Zilog looks toward post-reorganization growth

Zilog Inc. spokespersons call the company’s post-reorganization financial performance “the turnaround.”

CEO Perry Grace says the computer chip company with major manufacturing operations in Nampa is in much better shape now that it’s not weighed down with debt.

“In essence, we had this problem of being over-leveraged,” he said. Zilog’s debt and interest costs exceeded $300 million last year compared to revenues of $172 million.

In the first half of 2001, a depressed semiconductor market and Zilog’s negative cash flow presented “a real struggle,” Grace said, and led the company to approach bondholders about a reorganization in July.

Holders of $280 million in senior secured notes (paying 9.5 percent annual interest) got stock instead in a reorganization that included a Chapter 11 bankruptcy. The plan was court-approved in May. Zilog had shed some other costs earlier.

“Cash is king, especially in tough times,” Grace said.

“I don’t believe we lost any major customers through the reorganization,” he said. “A Chapter 11 is not easy for most people to deal with.”

In the quarter ended March 31, Zilog generated net sales of about $36 million, down from $44.3 million a year earlier. But its operating loss was far less – $3.2 million in the first quarter of 2002 compared to $16.6 million in the opening quarter of ’01.

“Even on the lower revenue base, we have turned from negative to positive cash flow, excluding restructuring activities,” Grace said.

Zilog used the Chapter 11 to “re-capitalize the balance sheet,” he said, but the company also has returned to its roots.

“The key to the whole thing was really re-focusing the business back to where we came from – continued presence in the 8-bit microcontroller market,” Grace said. At about $5 billion a year, it is “a huge market, with a lot of opportunities,” he added. The 8-bit microcontrollers are used in consumer and industrial controls, and in connectivity devices.

Zilog invested too much in new areas of the industry – namely, 32-bit microprocessors, he said.

“We approached the high end of the processor market; that was a different market for us,” Grace said.

The 32-bit market centers on networking and communications. At the time, the late 1990s heyday of those sectors, “it was a market that was supposed to be there,” he said. “It was bigger then than now.”

Zilog opened Mod III, a $250 million design and manufacturing facility on North Kings Road in Nampa, in 1996. It worked with 8-inch semiconductor wafers rather than the 5-inch wafers handled in Mod II on 11th Avenue North Extension.

Grace said the company expected Mod III would be used for “our growing business needs, a lot of which was to be growth in the 32-bit market.”

But Zilog could not grow revenues fast enough, he said. Early this year the company mothballed Mod III, which remains for sale.

Company directors and bondholders decided it was best to market Mod III rather than use it in existing operations or to sell it quickly at a “fire sale” price, Grace said. No buyer has emerged, but “we have had interested parties.”

“We spent a considerable amount of cash on the facility, and a considerable amount investing in 32-bit,” he said. “In essence we had built infrastructure in the company, subsequent to the leveraged buyout of 1998, to support a $400 million to $500 million business.”

Zilog’s business peaked at around $250 million a year at the height of the semiconductor market. “With the following rapid decline of the market, the company was in position of falling faster (revenue-wise) than it could shed costs. The peak was toward the end of 2000.”

The company started in 1974 and became a wholly owned subsidiary of Exxon in 1981. Management led a buyout from Exxon in 1989, and Zilog made a public stock offering in 1991. It became a private company again in 1998 when Texas Pacific Group bought it.

“In 2000, we de-emphasized some of our products, specifically in lower-margin TV and peripheral areas,” Grace said. “In the past year we have invested more in our 8-bit products.”

The only way to grow market share is to roll out new products that offer customers more functionality, he said. The pricing environment is “still profitable,” he said.

And there are “all sorts of applications and all sorts of businesses, from battery chargers to garage door openers to remote controls, industrial and consumer control products,” Grace said.

Zilog employs about 250 in Nampa, compared to a peak of 400 about 18 months ago when it announced plans to close Mod III.

“We have had to make some really hard choices. One of the hardest choices was Mod III in Nampa,” Grace said.

In addition to its Nampa wafer fabrication operations, the company runs assembly and test functions in the Philippines. A consolidation moved 20 to 30 positions from Idaho to the Philippines in the third quarter of 2001, he said.

But the Nampa management team has taken more product management and engineering responsibilities.

“We are putting management in the hands of the people who can have the most impact,” Grace said.

The company is “open” to adding staff in Nampa, he said. “We do have a design facility in Nampa, and are hiring engineers in Nampa and San Jose.”

Zilog moved its headquarters from Campbell, Calif., to San Jose in January.

“We have basically stabilized the company, and positioned ourselves to deal with hiring the right people, versus getting costs in line,” Grace said.

The former bondholders are “on-board” and “believe there is real value in this company,” he said.

In the reorganization, an owner of $10,000 in bonds received 1,000 shares of Zilog common stock, one share of Mod III Preferred stock and one share of Series B Preferred. Both preferred stocks relate to the now-dormant Mod III operation.

When Mod III is sold, owners of the preferred stock will receive a distribution. When it is sold, the first $30 million will be distributed to former bondholders.

Since Zilog stock pays no periodic dividend, the company removed $100 million in annualized costs.

That is being invested where Zilog excels and can generate the highest return – the 8-bit market, Grace said. The market is expected to grow by 8 to 10 percent annually over three to four years, and “we think we have an opportunity to grow beyond that.”

Zilog common stock (ZILG.OB) trades on the over-the-counter bulletin board. It was priced at $5.75 last week compared to a to-date range between $5 and $6.62/

The only debt the company has is a $10 million revolving line of credit, “for additional liquidity,” Grace said, adding that it has been paid down to about $9 million. The account, recently refinanced with CIT Bank, is secured by accounts receivable.

Swings in supply and demand are narrower on Zilog’s specialized chips, compared to more commodity-like computer chips. “We do have traditional pressures of competitiveness. Each major supplier has unique architecture that they support,” Grace said.