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National Semiconductor Corporation (NSM)

Q4 2006 Earnings Conference Call

June 8th, 2006 4.30pm EST

Executives:

Long Ly, Investor Relations Manager

Brian Halla, Chairman and Chief Executive Officer

Lewis Chew, Chief Financial Officer

Don Macleod, President and Chief Operating Officer

Analysts:

Mark Edelstone, Morgan Stanley

William Lewis, JP Morgan

Ross Seymore, Deutsche Bank

Craig Ellis, Citigroup

(Ahmed Seraffe?), Credit Suisse

Krishna Shankar, JMP Securities

Simona Jankowski, Goldman Sachs

Tore Svanberg, Piper Jaffray

Eric Ghernati, Banc of America Securities

Romit Shah, Lehman Brothers

Presentation

Operator

Good afternoon, ladies and gentlemen, my name is Carlie, and I will be your conference facilitator today. At this time I would like to welcome everyone to the National Semiconductor Q4 2006 earnings release conference call. Operator instructions. It is now my pleasure to turn the floor over to your host, Mr. Long Ly, Investor Relations Manager.

Long Ly, Investor Relations Manager

I would like to again, welcome everyone to our call today. Joining me are Brian Halla, Chairman and Chief Executive Officer, Lewis Chew, Chief Financial Officer, and Don Macleod, President and Chief Operating Officer. The purpose of today's call is to discuss National Semiconductor's Q4 FY2006 results, which ended on May 28th, 2006. As a reminder, today's call will contain forward-looking statements and projections that involve risks and uncertainties that could cause actual results to differ materially. You should review the Safe Harbor statement contained in the press release published today, as well as our most recent SEC filings for a complete discussion of those risks and uncertainties. Also in compliance with SEC regulation FD, this call is open to all and is being broadcast live over our Investor Relations website. For those of you who missed the press release, or would like a replay of the call, you can find it on National's IR website at www.national.com. In today's call, I will provide a recap of Q4 financial results. Brian Halla will provide an overview of the Company's progress. Lewis Chew will compare our Q4 results and provide an outlook for Q1, and Don McLeod will discuss our analog standard linear product progress. We will then take questions until 2:30pm pacific time.

Q4 results were as follows: Sales were $572.6 million, up from $547.7 million in Q3 fiscal year 2006, and up from $467 million in last year's Q4. Gross margins were 61.4%, up from 60.7% in the prior quarter and up from 54.7% from last year's Q4. Operating expenses were $164 million. Interest income was $8.7 million, and the effective tax rate for the quarter was 41.7%, but that included about $25 million in one-time tax expenses related to the repatriation of foreign earnings during the quarter. As a result National posted net earnings of $118.8 million, or $0.34 per fully diluted share. The fully diluted share count for the quarter was 352.3 million shares. I will now turn it over to Brian Halla for an overview of the company's progress. Brian?

Brian Halla, Chairman and Chief Executive Officer

Thank you, Long. All in all, it was a year of good progress, the progress continued throughout the quarter. But it's just that, progress. Management team believes that we still have a lot of work to do and we're still a long ways from achieving the results that we know are possible both at bottom and top lines. For the quarter just completed, we achieved revenues of $572 million, which was up 4.5% over the prior quarter and up 23% over the same quarter last year. Gross margins came in at 61.4%. By keeping our focused R&D spending to innovations in the standard linear analog market, we managed to achieve 34.5% at the operating margin line. This is up a point from the prior quarter and 11 points higher than last year's Q4. ROIC, or return on invested capital, came in at 30% and allowed us to realize the third straight year of ROIC above 20 points, which has been a progress milestone for us. Three years of ROIC performance and two quarters of results better than our old 60-30-30 business model, appropriately begs the question of where do we go from here?

We should continue to see improvement in the gross margins and the way is clear to 55%, even after covering the expense of stock options. Our well-focused R&D spending will represent a smaller percentage of any improving revenues for the extending follow-through bodes well for continuous long-term earnings growth. So a logical question is, how are we doing this, and what additional work needs to be done? We continued to successfully reposition the product portfolio away from lower margin business and our R&D spending has been and will continue to be targeted at the more unique value-added products in the precision and high-speed arena and also products with the lowest possible power consumption and efficiency is key. These characteristics are apparent and pervasive in the hundreds of new products released this last year. We continue to outperform in our family of ultra-high performance but lowest power consuming data conversion devices. As an example, just this last week, we announced the 3 giga-sample member of this family, which is easily interleaved in pairs to create a 6 giga-sample converter, which runs at one-fifth the power consumption of anything else available in the commercial market.

We've introduced new precision amplifier products, which are well received and adopted in the broad in applications such as advanced ultrasound and other instrumentation products. As the communications industry continues to drive higher bandwidths of data over longer and longer transmission lines, our interface products ensure that the signals arrive are the same as the ones originally transmitted. And of course, we continue to lead in power management. Many of these products end up in the broader markets, which are largely serviced throughout our distribution partners, and characterized by higher ASPs and higher margins. So why shouldn't National Semiconductor succeed in the midst of the heavy competition from other analog companies going after the same markets? Simplistically, achieving peer group status is not the way we want to be ultimately viewed. We believe in fact, that we have a success formula that sets us apart. Fundamentally there are 3 elements contributing to success in this business: excellent circuit design, outstanding package and process technology, and flawless service supply and logistics.

