers to enhance our supply source flexibility and obtain continued competitive vendor pricing.

Research and Development Expenses

Research and development expenses were $20.5 million in fiscal 2007, as compared to $21.0 million in fiscal 2006. Research and development expenses for 2007 included approximately $0.3 million in stock based compensation expense as a result of our adoption of SFAS 123R at the beginning of the fiscal year. The overall reduction in our research and development expenses in fiscal 2007 was the result of lower variable program costs as product platform development activity was completed.

In March 2007, we initiated actions to consolidate our research and development activities from 4 sites to 2 sites by closing our Seattle, Washington and Shanghai, China design centers. Although we have taken these actions to consolidate our research and development activities which are designed to reduce our overall spending, our research and development efforts were, and continue to be, primarily directed towards the development of core micrologic devices and the associated design tools. Our design resources are focused on servicing the segments of the 8 and 16-bit markets where more complexity and greater value can be obtained from our solutions by the customer.

We continue to focus our resources on our CRIMZON consumer solutions family of products targeted at the Universal remote control market. Additionally, we are focused on our new 32-bit ARM based portfolio of products initially targeted to support secured transaction opportunities in the point of sale markets.

Selling, General and Administrative Expenses

Selling, general and administrative ("SG&A") expenses were $22.7 million in fiscal 2007, as compared to $23.7 million in fiscal 2006. SG&A costs were lower in fiscal 2007 even after including a $1.0 million increase in stock-based compensation expense as a result of our adoption of SFAS 123R at the beginning of the fiscal year. The decrease in SG&A expenses is primarily due to savings from cost reduction programs to reduce headcount in our sales and marketing support functions, as well as savings from the consolidation of certain administrative functions in our Philippines operations. These savings were partially offset by higher marketing costs associated with new products and their market introductions and costs to support intellectual property activity.

Special Charges

Fiscal 2007 Activities

As part of the our ongoing efforts to reduce costs and streamline activities, in March 2007, a plan of action was initiated to consolidate certain research and development activities and transfer certain of these activities from our Shanghai, China and Seattle, Washington facilities to our San Jose, California and Meridian, Idaho facilities. During fiscal 2007, we incurred $1.0 million of severance and benefits costs related to this restructuring activity, which has been recorded as special charges. Other severance and benefit related costs of $0.8 million were incurred as a result of the resignation of our former CEO, James M. Thorburn and the hiring of our current CEO, Darin G. Billerbeck. In addition, we continued to incur period expenses to sustain the dormant MOD II facility included in assets held for sale on the consolidated balance sheet as of March 31, 2007. In May 2007, the MOD II facility was sold for a net sales price of $3.1 million.

Fiscal 2006 Activities

In April 2005, we initiated a plan of action to consolidate certain support activities and transfer certain of these activities to our Philippines operations. Total severance and benefits costs of $1.7 million related to a reduction-in-force and support activity consolidation were recorded as special charges during fiscal 2006, and the remaining amount was recorded over the terminated employee's required service periods completed during the quarter ended June 30, 2006. During fiscal 2006, we incurred $2.4 million of special charges, including the net reimbursement of $0.8 million of MOD III sustaining and maintenance costs and period expenses of $0.7 million to sustain the dormant MOD II facility which is included in assets held for sale of $1.8 million on the consolidated balance sheet as of March 31, 2006.

Stock-Based Compensation

During fiscal 2007, we recognized $1.4 million of stock-based compensation expense, as compared to $0.7 million during fiscal 2006, primarily in connection with the award of restricted stock and stock options to certain executives and employees. This non-cash stock-based compensation expense is included in our research and development and selling, general and administrative expenses. Stock-based compensation expense for employee stock awards was measured on the award date and is being recognized over the vesting period of these awards.

Amortization of Intangible Assets

Effective January 1, 2002, we adopted the provisions of SFAS 142, "Goodwill and Other Intangible Assets." Under SFAS 142, goodwill and intangible assets with indefinite lives are not amortized, but are reviewed annually or more frequently if impairment indicators arise. Separable intangible assets that are deemed to have defined lives will continue to be amortized over their useful lives. In connection with our fresh-start reporting, separable intangible assets based on independent valuations were created with deemed defined lives. These intangible assets are being amortized utilizing the pattern-of-use method over their estimated useful lives of 3 to 7 years for current technology and ten years for brand name. We evaluate existing technology and brand name whenever events and circumstances indicate that their fair value may be less than their carrying value and, if appropriate, record an impairment charge. Additionally, goodwill is tested for impairment at least annually and more often if events and circumstances indicate that its fair value may be less than its carrying value. We performed the annual impairment test for goodwill at March 31, 2007, and no impairment charge was recorded as no impairment of the carrying value was indicated. We perform this test in the third quarter of each fiscal year unless the existence of triggering events indicates that an earlier review should be performed.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Net Sales . Net sales were $17.0 million for the quarter ended December 29, 2007, a decrease of 18% as compared to net sales of $20.7 million for the quarter ended December 30, 2006.

