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Executives

Mark Veeh – Investor Relations Manager

Brian Halla – Chief Executive Officer

Lewis Chew – Chief Financial Officer

Don Macleod – President & Chief Operating Officer

Analysts

Craig Ellis - Caris & Co.

Romit Shah- Barclays Capital

Douglas Freedman - Broadpoint Amtech

James Schneider - Goldman Sachs

Chris Danely - JP Morgan

Brendon Furlong - Miller Tabak

Uche Orji - UBS Securities

Ross Seymore - Deutsche Bank

Analyst for John Pitzer - Credit Suisse

Stacy Rasgon - Sanford C. Bernstein & Co.

National Semiconductor Corp. (NSM) F1Q10 Earnings Call September 10, 2009 4:30 PM ET

Operator

Good afternoon, at this time I would like to welcome everyone to the National Semiconductor quarter one fiscal year 2010 conference call. (Operator Instructions) At this time I will now turn the conference over to Mr. Mark Veeh, Investor Relations Manager.

Mark Veeh

Welcome to National Semiconductor’s Q1 fiscal year 2010 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.

As part of today's call Brian Halla will give an overview of the current business environment and an update on the company’s focus and priorities moving forward. Lewis Chew will review our fourth quarter results and provide the background to our outlook for the second quarter of fiscal year 2010. And lastly, Don Macleod will then discuss market trends and product areas in more detail. At the end of our prepared comments, we will then take questions until approximately 2:30 pm Pacific Standard Time.

As we begin our call, let me remind everyone that today's discussion will contain forward-looking statements that involve risk factors that could cause National Semiconductor’s results to differ materially from management’s current expectations. Please 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 Web site at www.national.com.

At this time, I would like to take just a minute to highlight a couple of notable items within our just-completed first quarter. Revenue for the quarter came in at $314.0 million, up 12% from $281.0 million in the previous quarter and down 32% from $466.0 million in last year's first quarter. GAAP net income for the quarter was $29.8 million, or $0.13 per fully diluted share.

Included in this quarter's net income numbers were the following notable items. First, a $5.7 million expense in restructuring, primarily for process transfer costs associated with the Texas fab consolidation, and secondly, Q1 included approximately $16.0 million of stock compensation that was broken out as follows: $3.0 million in cost of sales; $4.0 million in R&D; and $9.0 million in SG&A.

So before I turn it over to Brian, I would like to remind everyone that our upcoming annual shareholders meeting and analyst day will be held on Friday, September 25, 2009, at 10:00 a.m. Pacific time at our corporate headquarters in Santa Clara, California.

We will have the formal annual meeting of stockholders, immediately followed by the analyst meeting. For more information and details regarding this event, please visit National's IR Web site.

So with that, I will now turn it over to Brian.

Brian Halla

In my brief comments overview our just competed Q1 FY2010 I will try to cover the following questions you might have. Number one, how did the quarter turn out relative to our expectations a quarter ago? Number two, given the numbers just announced, does this represent an indication of a true recovery or is distributor restocking responsible for the upside? Number three, how do we feel about that quarter we're in, that is what's the basis for our guidance? And Number four, moving forward what are our priorities and areas of focus?

On the quarter just completed, as you can imagine, we were quite pleased versus our expectations coming into this quarter. Everything came in better than expected, and even Donnie smiled on occasion.

To recap, revenue came in above the high end of our projected range at $314.0 million, or 12% over the prior quarter, versus a 9% at the high end of our projections when we started the quarter.

Turns came in at much stronger than we expected throughout the quarter as distribution orders, driven by stronger resales, were better than expected.

Gross margins came in at 61.1%, or roughly a 300 basis point improvement over the prior quarter's 58.3%. Getting back to over 60% in gross margins sooner than expected came as a result of better product mix, factory utilization, and completing the China plant production ramp down ahead of schedule.

The higher revenue, combined with these higher margins, gave us GAAP net earnings much better than we expected at $0.13 a share. We continue to bring down inventories throughout the quarter, both in dollars and days, and the distribution weeks of inventories remained at under 10 weeks. Both OEM, as well as distributor sales, were up in the quarter.

So the question is was the good news the result of a recovery or restocking? We believe that the answer is a little of both. While sales were up 12% in the quarter, bookings were up even higher, giving us a positive book to bill. Overall, company bookings grew by 17%. Some of the distributor bookings did go to support the higher opening backlog as orders on national were higher than the channel's resales. This improvement in disti resales did bolster our confidence in the overall market strength, but we'll continue to watch this and leave the cork in the bottle for now.

Our lead time stayed pretty much the same in the quarter and our delivery performance stayed pretty much the same as always, at great. So if fear of shortages stimulated some of the higher bookings, it didn't come from us.