A good analog company typically excels at two of these three elements. National is striving to excel at all three of these elements, and this is already being reflected in the hundreds of new products that are achieving higher ASPs and higher gross margins. Shifting back to the outlook for the quarter we're in, wee feel good about the quality of our backlog. In Q4 we continued to spend a great deal of time and effort to make sure our distributor inventories were balanced and in line for their sales out of our products. Historically, however, the summer quarter is a little slower, as among other factors, Europe goes on vacation, and also this quarter, we will see an impact of the top line as a result of the declining lower margin foundry revenues from the businesses previously disposed of. Comprehending all of this, and even though we have hopefully demonstrated that we're no longer the historic National Semiconductor, we don't expect to be paid in advance for a job well done, and having said this, we're projecting a down 53% out of revenue outlook.

Those who seem to be preoccupied looking only for a signs of an industry downturn, I'll end this commentary by offering a slightly more balanced perspective for the future of the industry, and in particular, the analog portion of the semiconductor industry. I couldn't help but be perplexed at the general reaction to the topic of inventory in our prior earnings call. It was like someone had yelled ‘fire’ in a crowded theater. If you look at what drives demand today in the semiconductor industry, it's composed of a collection of demands from a wide diversity of products, such as, PCs, cell phones, PDAs, MP3 players, DVDs, HDTVs, DVRs, automotive electronics, instrumentation, security, and medical applications. This is different than the prior cycles where demand came predominantly from one or at most two applications. Applications, so disproportionately attractive from a volume standpoint that many companies would fill their caps with products targeted at those enticing sockets, and inevitably, build more product collectively than the market could absorb.

Today it's more difficult to predict what kind of an inventory overbuilt for what application in particular would cause a precipitous drop in overall industry order rates. The prior cycles, the semiconductor content and the mainframe contributor was negligible to the production of the whole, when the PC was the predominant killer app driving demand, semiconductor content was measurable at 10-20%. Semiconductor content of the more obvious demand drivers today has risen to more like 40% of the overall content of the device. Further, with the emergence of the China market alone, there are 400 million new consumers with cell phones and other gadgets, which are replaced and upgraded much more frequently than the products in prior cycles. In addition to China, demand comes from India, Russia, Africa, and other emerging nations, consuming at an accelerated pace. In essence, demand today is driven by hundreds of millions of consumers buying or upgrading hundreds of devices per year made up of 40% or more semiconductor content. More and more of that content, by the way, is analog semiconductor content, as it is analog, particularly standard linear that makes a difference in the user experience in most products with better displays, better audio, better wireless, and longer battery life.

It didn't surprise me that for the SIA-WSTS board pass for the analog standard linear market made last summer which predicted then an 8% growth for the sector is now after three subsequent revisions, including yesterday's latest SIA outlook, currently predicting standard linear growth for the year, for this year, to be an excess of 15%, while the entire semiconductor industry growth rate is projected to be just 9.8%. By the way of the revised estimate for power management growth, the standard linear segment led by National Semiconductor is now expected to come in just under 18% for the year. Swooping skyward again for a second, that first semiconductor cycle driven by DRAMs and mainframe computers brought our collective industry revenues to $5 billion. The second major killer app, the PC, drove demand for our collective products for a whopping $25 billion, or a 5X multiple over the prior cycle. The third major cycle, the dot-com boom, drove demand to a staggering $204 billion or 8 times the peak of the prior cycle before the bubble burst.

Our industry, according to SIA-WSTS forecast, is on track to realize around $250 billion in sales for the year across a wide diversity of products with demand for these products, from our perspective, being reasonably healthy and expanding. Given the historical precedent of each new cycle peaking at multiples of the priors, it's entirely plausible that this industry will remain healthy for a long, long time. I'll finish by thanking the employees of this company for delivering excellent circuit designs, outstanding package and process technology, and flawless service supply and logistics, and I'll thank our customers who pay us for this. Lewis?

Lewis Chew, Chief Financial Officer

Thanks, Brian. In my portion of the call today, I'll cover the following: core business versus the foundry revenue that supports recently sold businesses; inventories lead times and backlogs; and details on the income statement outlook. Including our estimate of stock compensation expense and the various income statement line items. Let me start with some comments on Q4 activity and use that as a bridge into the Q1 revenue outlook. First, the foundry revenue, which carries a much lower gross margin percent than the rest of the company. In Q4, our revenue from providing the foundry materials for Super-IO and Cordless was in the low $30 million range compared to the mid $30 million range in Q3. Going forward into Q1, we expect that same category revenue to drop by more than $10 million, thereby making it the large portion of our total company's projected revenue decrease in Q1. My comments will now be focused on the rest of the company's ongoing business.

During Q4, we kept our lead-time steady at around 6 weeks. We actively managed our production activities and inventory profiles in order to maintain the lead times at that level. And at the same time, we also brought down distributor weeks of inventories to below 10 weeks at the end of Q4, and this compares to a little more than 10 weeks at the end of Q3. Distributor resales in Q4 were up by double-digit percentages across the board in all regions compared to Q3, and distributor weeks of inventory were lowered in all regions except Europe. The largest reduction in distributor inventory weeks occurred in Asia/Pacific, which is our largest sales region making up about 45% of the Company's total sales. Our own on hand inventory was up $9.7 million in Q4. But within that, finished goods was actually down for the quarter. All of the increases in Q4 was in diode(?) banks, which again is a way for us to keep lead times under control at the same time the customers and distributors are keeping their inventories at such a low level. Heading into Q1, our opening 13 week backlog was a little below than it was at the beginning of Q4, which for us is not unusual as we head into the summer.

