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Executives

Mark Veeh - Investor Relations Manager

Brian Halla - Chairman and Chief Executive Officer

Lewis Chew - Chief Financial Officer

Don Macleod - President and Chief Operating Officer

Analysts

Chris Danely – JP Morgan

Ross Seymore – Deutsche Bank

Tore Svanberg – Thomas Weisel

Doug Freedman - American Technology Research

Sumit Dhanda – Banc of America

Romit Shah – Barclays Capital

Uche Orji – UBS

Craig Hettenbach – Goldman Sachs

John Dryden – Charter Equity

Craig Berger - Friedman, Billings, Ramsey

Mahesh Sanganeria – RBC Capital Markets

National Semiconductor Corporation (NSM) F3Q09 Earnings Call March 11, 2009 8:00 AM ET

Operator

(Operator Instructions) Welcome everyone to the National Semiconductor Third Quarter Fiscal Year 2009 Conference Call. I will now turn the call over to Mr. Mark Veeh, Investor Relations Manager.

Mark Veeh

I’d like to welcome everyone to National Semiconductor’s third quarter fiscal year 2009 earnings call. Joining me on the call today are Brian Halla, Chairman and Chief Executive Officer, Lewis Chew, Chief Financial Officer and Don Macleod, President and Chief Operating Officer.

In today’s call I will provide a recap of the third quarter financial results. Brian Halla will give an overview of the current business environment and an update on the company’s focus and priorities going forward. Lewis Chew will expand on the third quarter results and provide the background to our outlook for the fourth quarter of fiscal year 2009. Lastly, Don Macleod will then discuss market trends and products in more detail. We will then take questions until approximately 9:00 am Eastern Daylight Time.

As a reminder, this call will contain forward looking statements that involve risk factors that could cause National’s results to differ materially from management’s current expectations. You should review the safe harbor statement contained in the press release published today as well as our most recent SEC filing for a complete description of those risks.

Also in compliance with SEC Regulation FD, this call is being broadcast live over our Investor Relations website. For those of you who have 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.

Now moving on to our third quarter results as follows. Sales for the quarter were in line with our original guidance and came in at $292 million down 31% from $422 million in the previous quarter and down 36% from $453 million in last year’s third quarter. Gross margins for the quarter came in better then our original guidance at 57.5%, down from 65.8% in the prior quarter and down from 64.3% in last years third quarter. This decrease in gross margin was attributed to both lower revenue and lower factory utilization in the quarter.

Operating expenses for the third quarter came in at $139.4 million. Net interest expense was $16.7 million and the income tax for the quarter was the benefit of $6.5 million. Included in this number is approximately $11 million of discrete tax benefits that have been highlighted in today’s press release. As a result, National posted GAAP net earnings of $21.1 million or $0.09 per fully diluted share in Q3 fiscal year 2009. The fully diluted share count for the third quarter was 231 million shares.

With that I will now turn it over to Brian.

Brian Halla

For this commentary I’ll assume that your questions include:

1) Does National have a unique perspective on market conditions and how are we faring give those conditions?

2) If we have been affected, how bad? More importantly what are we doing about it?

3) I’m sure you’re interested in knowing if National has any more visibility then the other guys in to when things are likely to get better.

4) If this is to be a long protracted down market do we plan to just hunker down until it’s over or do we have a plan for growth in spite of the economy and current shake in consumer confidence.

Let’s review the quarter just ended. National generated revenues of $292 million roughly in line with our guidance of a 30% revenue drop in the quarter. Our gross margins on the declining revenues dropped to 57.5% and gave us net income of $21 million or $0.09 per share which included a tax benefit from about $11 million. The organization did a good job of holding OpEx in the quarter to $139 million, $73 million of which was R&D.

Given the uncertainty in the market and limited visibility we took down inventories by around $5 million; plan to take them down again in the current quarter. In addition our opening backlog is down from where it was when we entered last quarter so we’re guiding somewhere in the range of down 5% to 10% in revenues in the current quarter. A bright spot, however, is that weekly run rates for new orders seemed to stabilize since early January but at lower run rates as you would expect.

Given the lower run rates, what we’ve seen in the marketplace, and in lieu of any eminent restoration of consumer confidence we’re taking immediate actions to resize and reposition both our operating spending and our factory capacity. These actions will lower our break even point and will provide more earnings leverage when revenues do recover in the future.

Starting today we will reduce our headcount by approximately 850 employees with another 875 or so employees to be let go over the next several quarters as we close down our Texas and Suzhou, China manufacturing facilities. This reduction of approximately 1,700 heads represents approximately 26% of our worldwide headcount. Other temporary cost reduction actions include mandatory shut down days in the current quarter and executive salary cuts.

Despite the rigid cost controls we continue to invest in our National 3.0 initiatives. Over the last several years we’ve been delighted to see that our leadership in analog power management combined with our PowerWise family of some 300 to 400 products has given us a unique position in being a leader in electronic solutions for worldwide energy initiatives. For National we’re adding unique value here in three areas. Those areas are energy generation, energy consumption and energy storage.

In energy generation our most imminent product is our SolarMagic power optimizer module. To remind everyone, our SolarMagic module attaches to any of the now widely available solar panel technologies and works to recover the up to 50% of the power loss in that string of panels due to shade, debris, panel mismatching and degradation as they age.