So the across the board improvement does give us an indication of recovery, but we will put some time and data in before we can gauge the magnitude.

Some of you are wondering, they're leaving the cork in the bottle but are they at least chilling it? A higher opening backlog and continued strengths in our turns business does give us the confidence to project further growth in this quarter in the 3% to 8% range where the midpoint of that range won't require any higher turns than we saw in Q1.

Our performance in the cell phone market will pretty much depend on the adoption of the smart phones, as that's where we continue to see improved penetration. The rest of the phone market for us pretty much follows the industry-wide trends as we are well enough diversified so that when one of our customers lose market share, another of our customers find it.

The broad distributor demand will really determine the overall health of the market, and while our visibility has improved, it hasn't improved enough to give us clarity on the quarter, beyond the one we're in.

So, given that good things happen when margins go up, we'll continue to execute on the plant consolidation already announced and on emphasizing growth in the sales of our richer mix of higher valued core analog products to leverage our in-house fabs.

The strength in the quarter came primarily from our core analog business and I'll remind everyone that our differentiating strength is power management and power efficiency. Growth in the quarter also came from the traditional markets and customers to whom we enjoy providing the best service, supply, and logistics. We will continue to invest in these customers and these markets.

We have made several announcements throughout the quarter on new exciting products to serve these now more energized markets and Donnie will highlight a few of these product areas in a minute.

We will also continue to work on accelerating the penetration of our analog solutions into newer high growth areas such as LED lighting solutions, renewables, personal mobile devices, and medical applications. Though the numbers just turned in do not reflect major contributions from any of these newer sectors, we are seeing early signs of a strong wrap in our LED lighting drivers and we have received and fulfilled first orders for our SolarMagic power optimizer solutions from Europe, Japan, and the Americas.

Overall, we will continue to keep expenses under control, continue to focus on the momentum of the analog business that is driving our top line growth, and continue to work with our distributors to maintain our solid performance to them and their customer base.

If this is the beginning of a sustainable recovery, the actions we've already taken over the past several quarters, have us very nicely positioned for a much higher fall through to the bottom line.

Let me now turn it over to Lewis.

Lewis Chew

I will start my comments today by reviewing details on the bookings and the turns activity that we saw during Q1. As a reminder, turns orders are those orders placed where the customer requests deliver in the same quarter. After going over the Q1 detail, I will tie that into the outlook that we have revenue in the second quarter.

I will also cover our gross margin trend and the key items that are affecting it, then I'll review the operating expenses for Q2 and highlight for you the things that impact the transition from the first quarter to the second quarter. I will finish with a few comments on the balance sheet and key metrics.

So let's begin with bookings and turns. Total company bookings increased by about 17% in Q1 compared to Q4. Some of that increase was converted to revenue in Q1 and was a contributing factor to our Q1 coming in at 12% up, which was above the original expectations. The increased booking also allowed us to grow our backlog going into the second quarter.

Using a normalized 4-week run rate, the bookings increased in both June and July compared to May. August bookings were a little below the July run rate, but they were higher than June.

Turns orders were strong for all three of the months in Q1. They were higher than we originally expected and also higher than Q4. The increase in turns was driven mostly by our distribution channel as we saw the resales rise by around 5% or 6% during our Q1. We had entered the quarter anticipating that resales would be somewhat flat in the summer.

Distributor inventory dollars went up by just a few million in the quarter and because resales were also up, ending distributor inventory in weeks, stayed below 10 weeks, similar to the end of Q4.

We also had increased revenue in Q1 from our direct customer base. In other words, not the disti channels. That increase was consistent with the higher backlog in place at the beginning of the quarter so there were no big surprised in that group as whole. Don Macloed will provide more specific commentary in a few minutes.

Regarding the Q2 revenue outlook, we anticipate the turns orders will continue to hold up, so with all factors considered, we are guiding Q2 revenues to range from $325.0 million to $340.0 million, or roughly a 3% to 8% sequential increase over Q1.

Let's talk about gross margins. In Q1 our gross margin was 61.1% and it was nice to see that number get back about 60% sooner than we expected. The higher gross margin in Q1 was helped by favorable product mix as well as faster completion of final production at the China assembly plants.

By finishing the production in China ahead of schedule, we were able to realize gross margin savings in Q1 that were not originally expected until Q2.

Our fab utilization in Q1, based on wafer starts, was about 46% compared to around 38% in Q4. Total inventory on hand decreased by about $12.0 million from Q4 and this includes several million dollars of buffer inventory we built as of the end of Q1 in order to support the transition to the Texas plant closure, which is on track to complete its production by the end of this fiscal year.