So with the decline in foundry revenue for Super-IO and Cordless, along with some typical summer seasonality, we are projecting our Q1 revenues to be down 2 or 3% sequentially. Gross margin was 61.4% in Q4, which means our gross margin fall through on incremental sales during Q4 was around 77%. Fab utilization in Q4 averaged in the mid to high 80% range, which was down a little compared to Q3. As I get ready to go over the gross margin outlook as well as the rest of the income statement line items, I'd like to remind everyone that Q1 of FY2007 is Q1 that we'll be recording under FAS123-R. So the way I'll do the outlook is for each line item, I will provide the total, in other words the fully loaded amount for each line item, then I will identify the estimated amount of stock comp expense we have included in that total. And then ever after I've covered all of the line items, I will recap stock compensation in total. So let me now continue with the gross margin outlook. We expect that Q1 gross margin percentage, including stock comp expense, will be about the same as Q4 gross margin percentage. The estimated amount of stock compensation expense that has been included in that Q1 gross margin outlook, is a little over $2 million. This means that on an apples to apples basis, we are looking for gross margin to improve slightly in Q1 over Q4, and that's because obviously in Q4 we didn't have any stock comp expense in the gross margin.

R&D expense in Q1, including stock compensation expense, is expected to range from $91 to $93 million. The estimated stock comp embedded in that range is a little over $8 million. SG&A expense, including stock compensation, is expected to range from $86 to $89 million, and this range includes estimated stock compensation expense of around $16 million. So in total, for Q1, we are estimating stock compensation expense in the quarter to be around $26-27 million, and on an after tax basis this would equate to about $0.05 per share, fully diluted. Regarding stock compensation expenses going forward, we will provide details each quarter of the actual amount of stock comp that has been included in each of the various line items and income statements. As of right now, we anticipate there will be a gradual decline in the total amount of stock comp expense for the next couple of years because we'll see the impact of lower stock option burn rates that we have implemented over the last two years. Moving on now to the rest of the P&L outlook, other income and expense in Q1 should be relatively minor, around $1 million of expense, interest income is expected to range from $9-10 million, and the effective tax rate for Q1 is projected to be around 31.5%.

As for the balance sheet and return on capital, our capital expenditures in Q4 were $63 million and we're projecting Q1 capex of $55-60 million. We are beginning to convert some of our capacity in the Texas fab from 6-inch wafers to 8-inch wafers. So as part of that project, we will be transferring some processes from Texas to our plant in Scotland. In our business model, we will continue to hold capex as a percent of revenue at below 10% annually. In FY2006, for example, our capex to sales ratio for the whole year was approximately 8%. Regarding the Singapore plant closure, we expect all remaining equipment transfers to be completed by the end of Q1. During Q4, we bought back another $200 million of our stock, or about 7 million shares, and ended the quarter with a little over $1 billion in cash reserves. As we indicated in the press release today, our board has approved another $500 million of stock repurchase activity going forward. Operating margin in Q4 was above 34% and return on invested capital for the quarter was around 30%. Both higher than what they were in Q3. Since this is our Q4 earnings call, I guess it's worth recapping a few key measures for fiscal year 2006 in total.

For the year, we had sales of over $2.1 billion, which was up about 13% over last year. We generated nearly $700 million of profit before tax and $449 million of net income after tax. And that's because we increased our operating margin from 22.6% last year to over 31% in FY2006. And return on invested capital for the year as a whole was about 25%. And these results clearly were driven by the progress we continue to make in our high value analog portfolio and to give more comments on that portfolio, I'd like to turn it over now to Don McLeod.

Don Macleod, President and Chief Operating Officer

Brian referred earlier to 61.4% cross margin in the quarter, which is a new high, and that we could see a clear path to 65% gross margins in the future. Let me now expand on that topic and discuss the product drivers in our portfolio that will get us there. As most of you know, our goal is to continue growing our standard linear business, both in absolute revenue growth terms, and in overall proportion of our total revenues. But also focused on growing our market share and presence in higher ASP and higher margin areas within that business. What progress are we able to demonstrate in this just completed quarter towards these objectives? Overall sales of standard linear products in the quarter made up 74% of our sales, up from 72% in last year's Q4 and in line with Q3, 74%. Sales of our standard linear products were up 4% sequentially and 28% on last year's Q4. With the interface product category at most at 30% sequentially and 50% over last year's Q4. Sales of data converters grew just over 10% sequentially and just over 40% over last year's Q4. Power management and amplifier sales were both about flat with Q3 and up about 25% on last year's Q4. Two of these product areas, interface and data converters, are relatively new focus areas for us at National Semiconductor.

We began investing more heavily in these two product categories 2-3 years ago. In the interface area, our initial high-speed LVDS focus is now being complemented with new signal conditioning and precision timing products, which gives us an interface business that already enjoys gross margins well above the mid 60% to date. And also had the highest ASPs of our standard linear product area. Our flow of new interface products now reflects our increasing R&D emphasis in this area. In the fiscal year just completed, we introduced 5 times as many new interface products as we did in FY2004. This increased new product flow was prompted and enabled product by a recent new silicon germanium proprietary process that gives us new products with the lowest and best power performance in the industry. Our market share here is now about 11%, up from just over 6% three years ago according to the SIA-WSTS April data that was released last week. The second of these new analog standard linear focus areas, data converters, is showing similar characteristics. Gross margins are already well over 65%, and we're growing market share. Just over 3% market share 3 years ago to just below 6% as of the April SIA-WSTS data. Even data converters. We also began a broader market focus about 3 years ago. First with general purpose (A to B?) products, but more recently with industry-leading ultra high speed and high-speed converters, based on our internal proprietary sim-ops nynex analog optimized fab process.