Over the course of a normal day, SolarMagic can recoup 12% to 20% of the power which could have been lost in the entire ray. We’ve now completed a worldwide set of visits to panel vendors over the last several weeks including my own visit to the largest vendors in Japan. I’m happy to say that the technology was enthusiastically received at 100% of the visits. Having passed the necessary UL, CE and other certifications we began production last week.

The second area is that of reduction of energy consumption with such products as our AVS or Adaptive Voltage Scaling technology and more recently with the introduction of our new LED driver technology for high brightness in scalable TRIAC dimming capabilities. Chosen for our “high energy efficiency and high reliability” we are now the company providing the circuits that light up the LEDs in Hong Kong’s MTR or Mass Transit Railway System.

With so many municipalities around the world moving rapidly to replace high pressure sodium street lamps with more power efficient LED lighting for energy and monetary savings we expect this product line to ramp fairly rapidly. Other advantages of being a leader in power efficient circuits is that we can enable very powerful technology to now be powered by batteries. Applications here include portable low cost but high performance medical diagnostic equipment for the home for self diagnosis of heart problems and other diseases.

The third area where we find our technology moving is in the area of energy storage or specifically battery management. Though new Tesla Roadster uses 25 National semiconductor PowerWise circuits in its power electronics module or PEM we believe there’s much opportunity left in making electric vehicles and HEVs viable.

For example, in the Tesla, even though it can achieve 245 miles per charge, when the motor is shut off two fans blow for several minutes to cool off the 6,000 lithium ion batteries. All of us know that anything that gets hot like a battery or appliance is using power inefficiently. That heat you feel is wasted energy.

We’re getting ready to bring to market National’s new Smart Energy Management Systems which use technology similar to our SolarMagic solution but specific to making batteries more efficient and extending the battery’s life. This technology will not only improve the driving distance per charge for electric vehicles but also will prolong the replacement of those batteries. Something to make the planet much more green in use and generate energy much more efficiently while getting paid for that it’s a nice position to be in especially if the economy starts to improve.

As we projected, coming into the last quarter revenues did decline significantly thanks to the discipline of the organization in controlling expenses we were still able to generate a profit. Limited visibility should not be taken as good visibility so we have reacted accordingly to quickly reduce our break even but still allow us to invest in our new National 3.0 initiatives.

Given all of the ongoing economic issues in lieu of any news of a turn around we’re guiding further revenue reductions in the current quarter.

Over to you Lewis.

Lewis Chew

Today I’ll concentrate my discussion on three key topics:

1) The background and assumptions behind our Q4 revenue outlook.

2) The operating expense transition for the company from Q3 to Q4.

3) A more detailed discussion of how the restructuring actions we’re launching in Q4 will affect the company’s results and business model going forward.

Let’s start with the revenue outlook for Q4 and the main items that impact our estimate. In Q3 our bookings for the whole quarter were down about 25% sequentially. This decline was significantly impacted by very weak bookings in December and in fact the weekly run rate of bookings in December was nearly half of what it was in January and February. As a result, the opening backlog we have going into Q4 is below what it was at the beginning of Q3.

Our turns orders which are those orders received with delivery requested in the same quarter, were about the same in total for Q3 as they were in Q2 and that includes the fact that net turns orders in December were actually negative, meaning that short term customer push outs and cancellations during that month were higher in total then all the positive turns orders we received during the same period. However, turns orders moved back into positive territory in January and February and were relatively steady albeit at lower levels then we have seen historically.

Let’s talk about the distribution channel and the main factors there that typically affect our revenue. During Q3 our distributor’s re-sales were down roughly 25% compared to Q2 and the ending distributor inventories were also down compared to Q2. That decrease was in the neighborhood of about $15 million. In Q4 distributor inventory dollars are expected to be down again but to a much lesser extent then the decrease we saw in Q3.

Our OEM activity in Q4 is expected to be more stable in aggregate now that the large adjustments to run rate have been taken over the last two quarters. We are estimating that our revenue in Q4 will be down 5% to 10% sequentially largely driven by distributor channel decreases. By the way, historically, our Q4 has usually been an up quarter typically anywhere from 3% to 6% but of course not much is behaving typically right now.

Let me move on to talk about gross margin and operating expenses and a transition of those items from Q3 to Q4. First let me make a sweeping comment about spending in Q3 which relates to both gross margins as well as operating expenses. If you look at the gross margin and operating expenses we achieved in Q3 both of these were noticeably better then we had originally projected at the beginning of the quarter.

For example, operating expenses which is R&D plus SG&A in Q3 were down roughly $34 million from the base run rate in Q2. Some of this was due to the savings from the headcount action we took in November of 2008 but a large portion was due to what I would categorize as temporary measures. This scale of temporary savings cannot be sustained indefinitely. In our press release today we announced major cost reduction plans that we will commence immediately to yield savings that are more permanent and more sustainable.

As I talk through the rest of the P&L guidance for Q4 I will include comments that clarify how these cost reduction plans affect the transition from Q3 to Q4, starting with gross margin. In Q3 we ran our wafer fab utilization based on wafer starts at about 37% for the quarter and we were able to reduce any inventory by about $5 million. Our gross margin for the quarter ended up at 57.5% which was down eight points from the Q2 gross margin but was better then we had originally thought. This was due to a combination of better then expected product mix, and lower then projected spending.