In Q2 we anticipate that gross margin percentage will range from 62% to 63% based on the range of revenue that we are projecting. This includes the remaining gross margin benefit we get from the closure of the China plant. In other words, beyond what was already realized in the Q1 numbers.

We will continue transferring our manufacturing processes from the Texas plant to our remaining fab plants in Q2. These activities will cost approximately $6.0 million to $8.0 million of restructuring expenses during the quarter, which are broken out in the separate line item on our income statement. We anticipate that these restructuring expenses will drop off in Q3 and Q4 as we near completion of the overall project.

Once we complete the exit of the Texas fab, we should see gross margin improvement of roughly 4% and that's based on Q1 revenue levels. A large portion of this margin improvement is expected to occur in the first quarter of fiscal 2011.

Also, we continue to drive a model in which incremental gross margin fall through on incremental sales dollars will be roughly 80%, and this is separate from the margin benefit we get from the Texas fab closure.

Let's cover operating expenses. R&D expense are projected to range from $67.0 million to $70.0 million in Q2 and SG&A expenses should range from $73.0 million to $75.0 million. A large portion of the operating expense increase from Q1 to Q2 is driven by higher stock compensation expense that always impacts us in our second fiscal quarter because of the timing of our stock-based grants.

Because of the accounting treatment of grants made to individuals who are eligible for retirement, we get a seasonal spike in expense in Q2 and then it declines in Q3 and Q4. This is the pattern we've seen in each of the last three years since we started accounting for stock under FAS E123R. Total stock compensation in Q2 is projected to be approximately $21.0 million, compared to $16.0 million in Q1. In Q2, the break out by line item is estimated as follows: Cost of sales, $3.0 million; R&D $5.0 million; and SG&A $13.0 million.

Operating expenses are also higher in Q2 due to the increase in sales, as well as seasonally higher spending, as there will be less savings from holidays and vacations during this quarter. Other income and expense is anticipated to be about $1.0 million of expense in Q2.

Interest expense net is expected to range from $14.5 million to $15.5 million. The effective income tax rate in Q2 is projected to range from 29% to 30%. The lower than expected tax rate in Q1 was helped by a positive impact from certain foreign-income-related taxes.

Let's talk about the balance sheet and operating metrics. Our capital expenditures in Q1 were about $5.0 million. We estimate that Q2 capital spending will range from $12.0 million to $18.0 million. Our ending inventory for Q1 was $123.0 million, down from $134.0 million in Q4. Days of inventory on hand ended at around 92 days, which is down 11 days from the 103 we had at the end of Q4.

Our days of receivable at the end of Q1 was about 24 days, as we continued to operate with very good linearity in our revenue shipments through the quarter, and we combined that with timely cash collections.

The company's cash reserves ended Q1 at $734.0 million, up from $700.0 million in the prior quarter. And during Q1 we paid down about $16.0 million of our debt principal, which was in line with the original schedule.

Operating margin in Q1 was about 18% and return on invested capital was nearly 13%. Both of these include stock expense but not restructuring charges.

I will now turn it over to Don Macloed.

Don Macleod

Let me now update you on our business trends. As usual, I will do first by the major market segments and then I will cover on all our product categories. And I'll finish by making a few comments on our business operations for the quarter.

First, trends in our major market segments. The broad industrial market, which includes medical, automotive, aerospace, military and the general industrial segment, which really accounts for about 40% of our sales in the quarter. Here sales were up about 15% sequentially. As Lewis indicated earlier, most of these additional sales to the industrial segment went through the distribution channel where their total resales of our product in the quarter grew over Q4 and that was more than our beginning quarter expectation.

We saw growth in sales of our management products, precision amplifiers, and interface products to this industrial market. But overall our largest growth product area was a simple switch, or power management product family. Our distributors in the Americas and in Europe are telling us that they now have higher order backlog from their customers for September delivery, so hopefully this momentum in the broad industrial market can continue.

Our next largest market segment, the mobile device market, representing about 30% of our sales in the quarter, sales grew about 7% sequentially. And this growth mainly came from two of our power management areas, that is our display and backlighting initiative and RF power products.

The third largest market segment for us, communications and networking, had about 11% or 12% of our sales in the quarter. Here, overall sales to the segment grew by about 9% sequentially. Sales to cellular base station customers were down in the quarter. And this was driven by lower demand from European base station suppliers while sales to the communications networking customer base grew to more than offset the decline in base station sales.

These three market segments I just covered, industrial, mobile devices, and communications and networking, covered in aggregate, just over 80% of our sales in the quarter.