An example of a new product introduced in the last three months is our 14 bit 155 mega sample per second converter that offers industry-leading full power bandwidth of 1.1 gigahertz, and this product is targeted at CG Wireless base stations and test equipment applications. Another example of industry-leading data converter performance is the new family of (A to B?) converters that Brian referred to earlier that set new performance standards for sampling speed and can also deliver up to 6 giga sample data capture capability. These are just examples of very high performance and high ASP new data converter product. Our 40 new data converter products released in FY2006 more than double the equivalent new product releases of just 2 years ago. And further, as an indication of our increased investment in data converters, we've just started two new design teams, one in the UK and one in India for this new product line. Our amplifier product area is another good example of how we've successfully transitioned the product portfolio towards higher ASP and higher margin product area. In operational amplifiers, we continue to shift the portfolio from general purpose amplifiers toward more proprietary, low voltage, low power, high speed and precision product. These represented 75% of amplifier sales in the just completed Q4. This is again substantially enabled by a combination of world class design IP and high performance proprietary process technology.

As an example, in April this year, EDN magazine selected National's swift-50 process and its amplifier products as the overall analog innovation of the year. Also, we continue to recruit new design talent. Last week we opened a new amplifier design center in Italy. In the audio portion of the amplifier product category, we see the same portfolio rotation. More of the revenues are coming from audio subsystems rather than just pure power amplifiers, again giving us higher ASPs and margins. Going forward, we're also investing in proprietary new performance audio products that have precision characteristics and are derived from an in-house high voltage process that is currently in development. Our power management products represented approximately 40% of our sales in the quarter. Here, our ASP was up about 6% in the quarter sequentially, driven by an increase in the mix of switching regulators to both the wireless handset and broader markets through our distributors. Application specific power management products for small format displays, powered over Ethernet and applications processes also enrich the ASP for this area for the quarter.

In power management, we continue to de-emphasize commodity product and replace those revenues with new and more proprietary and higher ASP products. For example, in Q4 just completed, about 40% of our power management revenues came from new products introduced to the market in the last three years. More of these new product revenues are coming. In FY2006, we doubled the number of new power management products released to the market over FY2004. In addition, more and more of these new power management products are focused on higher margin, broader market applications that complement our already successful portable power management application specific portfolio. So, are we giving out analog standard linear market share to focus on higher ASP, higher margin, and more proprietary performance products? Absolutely not. Our standard linear market share continues to grow. Based on the April SIA-WSTS data released last week, we grew our standard linear sales for the first 11 months of our fiscal year to April by just over 20%. By comparison, the worldwide standard linear market only grew 12% over the same period. We exceeded industry growth in all 4 categories, amplifiers, data converters, interface, and power management. In the analog business, ASPs and gross margins generally move in the same direction. But there are also additional productivity and ROIC benefits from higher ASP.

For example, in Q4 just completed, our overall analog standard linear ASP increased by about 11% over Q3. Analog standard linear sales dollars increased by just over 4% over Q3. So analog standard linear units actually dropped by about 7%: we used less of our fabs and logistics and other support to generate these higher dollars. These higher ASPs come from a focus on providing our customers with more value. Differentiate analog products increasingly have higher speeds speed, more precision. This is earning us the higher ASPs and margins that will easily take us to the mid 60% gross margins and beyond. This quarter was just another step in that direction. I'd like to hand it back over to you, Long, so you can moderate Q&A.

Long Ly

Thanks, Don. I at this time I will ask the operator to open up the lines to begin the Q&A session. Please limit yourself to one question and one follow-up, so that we may accommodate as many people as possible. Operator?

Questions and Answers

Operator

Operator instructions. Your first question is coming from Mark Edelstone from Morgan Stanley.

Q – Mark Edelstone, Morgan Stanley

Nice quarter yet again. I had two basic questions, if I could. First one is, Lewis, what was the growth in the direct business that you had in the quarter? And then I had a specific question on power management amplifiers.

A – Lewis Chew

What was the second question, Mark?

Q – Mark Edelstone, Morgan Stanley

Sorry, you might as well look this one up, as well. You suggested on the call basically, the power management and amplifier sales were flat.

A – Lewis Chew

Sorry, on the first one it was up about 3%. Go ahead.

Q – Mark Edelstone, Morgan Stanley

OK, great. So you had said that power management amplifiers were basically flat quarter to quarter. And I was just wondering with the POS growth would have been for those two product segments in the quarter?

A – Lewis Chew

What do you mean by POS?

Q – Mark Edelstone, Morgan Stanley

Sorry, just basically the actual distribution oriented portion of that business. So in other words I'm assuming that the sales in those two categories were flat because you basically had inventories coming down, so you shipped in less than actually shipped out. So I wanted to understand the growth of that business was if you were recognizing on a sell out basis.

A – Lewis Chew

We don't really break out our sales and resales down to the unit level Mark. On that one I just can't even answer that one.

Q – Mark Edelstone, Morgan Stanley

OK. I guess does that make sense though when you look at the market? Is that why the two product categories you think were actually flat versus seeing the growth you saw in standard linear overall?

A – Lewis Chew

I guess I can make one general comment, which addresses your question, which is for the broad amplifiers, and the broad based power business, that does go more heavily through distribution. And I will amplify that during the quarter, our weeks of distributed inventories did go down. So I don't know if that finishes the question. Don, do you want to add anything to that?

A – Don Macleod

Well, one way of looking at that, is amplifier business, which is really two persons. One is the operational amplifier business, which is very broad, probably 60 plus percent of that goes to distribution and the other portion of that business is the audio amplifier business, which has a heavier slant toward mobile phones. We actually grew the operational amplifier business, but that was offset by a small decline in the overall audio business, which again had that mobile phone content. And actually the same characteristics exist in the power management space, which goes more than half through distribution, actually grew slightly in sales. But very, very modest decline in the portable business, which has a heavy emphasis also on the mobile market.