In Q4 we will bring utilization down a little to reflect a lower sales level. We are anticipating that gross margin percentage in Q4 will range from 55% to 56%. This range includes a negative impact of about one to one and a half percentage points from accelerated depreciation relating to transition activity that we will be starting as part of the phased shut down of the China assembly plant and the Texas wafer fab. The accelerated depreciation will continue throughout the plant closure timeframe.

We currently estimate that the China plant will cease production around the end of Q2 of fiscal 2010 and the Texas plant will cease production around the end of Q4 fiscal 2010. The phases of the closure activity consists primarily of one, building up some buffer inventory stock to bridge the transition period which in Q4 will be a few million dollars worth. Two, transferring all existing manufacturing processes to other facilities along with selected tools as necessary and qualifying those transfers. Three, decommissioning the facilities which includes final disposal of any remaining tools and equipment.

Once production has stopped at each of the two plants we estimate it will take one to two quarters beyond that to finish the exit related activities. We are estimating that the cost of the plant closure activities will range from $3 to $4 million per quarter. In the future, I will provide an update each quarter on the progress of these activities and the associated dollar amounts.

Moving on to operating expense, of the 850 headcount reduction that we identified in the press release, that is separate from the plant closures approximately 525 of those are related to headquarters and other non-manufacturing sites, while the remaining 325 are related to factories. The vast majority will be notified within Q4 starting right away. We will get much but not all of the savings from this portion of our action in Q4 and the remainder of the savings should be realized in our Q1 fiscal ’10.

In Q4 R&D expense is expected to range from $68 to $72 million. SG&A expense is expected to range from $68 to $71 million and also today’s press release contains more detail on the Q4 restructuring actions including cost estimates etc. that I do not need to repeat here.

At a high level, the OpEx related headcount reductions announced today along with the carry over benefit from the action announced in Q2 are aimed at achieving over $30 million of OpEx savings per quarter that can be sustained through this economic downturn. The point of reference for this savings is the Q2 base run rate of OpEx which was roughly $173 million per quarter.

Other income and expense is estimated to run at around $1 million of expense in Q4, interest expense net is expected to range from $15 to $16 million of expense, and our interest expense is coming down from Q3 but our interest income is also expected to be very low simply due to the extremely low yield that we get these days. The effective income tax rate is estimated at 30% to 31%.

Included in the figures I just provided is stock compensation of approximately $18 million in Q4 and here’s a breakout by the various line items that are impacted; cost of sales $4 million, R&D $6 million, and SG&A $8 million.

Let’s move on to the balance sheet. Our capital expenditures in Q3 were about $13 million. In Q4 we anticipate that capital spending will be around $8 to $10 million. Our days of inventory at the end of Q3 were about 118 days up from 97 days in Q2. The actual inventory dollars were down about $5 million in the quarter so the increase in days was really driven by the decline in sales.

Our days of receivables at the end of Q3 was around 28 days which was at the low end of our normal operating range and was similar to what we had in Q2. Our cash reserves ended Q3 at $777 million down slightly from $786 million we had at the end of last quarter. We had positive operating cash flow in Q3 and so the $9 million decrease in cash can be mainly attributable to our normal quarterly debt payment of about $15 million as well as our dividends of about $18 million.

Speaking of debt, we were able to amend our term loan facility at the end of Q3. Under that amendment our two debt covenants were expanded to give us more cushion over the next seven quarters. In return for that we agreed to $125 million early pay down in Q4 along with a modest increase in rate. The Q4 interest expense guidance I gave a minute ago does reflect the new rate.

Operating margin in Q3 was about 6% down from about 24% in Q2 and return on invested capital was about 6% in Q3 versus 17% in Q2. Both of these measures include the impact of stock compensation.

It remains our longer term objective to run a business model that has gross margins in the mid 60s, operating margins in the 30s and ROIC in the 20s. Obviously in this economy we’re not generating those types of numbers right now, however, the major actions we’re launching in Q4 will bring our sustainable break even revenue down to below $300 million per quarter in the near term and once the manufacturing consolidation is completed that break even point will be closer to $250 million per quarter.

We will also continue to prioritize the company’s investments on specific markets that have nice growth potential and can leverage our strong base and power management and energy efficiency.

I will now turn it over to Don Macleod.

Don Macleod

I will now cover three topics; first the market and product trends that you saw in the quarter. Secondly, I’ll talk about our business model as it performed in the just completed quarter. Finally, how we plan to evolve that business model, in other words, how the repositioning actions we are announced today should leverage that business model in the future.

First, market and product trends as we saw them in the quarter. From an overall sales point of view we pretty much met the expectations we had going into the quarter. In our largest end market which is mobile phone handsets, our sales fell about 40% sequentially. Sales to our top seven mobile phone customers were in aggregate down in that same range.

New orders, however, from these top seven mobile phone customers in aggregate grew about 20% sequentially in the quarter indicating that their actions to reduce component inventories and clean up their supply chains appear to be largely behind them. This market accounted for about 30% of our overall sales in the quarter.

Our next largest market communications and networking which is about 12% of our sales in the quarter declined sequentially at about the same rate as the overall company. The cellular bay station portion of that market declined last as we increased shipments into suppliers to the new China 3G infrastructure build out towards the end of the quarter.

Looking at our business trends and other markets such as the broad industrial market which in aggregate account for about 35% to 40% of our sales, this is mainly through the distribution channel. Here sales declined sequentially in the low 20%.