Tonight let me talk about our analog product areas. General purpose analog, which used to be called standard linear by the WSTS trade statistics organization. Here sales were up about 15% sequentially. Within that category, our power management sales grew 19% sequentially and now represent 49% of the overall company sales.

Signal path products, that is amplifiers, data converters, and interface, collectively grew 11% and now represent about 39% of our sales in the quarter.

So let me now expand more on the largest product category for us and that is power management, which represents about half of our revenues.

Last quarter on our earnings call I talked about five major growth areas for our power management portfolio. And let me now update you on our progress on some of these. For a well established Simple Switcher family of easy-to-use power supply solutions, here we saw sales growth of 38% in the quarter, mostly to a very broad industrial base of customers.

As some of you know, we typically sell our Simple Switcher products to about 25,000 customers each year, and this is mainly through the distribution channel. Here, National Semiconductor has a 20 year history of brand equity as we are the go-to place for power supply designers. And applications of these products vary very widely, from Pachinko gaming machines to medical diagnostic equipment.

Another of these power management growth areas, our new LED lighting power thrust, we continue to grow our sales from the new base we established last year. We are on track to add significant incremental revenues this fiscal year. Q1 sales nearly doubled from the prior quarter with an addition of nearly 2 to 1 book to bill ratio in the quarter for these LED lighting products.

We have design wins for applications that range from automotive to projection to display back lighting to streetlights to retail lighting and home lighting, etc. More than half of the lighting sales in the quarter came from China, where I think we have the largest future growth potential for this attractive market.

A third growth area for us in power management is targeted and mobile devices. Two specific applications. One is powering the out aft portion of the mobile device to enable longer battery life through more efficient operation of the transmitter power amplifier. Here we saw increased sales in the quarter to two market leaders in the enterprise and smart phone category.

The second mobile device growth area, which is display and other back lighting for mobile devices. Here we saw increased sales in the quarter and an example of a driver of that growth is a new adaptive display back lighting solution in a range of android phones are just about to launched where the display automatically adjusts intensity based on the ambient lighting situation. For example, it's brighter at night or under different lighting conditions.

Another power management growth thrust for us in providing new power electronic solutions for solar energy and electric vehicle energy storage. Here, as we mentioned earlier, we made our first volume shipments of our SolarMagic power optimizer in the quarter, shipping a few thousand units to distributors and installers for them to do early market development.

In the solar energy area we are continuing our product development for the next level of our solar offering, which will be integrated more into the solar panel.

So to summarize on our power management business, we saw overall sales of these products grow 19% sequentially in the quarter, with a significant portion of that growth coming from an industrial Simple Switcher products.

We have a very broad offering of products and capability in this power management area, from solar to LED lighting to infrastructure power to industrial power supply to mobile devices. And all of these provide profitable revenue growth opportunities for National Semiconductor.

For the LAN signal path capabilities that accounted for 39% of our sales in the quarter, they grew in aggregate by 11% in sequential sales. And I plan to talk more about some of these signal path growth areas at our shareholder meeting on September 25, here in Santa Clara, California.

Next, a few comments about our business operations in the quarter. As we mentioned earlier, our gross margin came in at 61.1% for the quarter. Lewis already mentioned the contribution from the earlier-than-planned end of production at our China test and assembly plant. Our routine mix of higher margin, broad industrial product sales was also a key contributor to the gross margin improvement this quarter, even though our ASP for the quarter was flat. But on track to deliver the additional 400 basis points of gross margin improvement that Lewis mentioned, driven by wafer fab rationalization from 3 to 2 fabs.

We are also executing on our analog new product revenue growth initiatives and we just need to see that order improvement that we saw this quarter and the back log growth momentum continue for us to be able to deliver the full leverage that our business model is now capable of producing.

Mark, over to you for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Craig Ellis - Caris & Co.

Craig Ellis - Caris & Co.

Lewis, regarding the outlook for the gross margins, can you talk a little bit about how much of the uplift is coming from higher volume or from mix or other factors?

Lewis Chew

It's probably fair to say that we've actually assumed mix being relatively stable. So the improvement that we're projecting in the range that I gave of 62% to 63% is primarily driven by volume-related drivers as well as improvement we get because we're finishing off the closure of the China plant, and we get some benefit from that.

Craig Ellis - Caris & Co.

I know that the economic backdrop is a little bit tough to be thinking too far out but how would you think about normal fiscal third quarter seasonality?

Lewis Chew

You win the prize, because sometimes people wait until the end, so you ask it right at the beginning. It's not that we didn't anticipate that wouldn't be asked. So I actually took a look over the last, say, 18 to 20 years of the company, about 65% to 70% of the time, that is typically a down quarter for some very natural reasons.