Q – Mark Edelstone, Morgan Stanley

OK. Great, thank you very much.

Operator

Thank you. Your next question is coming from William Lewis from JP Morgan.

Q – William Lewis, JP Morgan

Great, thanks for taking my question. Could you just say what the turns were this quarter and what your requirement is to kind of achieve your guidance for next quarter?

A – Lewis Chew

Yes, Bill, this is Lewis. We don't typically give specific number on the turns, our range is typically from the low end would be maybe 20% of the revenue for the quarter and in some quarters, can range as high as the 30% of our revenue range. And I would say right now we're probably in that normal range, more towards the 20% revenue range. And I would say that we don't have anything unusual or expecting in turns revenue in Q1 versus Q4. I'd say that some color on Q4, we saw pretty steady turns throughout the quarter. And that's probably because inventories at both customers and DCs remained relatively low. So I can only give you more of a subjective answer, which is kind of a normal ongoing turns rate. There's nothing dramatic either falling off or increasing in Q1 that we're anticipating in our guidance.

Q – William Lewis, JP Morgan

OK. Another question if I could, about what your plans are factory loadings for this quarter? What you're expecting that to maybe look like relative to last quarter, or what utilization you expect to run at, roughly?

A – Brian Halla

You know, I made a couple of comments about inventory earlier on that we brought finished goods down during the quarter. And as we continue to transition to being pretty much a standard linear, which we're not at yet, but we will eventually be, we are kind of learning our way through what's the right profile. So the loading on the front end will probably moderate slightly on the back end right now we're toggling that to match whatever finished goods we have. You can make an assumption that that goes down a little bit because we're guiding revenue to be down, as well. Very quick as you can imagine. So it's not up or down. So in general for the company, the utilization probably expected to be down a little bit in Q1 versus Q4.

Q – William Lewis, JP Morgan

OK, Lewis, thank you.

Operator

Thank you. Your next question is coming from Adam Parker from Sanford Bernstein. Operator instructions. We'll move on to our next question. The next question is coming from Ross Seymore of Deutsche Bank.

Q – Ross Seymore, Deutsche Bank

You talked about the terms linearity. What about the bookings linearity in the quarter and specifically, how did align to, what guys would call a normal seasonality given the off quarter month-end you guys have, and then maybe a follow-on along the lines of that, if you could give a rough end-market break down. Handsets, PCs, etc., and if there was any different bookings patterns versus normal seasonality?

A – Lewis Chew

Maybe what I'll do is talk a little bit about and kick it over to Don or Brian to talk about end markets if they want to add on to that. I would say the bookings were pretty healthy throughout the quarter. We actually, and I can comment on this. But in the first part of this quarter we continued to see good bookings after the quarter end. I don't know if there was any particular spike. As you know, our Q3 would be a Christmas type quarter and that's why you would see more ups and downs. This would be a more normal quarter. I would say we had decent bookings throughout the quarter. In terms of end market, I don't think there's a lot of change this quarter. As you know Ross, we typically run wireless of about 30-35% of our revenues and I would say now we're running in the 30-ish range. Displays; actually the revenues and displays this quarter was actually not bad. We had some drop off in CRT, but strong revenue in flat panel display products probably ranging, PC is definitely dropping off for us. I'll add some color on the business that I mentioned was up, we're seeing more drop off from the Super-IO stuff than from the cordless stuff. So our PC revenues are now down well into the single digits. And one other area I might add on to is that in the infrastructure area, that continues to be a healthy business for us, that would include things like infrastructure and base stations.

Q – Ross Seymore, Deutsche Bank

OK. Great. And one question on the foundry stuff you talked about. It was helpful color with what it was last quarter, this quarter, and quarter after next. How should we think about that approaching zero over time? What sort of slope do we build into our models?

A – Lewis Chew

I think there will be where we're projecting a fairly sharp drop off this next quarter because the quarter we just finished, revenues ended up being a little stronger than we thought. And after that sharp drop off, we would see it gradually declining for the two quarters after that. I don't - actually have a way to say where we get to zero. There are some parts we've transferred production on. So it will depend on when they finish selling those. But I'd say a year from now, I could see that number being down, by three quarters of what it is today.

Q – Ross Seymore, Deutsche Bank

Great, thank you very much.

Operator

Thank you. Your next question is coming from Craig Ellis from Citigroup.

Q – Craig Ellis, Citigroup

Thank you, good afternoon, everybody. Just wanted to inquire about the comments on the 65% gross margin. Can you give us, Brian, or Lewis, some of the milestones that we might think about as the Company works towards that goal, either a percent of standard linear products or maybe volume related?

A – Brian Halla

This is Brian. The point we were trying to make is we could see - I said we could see a clear path, and Donny said we could easily get to it. So don't think of it the same way as you thought of the 60/30/30 three years ago. Relative to that, I would say it's imminent. And we know that because we look at the bookings margin every day, we look at the turns margin, and margins of new products launched into the field. And as Donny said, we're currently at about 74% of our revenues in standard linear with a goal to make that as close to 100% as we could get and already those products are well above that 65% gross margin area. But let me turn it over to Donny.