Let me move on to talk about some of the market and product growth initiatives that we progressed in the quarter. In the energy conservation area one of the key initiatives is to enable the mass marketed option of energy saving LED lighting solutions. We believe that National Semiconductor is the market share and technology leader in semiconductor drive electronics to the $6 billion LED lighting market. We currently have a full portfolio of LED driver ICs for their use in many broad applications such as street lights, back lighting, automotive, and increasingly in general illumination.

We’re now introducing more applications specific semiconductor solutions for this market. An example of this referred to earlier by Brian are TRIAC dimmable LED driver launched in February. TRIAC dimmers are the standard in wall dimmers commonly used in residential and commercial buildings for dimming incandescent lights.

This devise enables direct LED bulb replacement of existing incandescent or halogen bulb systems that are already connected to standard TRIAC wall dimmers. It enables flicker free full range dimming of LEDs with the existing TRIAC wall dimmer. It also maximizes light output while maintaining energy star per factory requirements. We’re very excited about the revenue growth opportunity in LED lighting in the energy efficiency market. With the increased R&D budgets here have in development more application specific system level LED lighting products.

In the personal mobile device market we’re also applying this lighting technology leadership. As I’ve covered in the past, we’ve extended our penetration into high end laptop LCD displays with new LED backlighting solutions. According to display search, 13% of laptops shipped in the fourth quarter of calendar year ’08 had LED backlit panels and this was more then double the percentage shipped in the immediately prior third quarter.

In mobile phones, we’re also the technology leader in flash lighting drivers that are used in camera applications. In the quarter we achieved design wins with flash drivers in upcoming new models with four large mobile phone providers.

In the area of energy generation our most imminent revenue generator is our SolarMagic power optimizer. As we said earlier we completed all of our external product reliability qualifications with underwriting labs in the US and for CE in Europe and have now begun production of for sale units. These units should be available in April for first revenue this fourth quarter.

As I referred to in our earnings call last quarter, we built an experienced team of sales, channel and business development employees from the solar industry who are now conducting field demonstrations with prospective OEM customers and distribution channel partners. We’re also internally working on follow on solar products and scaling up for them a range nearing business and market development organizations here.

In the energy storage and management area as Brian already mentioned we’re also scaling up our internal product and systems development resources, here addressing smart energy management systems for high voltage batteries and how they interface with both the prior use and the various energy supply alternatives such as solar and more on this in the future.

Moving on to my second topic, our business model, and how it performed in the quarter. We were able to manage our manufacturing and operational spending thanks to our employees stepping up to extend its shut downs and other discretionary cost actions. In the 14 week third quarter for example, our operational spending and R&D and SG&A fell about $34 million to allow us to achieve a 6% operating margin.

As Lewis mentioned, our fabs ran at about 37% capacity utilization. However, our average selling price or ASP increased 5% year on year and 4% sequentially enabling our gross margin at 57.5%.

This now brings me on to our last topic which is how we evolve our business model going forward given the current depressed business reality. You might view the cost reduction actions that we announced today as conventional cost cutting in response to the economic situation. I look at it a little differently. An element of the cost reduction is clearly designed to protect the downside profitability risk in that going forward we do indeed have a lower break even level.

However, we’re also using this new business reality to more aggressively reposition both our investments in R&D spending and our remaining manufacturing facilities to our new National 3.0 growth initiatives.

History tells us that the new growth drivers for our industry coming out of this recession will not be exactly those that were the drivers of the last up cycle and we’re positioning around accordingly. For example, by the first quarter of fiscal ’10 i.e. the upcoming August quarter the first full quarter after the non-manufacturing portion of these cost reductions and reallocations are completed, about one third of R&D spending will be on completely new energy generation, energy efficiency, energy storage and management, medical, and sensing and detection initiatives. If I look back two years our R&D spending for these areas was about zero.

Talking about leveraging our assets for growth and profitability going forward, when our factory consolidation actions are completed over two stages the assembly and test rationalization should be completed into one facility in Malaysia by the end of our Q2 fiscal ’10, i.e. November ’09. At today’s revenue levels this alone should improve our gross margins by about one percentage point in the second half of fiscal ’10, i.e. Q3 and Q4 of fiscal ’10.

The fab rationalization to production at two fabs down from three today should also complete by the end of Q4 fiscal ’10, i.e. a year from May. This again, in today’s revenue level, should add another four percentage points to our gross margin for a total in all of five percentage points. I stress that these numbers for gross margin improvement are based on today’s revenue levels. If and when we get back to higher revenue levels per quarter then you can add more percentage points to this.

Our business model has now been aggressively reshaped not only to provide downside revenue protection but also for manufacturing leverage and R&D repositioning for revenue growth in the future in completely new markets and energy related applications.

In conclusion, none of us thought that we would be running businesses but our sales volumes have come down so much. For us at National Semiconductor this has now been a catalyst to accelerate the urgency of our concession towards being a different kind of analog company when we come out of this recession.

Back over to you Mark for Q&A.

Mark Veeh

At this time I will ask the operator to open up the lines to begin the Q&A session. We will take questions until approximately 9:00 am Eastern Time. In order to accommodate as many people as possible, please limit yourself to one question and one follow up. Operator can we please have our first question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Chris Danely – JP Morgan

Chris Danely – JP Morgan

Can you comment on your inventory goals, do you have a certain goal in mind in terms of days or dollars?

