The News
Investors don't like the tune that SigmaTel is playing. Shares of the maker of chips for portable music devices plunged 12.5% Thursday after the Austin, Texas, company slashed its first-quarter sales forecast. The stock has been over the past year since peaking above $40 a share last spring.

SigmaTel, which not so long ago sold about half of all the chips used in MP3 players, announced late Wednesday that quarterly revenue will come in between $30 million and $35 million. That's sharply lower than previous guidance of $52 million to $60 million and analysts' consensus estimate of $54.5 million. Sales for the first quarter of 2005 were $99.3 million.

The company blamed the substantial shortfall on plummeting prices for NAND, a type of flash-memory chip used in consumer electronics, and delays in transition to its new 3600 chip set. As a result SigmaTel shuffled several managers, including naming Phil Pompa head of the portable systems group.

According to Chief Executive Ronald Edgerton, SigmaTel's struggles were driven by rapidly changing market conditions. There's significant inventory buildup, he said during a conference call late Wednesday, and NAND prices have dropped 48% since the beginning of the year.

"Regardless, our results are disappointing," Edgerton said. "Our customers, distributors and their respective customers are not willing to have high-cost player introductions or on shelves while many believe prices will continue to drop significantly."

SigmaTel didn't offer specific earnings estimates, but it said tax charges for foreign-earned income could pull quarterly profits down by as much as 50 cents a share. Wall Street analysts had expected a loss of nine cents a share before the warning. Craig Berger, an analyst with Wedbush Morgan Securities, downgraded the stock to Sell from Hold and put SigmaTel's losses for the first quarter at 70 cents a share. The company earned 68 cents a year ago.

The Analysis
If SigmaTel's situation sounds bad, that's because it is, Berger wrote in a research note published Thursday. A cash crunch could come as soon as the third quarter, he said, adding "we do not think management sufficiently appreciates the magnitude of financial peril that the firm now faces given its likely continuing operating losses, its expected first-quarter cash balance of only $50 million and prospects for continued MP3 chip commoditization."

New chip development was one of SigmaTel's weak spots. The company hoped to have its 3600 chip set available to all customers by the end of last year, says Dave Donovan, director of investor relations. SigmaTel spent a lot of time customizing configurations for some major clients, and that delayed the product's wider release.

"We focused on that, maybe to the detriment of getting it out to the broader market," Donovan says. The company's latest software development kit, to be used for video-capable media players, was also delayed and should be ready before the end of June, he adds.

One of SigmaTel's problems is that the media-player market is evolving so fast. IPods now dominate the top end of the market, but Apple Computer sources most of its chips from PortalPlayer. SigmaTel chips are used in the iPod Shuffle, among Apple's weakest-selling music players.

Adam Benjamin, an analyst with Jefferies & Co., says that's a big reason for SigmaTel's declining market share, now estimated at 37%. Portal Player has 20% of the world-wide market, and Actions, a Chinese manufacturer, commands 36%, according to iSuppli, an independent technology-research firm based in El Segundo, Calif.

"If you're not in Apple and Apple is taking share from those [lower-end] customers, then you're losing share too, as the provider of the silicon," Benjamin says. "This company is burning a lot of cash. It's a pretty rough story now."

The rest of the year will be equally rough for SigmaTel, he says. "We don't foresee a return to profitability until the fourth quarter at least," says Benjamin, who puts the full-year loss at 63 cents a share.

Wedbush Morgan's Berger has an even grimmer outlook. He projects a loss of $1.80 a share for 2006.

Benjamin points out that NAND flash chip prices continue to plummet, and many of SigmaTel's customers aren't ordering lower-end MP3 chips either. "Why buy them until you really need to?" he asks. "You can wait for both."

The Bottom Line
While the wider chip and semiconductor sector is headed for decline, according to a Feb. 23 report from ThinkEquity Partners, a San Francisco investment bank that downgraded the group, SigmaTel is well out in front.

Berger says he's done the math and doesn't much like what he sees.

"They went from having $119 million in cash exiting the year to $50 million now," he says. "That's a $70 million decline in a quarter, although $30 million of that was a stock buyback. They bought it at $13 a share, and it's at $8.50 now. That means they took $12 million and flushed it down the toilet and they're going to need that money."

SigmaTel has no debt, Berger says, which is a plus, but he thinks they could run out of cash by the end of 2006.

"We believe SigmaTel is in significant, possibly irreversible, financial peril," Berger wrote.