A – Don Macleod

Yeah. That's good - Craig you're looking at it the right way. If we project out four quarters from now, that 74%, we consider the standard linear in our revenue base. We'd be disappointed if that number's not more than 80% of that company's revenues four quarters out from now. And obviously somebody asked a question earlier about the foundry business, we'd be disappointed if that number's anything more than 3% of our sales a year from now and the way that business will profile down. And a bit in between is mostly harvest products, that we stopped investing in a number of years ago and clearly that part will be the squeeze. And the way to look at the company is that, 80 plus percent is the stuff that, you know, we think we can easily get to gross margins of 65% or better. Many are already at that category. More of the company sales represented by the stuff that's already at 65% and the other stuff falls off over time. And I think one should view that not as a fun game, because at the end of the day, the standard linear market provides enough opportunity to grow that business, as well, not just grow it as a part of the company. And Brian talked about the SI, forecast for the industry for '06. I think Brian mentioned the 15% growth rate that's on the table for the standard linear business at this point in time. So far we've shown reasonable success in growing our business at rates better than that, and I would also draw your attention to the fact that within that, the area that most of our sales come from, power management is forecast to grow at 17.8% for the year. So we can both grow the business of standard linear and make it a bigger portion of our sales and we'll continue to add to the quality of the products. So, you know, all of the moving parts get us to about 65% overall company margin in the not too distant future.

Q – Craig Ellis, Citigroup

That's very helpful color. Any particular noteworthy end market changes as we look out over the next year, for example? Talking about new products and base stations, perhaps industrial end markets what should we expect to be the particular growth opportunities for the company in the next four quarters?

A – Brian Halla

I'll start and Donny can finish. The thing that really encourages us is how well the value of standard linear products particularly the area of data conversion and amplifiers, particularly precision amplifiers how well they're being received in the broad market. And just to give you an example, today, precision amplifiers, it's less than one kilovolt of noise over the entire temperature range, today if you're in the ultra sound business, you've got to be producing a pretty good 3-dimensional of the fetus in order to compete, and the only way you can do that is to take those squishy signals that bounce back out of the fetus and put precision application on them. If you're in that business you're in the semiconductor business, like it or not. Just about across the board in the broad market, everybody, whatever kind of product they use to have is now looking at semiconductor technology. And as I said, my commentary for the extent, you need a better display or better battery life, or better image or better audio. You're going to have to turn to standard linear analog. Donny?

A – Don Macleod

There's two other facets to look at that way. Talked about those higher-performance product. To amplify our case, I said 75% of the product sales we had in the operational amplifier came this quarter from precision high-speed and low-voltage low power amplifier which are more and more unique. The other way of looking at this is what this enables us to address in market terms, it's no longer the traditional PC, whatever you might want to call it type market that's driving our business in those spaces. And Lewis mentioned the fact that our distributor resales were up double digit percent this quarter over last. We obviously dug into that to look at where those distributor sales were going. And one of our distributors came back and listed that the areas we saw as growing our business mostly were, for example, test and measurement, medical and dental, security and access control, these are examples of areas where those more proprietary products were opening up new opportunities for us. And obviously all of those products are higher margin, higher SP products that frankly are much more insulated in market terms than the traditional view that the PC up or vice versa.

Operator

Thank you, your next question is coming from Michael Masdea from Credit Suisse.

Q – (Ahmed Seraffe?), Credit Suisse

Yes, this is (Ahmed Seraffe?) calling in for Michael Masdea. Could you discuss, at a high level, hat you're seeing in terms of customer mentality in terms of visibility?

A – Brian Halla

I'll start again, this is Brian. We had one of the largest customers we have in last week in the cell phone business saying they were expecting a strong second half and his message was don't second guess, make sure the product is there.

A – Lewis Chew

And maybe I could add on to that with a comment about internal process without getting into the detailed of numbers. One of the things we do to manage the inventories out there is that our, our head of supply and logistics will review rolling forecast of many of our largest customers and we'll look at the change in attitude week to week. And I would say that I would characterize Q4 as a very steady quarter in terms of both looks. It continue to be a fairly stable environment in terms of the rolling forecast with many data points that staircase up on those.

Q – (Ahmed Seraffe?), Credit Suisse

Got it. And looking out over the next couple of months, what would you see as your greatest concern? Especially with the comments earlier in the call about inventories maybe not being as much of a concern in the industry. What would you say are the biggest concerns for National over the next few months?

A – Brian Halla

I would say if Wall Street keeps measuring our company on everything except results, you're going to shake consumer confidence all by yourself. Don't take that one, personally, by the way.

Q – (Ahmed Seraffe?), Credit Suisse

Got it. No problem, at all. I guess that covers my questions, thank you.

Operator

Thank you, your next question is coming from Krishna Shankar with JMP Securities.

Q – Krishna Shankar, JMP Securities

Yes, congratulations on a good quarter. Do you feel that your market share gains are here? Can you talk a little bit about the market share gain and each of the segments and where you feel they're going?

A – Don Macleod

Good afternoon. Clearly, you know, when we look at the standard linear market, we look at the four segments that we participate in. And, I think it's appropriate to say that we're making huge improvements in both interface and data converters based on our relatively new focus on putting heavy investment into these two areas. I wouldn't also neglect the fact that our share in the amplifier status is over 18% of that market. 5 years ago, we were 12% market share, for example. So on top of the very strong position we have in power, data converters, and interface we're making huge step as I said on the call. We've gone from 3-4% in data converters up to nearly 6. And amplifiers have gone from 7% to over 10 in the last three years in both of these cases, interface. So it's pretty broad and we intend to keep it that way. We're not just focused on any one of these four markets.

Q – Krishna Shankar, JMP Securities

And then in your vertical markets, hand sets, and LCD TVs, it sounds like hand sets was more seasonably flattish, LCDs, we see suppliers talk about excess inventories and a slowing in demand for LCD substrate? Can you talk about your sense of where LCD TV demand is going forward and also cell phone demand in the second half?