Lewis Chew

I would say that in a normal operating window we would and I would say typically our operating days are probably anywhere from 75 to 90 days. In this environment we’re probably more focused on the dollars. You’ll notice that in the current quarter we’ve brought dollars down about $5 million and next quarter even with revenue going down we’ll bring them down a little bit more in terms of dollars. We’re really not too obsessed with the days right now. I think we’re very comfortable with the nature of the inventories. I’d say from a dollar standpoint we’re probably getting close to the level we want to be at.

Chris Danely – JP Morgan

You guys talk about a lot of these new and emerging growth initiatives and investments but it seems to be that some of them are outside your core competency. Can you address how successful do you think you’ll be or why do you seek to go outside your core competency of power management ICs for these new growth initiatives?

Brian Halla

First of all it was our core competencies that made us decide to go into these markets and the core competency being that we’re the leader in power management, analog circuits all of which are directly targeted at these energy markets. It is our core competency that we’re leveraging here. In addition to that, as Don mentioned in his commentary, we have gone outside the company to secure competency from the various industries.

I’d go back and remind from previous phone calls we found that Tesla had designed in 25 of our PowerWise circuits without us really even calling on Tesla or knowing about that. The reason was they were on a power budget. Our circuits are very well positioned to get us into these energy markets, energy efficiency, energy generation, energy management, and energy storage. I don’t think they’re outside our core competency at all.

In fact, we’re the only electronic supplier right now doing anything in the area of solar generation with our SolarMagic modules.

Chris Danely – JP Morgan

Can you give us a hint of your larger businesses or more traditional businesses that you’ll be looking to de-emphasize?

Don Macleod

To build on the point that Brian made there, if you look at the core competency of energy management par management that we’re building on what we’re in fact doing is moving our portfolio forward from a standard building block supplier to at the very first level an application specific solution provider to at the next level an application specific system level solution provider to at the next level as much as possible the complete system in terms of the supply chain.

What we’re doing here is up-scaling the efforts we have based on the core competency we have going forward rather then changing the nature of that. The emphasis on the point and maybe Chris is making this, the skill set that we need to bring some of those system levels solutions to market may in some cases be skills that we haven’t had in the past when we were addressing a building block or catalog type portfolio.

We’re not abandoning the original portfolio that the company has evolved into over the past few years, we’re just developing that forward to provide more of the value to our end customers in the form of applications, specific solutions or system level solutions that build on these building blocks that we had. By definition that does mean that we aren’t doing as many derivatives or spins of the traditional building block products that we had in the past and we’re not necessarily filling out the catalog of those products.

Where we are introducing new products in what you might have called in the past the building block area, we tend to focus more on very high performance products that meet our PowerWise characteristics which is the very highest performance with the very best power efficiency factors depending on what they are. We’re evolving that rather then just building the catalog more broadly as we have in the past.

Operator

Your next question comes from Ross Seymore – Deutsche Bank

Ross Seymore – Deutsche Bank

With the closing of both the front end and the back end fab what’s going to be your total revenue capacity? I realize you have to make ASP assumptions in that.

Lewis Chew

To clarify what you just said, only one of the plants we’re closing is a fab and the other one is assembly and task. The plant in China is an assembly plant not a fab plant. I’d say that right now our revenue capability is still quite high even with that it’s probably north of $500 million per quarter.

Don Macleod

Just to give you a flavor, Lewis mentioned, I also amplified that we had our fabs utilized 37% in the quarter so you scale up that number and just imagine that we have an offload of extra capacity. By the way, its not just an issue of eliminating capacity, we have been converting more and more of our capacity to eight inch in the past and that is provided us inherently with more capacity in the existing facilities.

Mark Veeh

In case this question will come up later, if you look at our 37% fab utilization this quarter the Texas plant that we’re closing was just south of 20% of that number. Not 20 points of that number but 20% of this quarters starts was roughly being done in Texas.

Ross Seymore – Deutsche Bank

On the restructuring side of things it sounded like you said you wanted OpEx to be roughly $140 million when all this was done. It seems like that’s what you’re guiding May to. Are there incremental cuts from there or how are you getting the entirety of that benefit in the May quarter and it doesn’t sound like any more afterwards.

Lewis Chew

I really tried to avoid trying to give guidance beyond the current quarter. It is possible for our OpEx to be below $140 million but for the current quarter, as you said, our guidance is roughly $140 million of OpEx which is again a little bit more then the $30 million down from the run rate we were normalized last quarter. The key point there is that is now a number that’s pretty much embedded in the base and it doesn’t get into a lot of the temporary measures that we typically use in a short term period. We do have some flex beyond that yes.

Ross Seymore – Deutsche Bank

Does that $30 million delta down include all of the OpEx savings that you’re going to get on the restructuring temporary cuts aside?

Lewis Chew

There will be a little bit of carry over savings into Q1 as well because not all of the actions that we’re taking in Q4 will benefit Q4 100% but a lot of it will. If you hold everything else equal there will be a downward trajectory in Q1 as well.

Operator

Your next question comes from Tore Svanberg – Thomas Weisel

Tore Svanberg – Thomas Weisel

You talked about bookings improving in January and February, could you talk about how that trajectory is progressing into the month of March?