You know, we sell—Don went over the composition of our revenue in some of the vertical markets that we serve, and it's not uncommon right after the Christmas season to see some of those volumes drop off by anywhere from 10%, 15%, some years 20%. So I think the normal seasonality tracking would be down in that quarter. But as Brian said, it's way too early to have visibility that far out. But just to get that on the table, the normal trend would be for down post-Christmas.

Operator

Your next question comes from Romit Shah - Barclays Capital.

Romit Shah- Barclays Capital

If I remember correctly, the majority of your trends orders typically come from distribution. If I'm right in saying that, we're just starting to see that business recover. So I'm trying to understand why you're sending flatish turns. Do you expect your distis to drive inventories down even further?

Lewis Chew

First of all, the turns from distis did increase significantly in the quarter than we just finished and we're much higher than we thought. So our current expectation is that they will continue to run at these higher levels. So we're not anticipating any pull back from that.

Trying to say that they're going to accelerate and grow even further is a little bit of a tricky move, so right now our model assumes that the turns hold at the higher level they've been running now compared to last quarter.

Don Macleod

Just a little bit of flavor of the distribution business. Clearly, our distributors saw improved resale activity in the more recent months of our quarter. I think business really started off quite slow in the May period for distribution resales. But as you've seen from comments from some of the large distributors, they began to see growth in resales, first in the Americas market, towards the end of that quarter, and the beginning of signs of improving resale activity out of Europe.

Our business, I think in general, in the distribution channel in Asia has been relatively much stronger than the U.S. and Europe, primarily because of the industrial base that we service through our distributor customers in those more mature market places. And what we're seeing though at this point is that at least if we look at Asia, our business is holding up from a resale point of view, but the distributor inventories are at all time low levels, still.

And this is a major factor in the turns business that we are seeing out of the distribution channel, given that at least in Asia they don't have very much inventory on the shelf so we are seeing the resale activity translate into ongoing business.

From a business planning point of view, it's very difficult for us to kind of plan this business, but it's always very good to see distributors with lower levels of inventory because then there's no buffers in the supply chain and we deal directly with that.

But we're encouraged by the words that our distributors in the U.S. and in Europe are voice about distribution activity as far as September is concerned. Our customers and distributors are telling us that the—at least in the industrial market—are getting back to more typical work weeks and having come back from the holidays, so I think we're looking at a better set of resale activity going into this period.

The real question is will that continue and I think that's back to a question that was asked earlier, what is seasonality going to look like this year. And frankly, we're not experts at that at this point because we don't have any more data.

Lewis Chew

Romit, you lead into that question with an assumption that all of our turns come from disti and I would like to clarify that we do actually have some portion of our turns come from the non-disti channel.

Romit Shah- Barclays Capital

It would just seem everything, Don, that you said about the environment in distribution, in particular with inventories being low, that flat turns requirement for November is overly conservative.

Brian Halla

You asked absolutely the right question, and the turns assumption is conservative, but it's based on lack of any other information, not based on anything that would push against the turns momentum. So far in the quarter turns have remained very healthy.

Operator

Your next question comes from Douglas Freedman - Broadpoint Amtech.

Douglas Freedman - Broadpoint Amtech

Just working off of this general theme that you've already started to discuss, given the fact that disti inventories are so low, are you staring to see requests from some of your customers for more OEM coverage, and what is the present state of sort of the credit out there, in terms of your customers?

Don Macleod

Based on our flavor, credit is not an issue as far as the product base and through the distribution channel at this point. We tend to deal with the three very large distributor companies that are very global in their business, so clearly they are dealing with the better part of the customer base.

I would also add one factor in the distribution case. We do not have any product lead times that have stretched out at this point, so we're not inducing people to place orders on us because of extending lead time.

If I look at our product base at this point in time, 90% of our products are on 6 weeks or less lead time. And if you look at that statement in isolation, you need to qualify it with how does that compare with history. Our goal is to have 85% of our products on 6 weeks or less.

Our products are actually more available at this point than our goals. So none of the back log or turns or inventory requirements we're seeing are based us on us having a perceived shortage or extended lead time in the product base.

And that applies to the OEM customer base as well, so we're not seeing people scrambling around trying to double order or double cover with the product coming through distribution from traditional OEM customers at this point.

Douglas Freedman - Broadpoint Amtech

I believe there are signs out in the industry, though, that some suppliers are having difficulty keeping up with the demand. Are you seeing any of your back log move around? And can you comment on what you're seeing in terms of the ASP trends in your business, both presently and in a competitive situation and what the market is consuming as far as what you're shipping.