A – Lewis Chew

OK. Let me talk a little bit about numbers first and I'll turn it over to Brian or Don for color on the industry. During the quarter, our LCD revenues were actually up nicely for the quarter. But obviously that may not be the current indicator. On the booking side, we did see some signs of bookings slowing down, I wouldn't call it too dramatic. I would remind everyone that LCD makes up less than 10% of our revenues, but it would seem to be kind of be in line with some of these same reports we see about some potential excess supply out there. But the magnitude I would like to emphasize is not that large. We're maybe talking a few million decline in bookings quarter over quarter.

Operator

Thank you. Your next question is coming from Simona Jankowski from Goldman Sachs.

Q – Simona Jankowski, Goldman Sachs

I just wanted to clarify something first. I think you mentioned earlier in the call that your backlog was lower this quarter compared to a quarter ago. But it seems in the press release is commenting on a book to bill above one. I wanted to see what the timing or other factors that explained that?

A – Lewis Chew

Yes, Simona, this is Lewis. You're right, what we said, what I said, in fact, was that our 13-week backlog was lower compared to Q4 and that I do honestly believe that's not unusual for the summer. As we did have, as you can figure out a slight increase in our backlog from what I would refer to as the out quarter. I would not like to imply that's all 26 weeks out, because literally, the out quarters could be in the 14th week, so for the total company, the backlog grew slightly, but the mix in that backlog was a little bit lowering for the 13-week period and a little higher for what we would consider the pre-Christmas quarter, i.e., the November quarter.

Q – Simona Jankowski, Goldman Sachs

OK. I understand, and it sounds like the majority of your products still have a flat lead time of 6 weeks, does that mean some minority of products are stretching lead times and that's what falling into your out quarter backlog?

A – Lewis Chew

Actually no, I would say during the quarter if anything, our performance against the stated leave time I said the six weeks, my prepared comments actually improved slightly. I think I said last quarter that we were in the 80% range performance against six weeks. And what I saw toward the tail end of our quarter was our supply and logistics group showing that had improved slightly. We certainly don't view as a company that we had any extension of lead times during the quarter from a macro perspective. Obviously, you understand that our products have a very wide variety of lead times. But in general, if the embedded question is did that backlog grow because we extend the lead time, we don't think so, no.

Q – Simona Jankowski, Goldman Sachs

So it's just more of customers anticipating back to school demand would be the phenomenon there?

A – Lewis Chew

Yeah, I think it could be a timing of when they're anticipating to build the product. It is fairly typical for European suppliers to take time off in the summer. And certainly we see that this year. And so they're just molding their backlog to fit when they're going to produce the product.

A – Brian Halla

Simona, the thing I would add is, last quarter we talked about a rigorous process we have for analyzing distribution called Goldilocks, where we look at the orders based on whether the demand is real and in line with the sales out. And we may just reject the order or we move it out into another quarter. So the backlog is a cleansed backlog, if you will, as a result of Goldilocks.

Q – Simona Jankowski, Goldman Sachs

Sure, I appreciate that. Last one I if may. Also in the press release, sounds like your bookings were up in most regions. By implication, I would imagine they were flat or down in North America. And I just wanted to see if that was more on the distributor's side or the direct customer side?

A – Lewis Chew

There was some decline in distribution in North America. We also had, to be fair on ourselves, there was some shifting of when certain products get booked, whether it's booked in America versus Asia. As you know over the last many years that's been an ongoing story, anyway. I wouldn't want to imply there's any softening in America's business. . In terms of true declines in bookings in America, that would be more distribution-centric, yes.

Q – Simona Jankowski, Goldman Sachs

Basically since your resales were up double digits,, but their bookings only declined, sounds like they took a fairly assertive stance toward reducing their inventory.

A – Don Macleod

I would say we took that stance in working the distributor's inventory to, you know, take a view on the inventory rather than just letting them book what they thought might be…

A – Brian Halla

I would say across the board, we could have booked a lot more had we not been taking such a tough stance.

Q – Simona Jankowski, Goldman Sachs

Got it. Perfect. Thank you so much.

Operator

Thank you, your next question is coming from Tore Svanberg from Piper Jaffray.

Q - Tore Svanberg, Piper Jaffray

Yeah, two questions. First of all, what would be your opinion for growth rates for a $2 billion 65% gross margin analog company on a steady state? I'm just trying to understand, how fast the company can grow over the next couple of years at a 65% gross margin?

A – Don Macleod

You know, take the way we answered that question before. We're viewing the standard linear space as one that is growing 15% this calendar year over last. And our goal is to exceed those growth rates for a standard linear business. And you can form your own view of what it's going to be like of 2007 over 2006. The industry at this point is saying 10% for 2007 over 2006 and 14% for 2008 over 2007. We think these numbers need to be cleansed as we go forward in the future. But the 15% for this year is half done from our point of view. The industry is, almost into the second half. Take these numbers as proxies for what we can do better than.

Q - Tore Svanberg, Piper Jaffray

Great. And then second of all, Donny, in the past you've talked about the changes in data converters being more gradual, have you seen any change there? Is it accelerating or is it still more of a gradual move?

A – Don Macleod

What has happened is that we've been talking about data converters for like the last two years and their portfolio is out in the marketplace. We have more and more new products coming and our share is increasing. I mean, just give you a perspective. You want to take, any data you want this calendar year January through April, the SIA data that came out last week indicated that the data converter market January through April this year grew versus January through April last year by 7.1% while we grew our equivalent business over 30% in data converters for the same time frame. Any way you cut it, can give you the 11 months to April or the calendar year to date. Every time, we are significantly better than the industry and that's because both our general purpose and our high-speed products are beginning to get a presence in the market and we didn't have anything in those areas before.