Lewis Chew

It definitely was very low in December and it very noticeably was higher in January and February both Brian and Don said that so maybe I’ll be the third to repeat it. It pretty much has stabilized at a level that doesn’t look like its going down anymore. I think it’s at a level that’s below what we would like it to run long term. As I said in the revenue guidance we still see that channel taking the inventory out in this upcoming quarter. Right now I wouldn’t want to characterize it as increasing per se but it does feel like it has stabilized.

Tore Svanberg – Thomas Weisel

As you change the strategy from building block to more application specific, do you need to make any changes to either the manufacturing strategy or either your process technology development just trying to understand a little bit more what we should expect there going forward?

Don Macleod

At the end of the day part of the rationale for our manufacturing actions that we announced today is in fact the repositioning of our manufacturing for our National 3.0 strategy that you highlighted. When you move from a building block strategy to, I would go beyond just an application specific strategy, to both an application specific strategy and a system level strategy. Many of the ways you differentiate the product out beyond just the silicone and the classic sense.

For example, the packaging is becoming a bigger and bigger differentiation. I don’t mean the silicone type packaging you’ve been used to in the past, you’ve seen examples of our SolarMagic power optimizer as an example, the packaging and the value we put into that packaging really differentiates. Yes, at the end of the day when we look forward a few years less of the value add will come from traditional wafer fab and the classic sense and more of the value add will come from the system level capabilities including the packaging of our products.

That clearly was a factor in looking at our fab capabilities going forward in the future. You did ask the question about the process capabilities. We’ve always invested and differentiated internal process development capabilities in the company. These will continue going forward when we look for these higher performance differentiated features. In fact, the silicone in our SolarMagic capabilities come from internal differentiated processes.

Operator

Your next question comes from Doug Freedman - American Technology Research

Doug Freedman - American Technology Research

Can you touch on what has you attracted to the application specific or system level products. Are you close enough to communicating what the incremental business model is on SolarMagic and what you’re expecting out of that business for the coming year?

Brian Halla

We’re actually getting quite close since we’re going into production as Don said we’ll see first revenue next month on the SolarMagic product. Just to put things into perspective the SolarMagic allows fairly dramatic improvements of up to 50% of recovery of the power loss due to shade. If you look at the 25 million panels shipped this year maybe 10% of those are into shaded environments.

You could say on one hand the tam is 2.5 million units. Two and a half million units and the ASP of the SolarMagic modules at $150 each so you can do the math. Over time our intention is to get a much broader penetration as we add more capabilities to future generations. It should ramp fairly rapidly and we expect to see pretty good revenues.

The concern that we’re stepping out of our core competency area of familiarity I think it’s misguided. The other area Don talked about and I talked about is LED lighting. You can pick up the paper and look everyday you see a new headline of another city moving from the high pressure sodium lights to LED lighting. We’re the guys right now. That one, as I said in my commentary we should see revenues take off fairly rapidly.

Doug Freedman - American Technology Research

What I was looking for there is what type of operating gross margin opportunity is there in a SolarMagic type of product and what type of operating margins are these incremental to the present business model. There’s been a big focus on the company on the gross margin line I just wanted to get a sense?

Brian Halla

We’re continuing the focus and all of these products as Don talked about are coming out of what we call our key market segments. The charter of the key market segments is to improve all the numbers of the company and that includes gross margin.

Operator

Your next question comes from Sumit Dhanda – Banc of America

Sumit Dhanda – Banc of America

A clarification on the restructuring actions, the 875 individuals who you said would be let go over multiple quarters I’m assuming that benefit is not reflected in the decline in OpEx that you suggested because that is slated to occur by Q2?

Lewis Chew

It’s actually two factors, first of all those things are predominantly not OpEx because those are all the factory people that are impacted by the closure. The reason why it takes several quarters is because it will take us multiple quarters to do the actual closure. Until you turn lights out you need people there working. The 875 is one, not OpEx, and two, will take multiple quarters.

Sumit Dhanda – Banc of America

Is it fair to assume that just on a rough expense savings basis the savings given that the headcount reduction is similar is not too dissimilar whenever that full savings number hits the P&L that’s an open ended question?

Lewis Chew

Let me also clarify too that for example the headcount that is in that number for example our China assembly plant are relatively low wage earning employees. If you look at the saving we’re getting in OpEx from the roughly, when I talked about the 850 headcount reduction that’s happening now which 525 is non-manufacturing those are more your higher salaried employees. It really does have a different structure.

In terms of the savings that’s what Don went over in his commentary when he talked about a one plus another four point improvement in gross margin eventually when we’re done with this.

Operator

Your next question comes from Romit Shah – Barclays Capital

Romit Shah – Barclays Capital

Did you clarify when National would get the $250 million break even target?

Lewis Chew

What I said was that at the end of the factory consolidation our break even would be more in the $250 million neighborhood. Like I said, we’re going to see production in China Q2 of next year and cease production in Arlington Q4 of next year then it’ll take another one or two quarters beyond each of those two respective dates to finish the closure activity. By then we’ll have the full savings from this plant.

Romit Shah – Barclays Capital

It sounds like you guys are still committed to the mid 60 gross margin low 30 operating margin target. Can you give us a sense once you factor all these OpEx savings and consolidation efforts what revenue level you need to get to, to reach that target?