Lewis Chew

This quarter was actually very good in terms of what we saw in back log moving around. As you know, there is always some amount of pushing around and cancellations and push outs in a quarter. I would say this quarter was extremely normal. So we see the comments that are coming up out there about the lead times but at this point all we can do is address it from our standpoint and like Don said, our lead times have been very steady and we don't see any signs of problems in terms of our backlog or order rates that are being triggered because of lead times.

And ASPs for this quarter were relatively steady compared to last quarter. But that doesn't necessarily mean that we didn't get some improvement in margin, as I mentioned in my prepared comments. We did get some favorable impact on margin from improvement in mix.

Operator

Your next question comes from James Schneider - Goldman Sachs .

James Schneider - Goldman Sachs

Can we start out on the bookings commentary? I think in your press release you talked about orders increasing in several regions but Asia Pacific wasn't among them. Can you talk about what you're seeing from our Asia Pacific customers and also was that related to the handset dynamics we saw?

Lewis Chew

The thing I'll take you back to is that last quarter we also had a significant increase in bookings, bouncing off of the bottom. And that time a lot of that actually was centered in the Asia Pacific region. So I would say that they showed a healthy uptick in their bookings rate last quarter, which continued in this quarter. So I would characterize the Asia Pacific bookings as relatively steady.

But Europe and Americas, in particular last quarter, were still weak, and what we saw this quarter was a strengthening of those two markets. That's the way I would characterize that.

So that overall as a company we saw a nice improvement in our bookings where Asia held their ground and maintained. We didn't have a lot of cancellations but at the same time we saw some strengthening in north America and Europe. And Japan. Japan also saw a nice improvement in their bookings. We don't make a lot of big deal out of that because they are a smaller portion of the company's total but nevertheless they did see some very nice improvement as well.

James Schneider - Goldman Sachs

Could you address what you see going forward in terms of sustained R&D levels, where do you think that level kind of gets to over time, assuming your revenues continue to grow? What do you think is a normalized run rate for R&D dollars? And if you could just address that handset on a go forward basis.

Lewis Chew

Our business model would be to run R&D in the neighborhood of 20% of revenue. It can fluctuate a little bit. Obviously this last year is hard to gauge because everybody suffered a huge hit in their revenue, but we aim to run our R&D in that neighborhood of 20%, maybe as low as 18%, long term.

Don Macleod

As I mentioned, the handset portion, which is roughly 30% of our sales, grew 7% this quarter sequentially and if you look at the market research that talks about the units of mobile phones that are expected to be sold in this third quarter versus the second quarter, and the second versus the first, these are kind of typical of the unit growth that is happening in the generic macro mobile phone space. And I think we're pretty widely distributed in that space. Our customer base is wide and we don't really have a huge penetration in any particular one account.

We did see strong activity in the quarter with some of the well-known enterprise and high-end mobile phones that were very visible in the quarter. And we have been shipping in to some of the new android phones that are in the process of being launched as we go through this quarter.

And obviously our concern at this point is that all these production ramps, will they be reflected in end customer purchases of the handsets. It remains to be seen, but at this point we're not shipping into that market in aggregate at a rate greater than I think it's going to pull. So I think we are reasonably comfortable with that.

And at the same time, we're not inducing any of the customers in that handset space to believe products will be in short supply. So I think we're seeing honest statements of demand from them. So I think it's a pretty good orderly market and it's nice to see that we grew this quarter with complimentary growth in both the handset space and on the other end of the spectrum, the industrial market being the engine for the quarter.

Operator

Your next question comes from Chris Danely - JP Morgan.

Chris Danely - JP Morgan

You said that your gross margins should go up 4 points in the first quarter of fiscal 2011. Can you talk about the gross margin trends between now and then, so if we assume normal seasonality for Q3 and Q4 would they stay flat or could they go up a little bit?

Lewis Chew

I think in general we would anticipate that the margins have an upward bias. The biggest question mark in the way you ask that question is whatever you guys out there want to model for revenue growth between now and then. But if you want to assume that there will be revenue growth between now and then, our general commitment would be to try to get fall through on that growth to be in the neighborhood of 80%. And then on top of that, we would then look for the roughly 4 points of accretion in Q1 of 2011. And that 4 points is sized at today's revenue level, so you can translate that into whatever dollars you want to.

Chris Danely - JP Morgan

And after that are there any other step functions in gross margin, or could we still have the 80% incremental gross margin?

Lewis Chew

Yes, I think continuing beyond Q1 of 2011 we would, for the foreseeable future, continue to run fall through in that neighborhood. Maybe the low end of that range might be 75% but I would say 75% to 80% would be a safe fall through model for you all to use for a pretty significant runway of revenue growth. I would say until you get back over maybe the 500s per quarter, I don't see that slowing down.