Q - Tore Svanberg, Piper Jaffray

I guess my question is more, should I assume one to two percentage point gains every year, or do you think we're getting to a point where that will be higher than that, maybe 2-3% a year?

A – Lewis Chew

Give you the equivalent growth rates shows you that we're growing significantly better than the market. Just to quote the market, the data converter market is forecast to grow at just under 11% this year. We think we can do a lot better than that.

Operator

Thank you. Your next question is coming from Sumit Dhanda of Banc of America.

A – Eric Ghernati, Banc of America Securities

This Eric Ghernati for Sumit. Two questions if I may. Last quarter you mentioned that you had $9 million on the inventory side that you were impacted from two key items. One was the Singapore transfer, and two the bridge inventory build for the outgoing business. My question is, is that $9 million impact still occurring this quarter? Did this occur in May? And is it still going to occur also in August?

A – Lewis Chew

This is Lewis. If your question is - is some of that buffer still there, the answer is yes. As you can probably appreciate, when we decided to consolidate the Singapore facility, that meant we transferred all of the capacity and equipment out of there into China , and so that buffer that we built up last quarter, we would not consume that all in one quarter. And in my prepared comments even said that we'd be continuing to shift that even in Q1 and be done by Q1. Is there right now as a buffer to tide us over to transfer this equipment and bringing it back, you know, bringing that up to speed in the other facilities. Also let me add one thing on to that too. The products that we were making in Singapore were obviously distinct and discrete from most of the things we were making in China. That's why we need to have that buffer.

A – Eric Ghernati, Banc of America Securities

So since you were transferring in Q1, in July, will you, will buffer inventory come down in the current quarter?

A – Lewis Chew

At the current time, I'm probably not going to get to that level of detail. But in general, I would say no, that's what I was trying to say before, is assume that that buffer is there until not only have we completed the transfer, but we'll also have to get all of the equipment up and running and qualified, which as hopefully you can appreciate, can sometimes take several months to go.

A – Eric Ghernati, Banc of America Securities

OK and another question, last quarter you mentioned something with respect to the transfer of the Singapore facility, the benefits of that will show themselves much clearer current quarter. I guess my question is, how much of that benefit would you expect to incur this quarter?

A – Lewis Chew

We've been actually achieving some of the savings from Singapore as we went along. And, again, just to bring you back to the original plan, most of the savings came from consolidation of headcount because obviously we kept the equipment. We are going to see some incremental benefits in Q1. The one thing we see as an offset though is we have some transfer activity going on both for Singapore, as well as I mentioned in my comment, we're going to upgrading the Texas fab from 6-inch to 8-inch, we're incurring some transfer cost over to Scotland. Again, I'm not saying an excuse, it's all embedded our numbers. Some of the savings is consumed there, but eventually those savings will emerge in our numbers sometime down the road.

A – Eric Ghernati, Banc of America Securities

How long do you expect the process to last? And how much cost should we expect from that?

A – Lewis Chew

Well, we haven't broken out those costs specifically. They're not huge, but they're millions of dollars, not thousands of dollars. We expect that process transfer will take place over the course of FY2007 and that's about all I can comment on that.

Long Ly

Operator, we have time for one me question.

Operator

Thank you, your final question is coming from Romit Shah of Lehman Brothers.

Q – Romit Shah, Lehman Brothers

Thanks. You guys have been growing an above seasonal rate for the last several quarters. Does it become more difficult looking into the second half to grow in line with normal seasonality? Or do you feel as though you're designed in the right product cycles and have enough in the way of market share to really carry you through?

A – Lewis Chew

I'll take a stab at that. First, we're fortunately well-balanced in our product portfolio between vertical markets and broader markets. If you go back to Q1 of calendar 2005, we were very fortunate in the sense that we have a third of our sales just over 30% of our sales in the mobile phone market, the fourth calendar quarter was very strong. And in the first calendar quarter of this year, we benefited in the sense of our distributors to their broad market. And I would expect that we should see the same trend in the fourth calendar quarter of this year, which is substantially the second fiscal quarter of our FY2007, i.e. the mobile phone market as seasonal activity. And then we complement that going forward with more broader market business. So I think we have no reason to believe that the trend should change.

Q – Romit Shah, Lehman Brothers

OK. And then if - Donny if you could just elaborate on trends in the hand set market. There's been a couple of commodity supplies that have recently pointed to a slow down at one of the tier 1 customers, and I heard Brian's comment. It sounds like you're optimistic about the second half. Just curious at least on the outlook for the second half in the handset market.

A – Don Macleod

In fact, in the discussions we had with one of our customers last week, he referred to some constraints that he had on his, I think PC boards and other things were referred to as being harder to source. We're seeing a very orderly handset market, actually.

And we're going into a point now where we're seeing the backlog being put in place for the early part of the stronger selling period, we're seeing some September backlog, already being put in place. And we see the same seasonal patterns as we saw last year beginning to show, so we feel good about that market. We felt very good about Q1, we felt very good about Q2. And I think we'll see that the second half will - should be what everyone's forecasting, a billion units or something close to that. Our presence in that marketplace continues to improve, especially as mobile phone manufacturers move toward 3G phones. And we seem to be better placed in terms of these analog features. The most sophisticated 3G type phones, and that's the market that seems to be growing very fast at this point.

Long Ly

With that we're going to end our call. Let me remind you that the replay is available on our website. Thank you for attending.

Operator

Thank you, ladies and gentlemen, this does conclude today's teleconference. Have a wonderful day.

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Source: National Semiconductor Corporation, Q4 2006 Earnings Conference Call Transcript (NSM)
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