Lewis Chew

Once we’re done we’ll be able to generate 60% gross margins below $300 million in revenue. Then from an OpEx standpoint you can kind of look at what Ross asked a few minutes ago use the OpEx guidance I gave for this quarter as a new base point to toggle off of and you can start to figure out your own operating margins as well.

Romit Shah – Barclays Capital

You mentioned that cellular orders were up last quarter. Are you expecting wireless to grow in the May period?

Don Macleod

I actually said that we saw orders from our top seven mobile phone customers pick up in the just completed quarter over the quarter before and I think we attributed a lot of that to the mobile phone customers cleaning up their supply chains, in other words, stopping canceling, stopping cutting back on their supply chains and coming back to much more normal run rate.

At this point we’re not looking at growth from an OEM customer base in any significant way in the quarter ahead as Lewis mentioned to you the backdrop to our guidance of modestly down revenues in the May quarter is mainly driven by the continuing de-stocking that we’re seeing in the distribution channel.

Operator

Your next question comes from Uche Orji – UBS

Uche Orji – UBS

Some clarification on the capacity decisions you’re making. Effectively how much capacity is being taken out and this sounds like its permanent so in the future if demand were to come back will you be looking to transition to an outsourced model?

Lewis Chew

We will be perfectly happy at this point to have capacity issues because like I said, our revenue capacity is still well north of $500 million. The amount of free cash flow and operating margin we have at that point would be unbelievable. We don’t feel that we constrain anything on the revenue side for the company right now.

In terms of outsource as Don mentioned a second ago we still derive a lot of our value from the internal manufacturing processes that we do that are very specific to high performance analog which actually addresses part of what Chris Danely was asking as well. No, the current plan does not contemplate extensive moving to outsource manufacturing.

Down the road, things can change if there’s some packaging we need to do that’s outsourced that’s fine but in terms of our internal fab manufacturing our current plan has us continuing to make our products in-house.

Uche Orji – UBS

How much capacity is coming off that is it 15% to 20% I’m sorry I missed that part.

Lewis Chew

What I said was we were 37% utilized this quarter in terms of starts and even though I don’t normally give this information out since we’re getting ready to close Texas I said that just south of 20% of that 37% was being provided by Texas.

Uche Orji – UBS

Most people have talked about China an area where they’ve seen strength. Can you give any color as what you may be seeing in China?

Don Macleod

Just to talk about China from a manufacturing perspective the manufacturing facility that we are unfortunately closing in China today only accounts for about 20% of the output of our backend test and assembly operations. As we discussed earlier one of the objectives of this repositioning was to provide a factory with a perspective of where we’re going to be going under National 3.0 and frankly the factory we have in China today is manufacturing products in relatively mature packaging capabilities mainly SO packages which have less and less of a role going forward as we move up the value added chain in the company.

We made the choice that clearly the other 80% of our current capability in Melaka is the place that with today’s business reality we would consolidate our test and assembly operations. There was nothing more to it then that.

Operator

Your next question comes from Craig Hettenbach – Goldman Sachs

Craig Hettenbach – Goldman Sachs

Outside of Solar some of the new initiatives and the medical area and LED lighting are there any milestones we should be looking at in terms of design activity or time to revenue in the coming quarters for some of the new growth initiatives?

Don Macleod

At this point in time the first milestone we should be looking for is revenue ramping up in our SolarMagic capabilities. As we mentioned, we’re looking for first revenue in that capability. In the make order and obviously from the on we see that number ramping up. Internally we have a number of initiatives in the company that we’re pushing for sales growth in the fiscal year that’s coming up in front of us fiscal year ’10 starting at the end of May.

Clearly we’re measuring these internally and driving our field sales force on these internal initiatives. At this point in the marketplace there’s little point in going to try buying business from anybody else. We’re more investing in the opportunities that we think are going to differentiate ourselves in the future and that’s the focus of our efforts for internal milestones going through fiscal ’10 that’s ahead of us.

Operator

Your next question comes from John Dryden – Charter Equity

John Dryden – Charter Equity

Can you discuss what drove the change in the interest coverage terms and the payout looks to be $125 million that was identified as the minimum in the 8-K is there an accelerated payment also due in May or is that over. On restructuring charges of $130 million what’s cash versus non-cash?

Lewis Chew

In terms of the debt, the $125 million early prepayment is the only one that we’re required to make. Beyond that we have a normal quarterly payment of $15 million which has been the same as it’s been there from the beginning. Was there other question you had on the debt or just on the prepayment?

John Dryden – Charter Equity

On the prepayment then on the restructuring charge cash versus non-cash.

Lewis Chew

On the restructuring charge in the current quarter the cash portion will probably be in the neighborhood of $40 to $50 million. In longer term the cash piece in total will be in the neighborhood of $75 to $100 million. Some of that remember is the costs we incur to transfer these processes from a closed plant to an existing plant. No all of that is severance but a large portion of what I just said for the current quarter is severance.

Going back to an earlier question about the 875 people who work in the factories today that are affected by the shutdown we will have to pay severance to them as well but these are much lower paid individuals.

Operator

Your next question comes from Craig Berger - Friedman, Billings, Ramsey

Craig Berger - Friedman, Billings, Ramsey

I wanted to understand the gross margin guidance a little bit better. How much veracity do you have in that or how much confidence do you have it that? Can you go through some of the puts and takes that got us to this quarter’s gross margins, i.e. benefits from temporary actions, lower utilization going into next quarter etc?