Chris Danely - JP Morgan

On the outbacks, so it goes up a little bit this quarter because of the factors you indicated earlier, and then I think you said it would trend down a little bit in fiscal Q3. Can you give us a sense of how much it should trend down and then what it should do after that?

Lewis Chew

And you touched upon a point that bears explain. Obviously this quarter we are seeing a step up in our opex, but I would also point out to everyone that we now would be at what I call a fully pretty loaded rate. We really don’t have in the company this quarter any more of the sort of temporary measures we all had to deploy over the last 9 to 12 months. It's pretty fully loaded, which means you won't see that step function again for quite a while. Generally those step functions only happen roughly once per year, when we do whatever those might be, an annual focal increase or whatever.

So going forward into Q3, Q4, it is safe for us to model that we would see stock compensation drift down by a few million dollars over that period of time. That's very consistent. I went back and looked at the last three years in terms of my guidance. Obviously actual can fluctuate for something that happens in that specific quarter. But in terms of my guidance, it typically goes up in Q2 and then comes down by a few million over the course of Q3, Q4. That's stock compensation.

For the rest of the opex, I see us having a pattern where Q3, there's probably a little bit of savings because there are some holidays in Q3, and in Q4 we will probably be slight up or flat from there.

Chris Danely - JP Morgan

I think you mentioned that the August bookings or bookings pace was down a little bit from July. Was that unexpected or is that unusual?

Lewis Chew

The thing I think was unusual was that the bookings in July were particularly strong. And certainly more than we expect in a normal quarter. In a normal quarter, we would expect bookings to slowdown in July as people prepare for their August holidays, and when they come back from holidays they start ordering more to start building for September. But this year the bookings were pretty much strong all the way through the quarter. As we said, for the whole quarter bookings were up 17% so that's no slouch. And July just happened to be a tick up.

But as I said in my prepared comments, the August booking run rate was still higher than it was in June. So to kind of draw a straight line from June through August, it still had an upward bias. It's just that there's a little bit of a spike in July.

Operator

Your next question comes from Brendon Furlong - Miller Tabak.

Brendon Furlong - Miller Tabak

The restructuring charge in the August quarter was lower than you had guided to. I'm wondering why that was.

Lewis Chew

When I give guidance on the restructuring charges, like anything it's an estimate. And right now most of the restructuring charges that we're incurring are for transferring these processes from Texas to another plant. That's not an exact science. And so I think I guided 6 to 8 and we came in at 6. So I don't consider that far off of guidance. And for the quarter we're in, once again I'm guiding 6 to 8.

Maybe the more important point though is that by the end of Q2 we will be largely done with that, meaning that it won't continue at 6 to 8 every quarter. It's going to drift down to 3, 4 and eventually zero.

Brendon Furlong - Miller Tabak

On the inventory, what are planning to do in terms of inventory depletion over the next couple of quarters.

Lewis Chew

We brought inventory down 11 days this quarter. We were very happy with that. I think the manufacturing guys did a great job supporting the revenue growth but still bringing inventory down, and bringing up margins. I would say that's a trifecta right there.

So right now, now that we've gotten below 100, maybe the next step would be to go below 90. But once we go below 90 days, we're now in probably what is the sweet spot of our model. I've often said that we're a company that can very comfortably run inventory days into 80s up into the 90s. We've not had any significant inventory write-offs or obsolescence issues or whatever. And so I think in the near term here you might see a slight downward bias in inventory to maybe to get it below 90 days and they we'll probably level it out at that point.

Operator

Your next question comes from Uche Orji - UBS Securities.

Uche Orji - UBS Securities

Let me ask you about the SolarMagic and you talked making the first volume shipments this quarter. Just as we think about that business and with governments around the world pulling subsidy from the solar area, is that something that could be a near-term concern for the development of that business. [Inaudible] how that business can run by itself and what is [inaudible] be as—I know there is all this emphasis on alternative energy but I sometimes look at Europe, subsidies are getting pulled. So just tell me how that business navigates this political climate in the solar area.

Brian Halla

Certainly the solar industry itself had more steam before the credit crisis hit. A lot of these installations, particularly the large ones, do depend on financing and the financing has somewhat stalled out.

Right now the SolarMagic power booster that we're selling is finding its way into retrofit markets where it definitely helps boost the kilowatt hours generated from the arrays. In fact, typically the installed arrays out there can range anywhere from 40% to 60% of the original power the customer thought he was paying for. And our SolarMagic can boost that anywhere from 20% to 50% depending on what's causing the power to be lost.