Net sales of our 8-bit microcontroller products decreased by 4% to $9.1 million for the quarter ended December 29, 2007 compared to $9.5 million for the quarter ended December 30, 2006. This decrease was primarily driven by a decrease in sales of our remote control solutions resulting from an inventory correction at one of our key customers. Embedded flash sales decreased by 3% to $3.5 million for the quarter ended December 29, 2007 from $3.6million for the quarter ended December 30, 2006 reflecting a reduction in sales to the consumer market.

Our 32-bit ARM product sales were $0.6 million for the quarter ended December 29, 2007 as sales increased for our new secured transactions microprocessors for the point-of-sale market. Total new product sales comprised of our embedded flash, 32-bit ARM and universal remote control solutions increased by 2% to $9.7 million for the quarter ended December 29, 2007 compared to $9.5 million for the quarter ended December 30, 2006.

Our 8-bit classic product sales, consisting of our traditional Z8, Z80 and SCC products decreased by $3.9 million or 35% to $7.3 million for the quarter ended December 29, 2007, from $11.2 million for the quarter ended December 30, 2006, reflecting a decline in demand for certain consumer, security and telecommunications applications and lower distribution resales into the broad based general purpose market including industrial market applications. Compared to year ago levels, we have experienced a reduction in sales of certain security applications reflecting what we believe is the impact of a slow down in the U.S. economy as it relates to the housing market and lower overall housing starts.

Gross Margin . Cost of sales primarily represents manufacturing costs relating to wafer fabrication, package assembly, product testing operations and logistics costs. Cost of sales fluctuates, depending on materials and services prices from our vendors, manufacturing productivity, product mix, equipment utilization and depreciation. Gross margin as a percent of net sales was consistent at 47% for the quarters ended December 29, 2007 and December 30, 2006.

Research and Development Expenses. Research and development expenses decreased by 21% to $4.1 million for the quarter ended December 29, 2007 from $5.2 million for the quarter ended December 30, 2006. Research and development spending for the quarter ended December 29, 2007 was lower due to savings resulting from our engineering site consolidation efforts initiated in June 2007. Although our costs have decreased, we continue to expand our 8-bit embedded flash designs and invest in new products supporting our universal remote control solutions and our 32-bit Zatara ARM based microprocessor family of products.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $4.9 million for the quarter ended December 29, 2007 down from $5.3 million for the quarter ended December 30, 2006. Both sales and marketing and general and administrative costs decreased. We continue to streamline our global support activities thereby reducing our general support costs. Additionally, selling, general and administrative expense in the current quarter includes a credit of $0.2 million for the reversal of stock compensation expense related to the cancellation of previously expensed stock options.

During the quarter ended December 29, 2007, special charges totaled $0.6 million representing severance, termination and other costs associated with the consolidation of our engineering sites and test operations outsource initiatives. During the quarter ended December 30, 2006 special charges totaled $0.1 million and represented MOD II sustaining and maintenance costs.

Amortization of Intangible Assets. Under the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", goodwill and intangible assets with indefinite lives are not amortized, but are reviewed annually or more frequently if impairment indicators arise.

We performed our annual impairment test of goodwill and intangible assets during the quarter ended March 31, 2007. As of December 29, 2007, there was no indication of impairment of our intangible assets' carrying value.

Separable intangible assets that are deemed to have defined lives have been recorded and continue to be amortized over their useful lives. These intangible assets are being amortized utilizing the pattern-of-use method over their estimated useful lives of six years for current technology and ten years for brand name.

Interest Income and Expense. Interest income relates to interest earned on our cash and cash equivalents. Cash equivalents are primarily invested in money market funds and high-grade commercial paper with maturities of 90 days or less. Interest income for the quarter ended December 29, 2007, was $0.2 million as compared to $0.3 million for the quarter ended December 30, 2006. The lower interest income in the quarter ended December 29, 2007 is due to lower average invested cash balances, partially offset by higher interest rates.

Income Taxes. We adopted the provisions of Financial Standards Accounting Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes -an interpretation of FASB Statement No. 109 ("FIN48"), effective April 1, 2007. As a result of the implementation of FIN 48, we have analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions and have recognized no material adjustment in the liability for unrecognized income tax benefits as of December 29, 2007.

For the quarter ended December 29, 2007, our income tax provision reflects the amortization of deferred charges which has been fully amortized as of December 29, 2007, as well as provisions for taxes in certain profitable foreign jurisdictions. For the quarter ended December 30, 2006, our income tax provision reflects the amortization of deferred charges and provisions for taxes in certain profitable foreign jurisdictions. We anticipate operating at a loss for U.S. tax purposes for the fiscal year ending March 31, 2008 however, we provide for income tax expense in foreign jurisdictions where the foreign subsidiaries' operations generate profits that are taxable. Deferred tax assets have been recorded net of valuation allowances. A valuation allowance is required to be recorded if in management's judgment, and based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based on available evidence, we have concluded that a valuation allowance is necessary and have reduced our net deferred tax assets to the extent of our deferred tax liabilities.

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