Lewis Chew

To clarify, are you wanting some more color on the margin we had in Q3 or why I’m guiding it down in Q4?

Craig Berger - Friedman, Billings, Ramsey

More on guidance I guess, lower revenue guidance down 5% to 10% yet gross margins are only down a bit. What are utilizations going to do next quarter?

Lewis Chew

Utilization we’re expecting right now to drop just very slightly. Obviously last quarter was the big drop we went from like 66% to 37% so we will see a very slight drop this quarter. The margin downward trend is affected mostly by two factors; one that revenue is down so we’ve got more of our fixed cost divided over a smaller number. Two, as I mentioned, we’ve got anywhere from a point to a point and a half of negative impact from accelerated depreciation that we have to take because of the planned shut down of the Texas fab.

Then counter balancing that is some of the savings we get from the headcount reduction we’re taking that’s not related to the shut down but related to expense savings. From a mix standpoint we’re actually baking in a slightly lower mix then we had in Q3 because Q3 mix was quite strong and actually stronger then we had expected. Those are your main puts and takes right there.

Craig Berger - Friedman, Billings, Ramsey

On the SolarMagic can you help us understand how big that potential market might be in let’s say 2010? How many solar panels are sold, how many chips per panel, anything you can help us size that opportunity?

Brian Halla

If I remember correctly that the market this year was about 25 million panels from about 10 vendors and that’s Kyocera, Sanyo and Sharp in Japan that’s Suntech in Asia, Wushi China and Sun Power in the United States, Conergy and First Solar. That’s about the number of panel makers there’s a couple types of glass our SolarMagic is agnostic whether it’s thin film or crystal line.

The entire tam there is a potential for our technology, also it didn’t come up before but SolarMagic is technology that can be retrofitted in existing installations. The tam really is every panel that’s been installed since the beginning of mankind. That’s probably closer to 75 million.

By the way, we think there’ll be a significant retrofitting market because any installation that’s been around a while typically performs at much lower level then when it was first installed and the reason is one or two panels have gone bad and nobody knows about it. The retrofitting market will be fairly lucrative.

As I said before the ASP today is $150 a module. We don’t talk about it in terms of chips because it’s not a chip it’s a module.

Craig Berger - Friedman, Billings, Ramsey

Is it one module per panel?

Brian Halla

Yes. It can be one module per panel. Some installers may elect to put our module only on the string that is subject to shade, shade coming from chimneys or trees. You could put it in every single module and recoup the power lost when clouds go over.

Operator

Your last question comes from Mahesh Sanganeria – RBC Capital Markets

Mahesh Sanganeria – RBC Capital Markets

You guys talk about starting from next fiscal year one third of your R&D will be directed towards the new wrote initiatives. Can you have some comments on if that takes away from R&D directed towards existing business lines?

Don Macleod

At the end of the day there’s two dimensions to this its not just taking R&D away from existing business opportunities. Clearly we’ve taken action to size somewhat down the overall investment we’re making in R&D given the current business and economic situation.

The fact of life is that when you look back over time some of the business cases that we had in process for new product development in our R&D infrastructure yesterday the economic situation for those business cases that looked good at the time around six months to a year ago when we put these business cases into our R&D pipeline clearly don’t look so good going forward.

We’ve taken a pretty hard view on every one of the business cases in our pipeline and R&D and we’ve looked at those from a market perspective and obviously not all of those R&D projects that we had in the past are going forward. That’s pretty realistic assessment of the economic situation. Obviously where we’ve done on the other hand is look at the opportunities that can be driven by some of these newer mega trends faster growing, if you want opportunities and put more money into them. This is the National 3.0 focus on these new growth markets.

Brian Halla

I want to repeat out of Don’s commentary and I’ll quote him, “history tells us that new growth drivers for our industry coming out of this recession will not be exactly those that were the drivers on the last up cycle.” We absolutely believe that to be the case. If you look at the last up cycle for the semiconductor industry and in a way you could say it ended five years ago when the unit volume growth stopped outpacing the ASP erosion. All of a sudden the PE ratios for the entire industry went from the 30 to 50 range down to the low teens.

Just hunkering down, waiting for the smoke to clear and hoping that the same markets are going to drive our revenue you could ask companies like [Opti-peacle], Power S3 and Chips and Technology how well that strategy worked during the PC days. We’re not going to be one of those. We in fact want to be a leader in the emerging mega trends. It’s not a departure from what we’re good at its leveraging what we’re good at which is power management and analog. We feel pretty confident about what we talked about today and the position of the company going forward.

Mahesh Sanganeria – RBC Capital Markets

Can you talk about the turns assumptions that are built into the Q4 top line guidance?

Lewis Chew

Its fair to say right now that the turns picture has looked better in the last month and a half then it did say three months ago. We are assuming in our guidance that turns would be slightly better then it was in Q3 but recall that in Q3 one of the three months actually had negative turns for the entire month. We’re basically assuming that that month doesn’t repeat in Q4.

Mark Veeh

With that we’re now going to end the call. Let me remind you that the replay is available on our website and thank you for joining our call today.

Operator

This does conclude the National Semiconductor Third Quarter Fiscal Year 2009 Conference Call. You may now disconnect.

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Source: National Semiconductor Corporation F3Q09 (Qtr End 02/24/09) Earnings Call Transcript
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