Donnie mentioned in his commentary, and I will mention again, that the real opportunity for us here is when the panel makers start integrating the electronics that are inside our SolarMagic module into their junction boxes on the back of solar panels. And there is work being done out there by panel suppliers to make that happen. That's a real opportunity.

The question you asked about the political environment, certainly we know that California is way behind in solar deployment and they're going to have to do something about that. I think some of the incentives that Obama has talked about could get this thing kicked started in the United States.

In Spain and Germany most of the incentives have already been spent. Spain, the opportunity there is to go clean up and fix up the plants that went in and where the arrays that went in in a relative hurry.

And by the way, the solar industry is $37.5 billion last year. The year before that it was $17.0 billion, the year before that it was about $10.0 billion. So it has some momentum. Again, that momentum does depend on financing.

Don Macleod

The customer base we are addressing in that marketplace is pretty broad at this point in time. The shipments that we made today have been to installer, they've been to distributors, and they've been across three continents. So at this point, what we're looking at, there's a whole collection of retrofit initial home installations and commercial installations of the nature Brian talked about.

So from National's point of view, there is a short-term revenue opportunity with the products we have in the marketplace today to a very diverse part of the solar market. And then in the longer term the integrated product clearly offers a big opportunity for panel manufacturers to differentiate their offering with more power efficiency, and we can provide that.

Brian Halla

There have been some significant incentive programs that have gone in in the way of feed-in tariffs in Japan and China. And those have certainly stimulated demand. If fact, in Japan, after those feed-in tariffs were put in place, that was actually where we started selling SolarMagic first, and primarily because the roof tops in Japan really need help in terms of panel deployment because they're so much smaller.

Uche Orji - UBS Securities

What kind of revenue should we be modeling, thinking about this business? Is it too early to tell or is there something that you can give us in the way to think about modeling this business.

Don Macleod

We'll see you on the 25th.

Uche Orji - UBS Securities

Don, you mentioned earlier the backlighting. This seems to be very interesting as we see more and more, even notebooks, most of the design now being mostly for backlighting. Can you talk about your competition and your positioning within this market, both on the TV side, monitor on notebook side, and then on the lighting side and what revenues you anticipate.

Don Macleod

There are really three markets that we address in the LED space. The one we generally talk about, there is more of that. If you want broad market where you talk about lighting applications, automotive applications, etc.

Another market we address in the LED space is the one you talked about, which is backlighting displays and we have a particularly strong position in the high-end notebook marketplace where we provide much better contrast rations, much better reliability, and much better user experience. And we get paid for that.

Then our third area where we apply our LED skills is in the area of LED lighting and backlighting on mobile devices, such as mobile phones.

So we have a pretty broad spectrum of skill sets here. And the one we look at this moment for the most significant growth is in this very broad market area that I mentioned, which really was almost zero business for us last year but is growing very fast and I'm looking for an opportunity in that space for it to be at least a double digits millions number for our revenues this calendar year and growing dramatically after that.

And again, we'll talk more about that and give you more of an opportunity to ask questions on the 25th at our shareholder meeting day here in Santa Clara.

Operator

Your next question comes from Ross Seymore - Deutsche Bank.

Ross Seymore - Deutsche Bank

You talked a lot about the turns assumption and disti, etc. Can you talk about what you assumptions are on the disti inventory level in this upcoming quarter, as well as what you think the disti resales are underlying your revenue growth guidance?

Lewis Chew

Right now we are assuming that resales in our Q2 will continue to grow. That's a seasonal pattern as well as a specific of this year's indicators from our distis, given their strength. And we are assuming that inventories will grow modestly but not by a lot.

But at this point it's very hard to size up the impact in inventories because obviously we toggle what we ship based on what the resales are looking like. So we're looking hold any inventory growth be very modest.

As I said in my prepared comments, the inventory weeks are still nicely below 10 weeks, which is all the way at the low end of our normal operating range, so we're very comfortable that we can support that.

Ross Seymore - Deutsche Bank

And what has that been normal range?

Lewis Chew

Until just this last year or so we would have said that the low end of the range was 10 and the high end was 12, but we saw it dip down into the 9s and as everybody has pointed out over this last several quarters, distis have not been hesitant to let it stay there and let us carry more of the inventory.

But I would say that the range would still be probably in the 9s up to the 11s would be what I see as the range. And that's not a very large fluctuation, two weeks.

Ross Seymore - Deutsche Bank

And is there anything you've seen that systematically changes in the channel that would allow them to have that below the historic range on a more of a permanent basis?

Lewis Chew

I don't think long term that we could see our lead times necessarily get any shorter. We are sort of operating today at fairly optimal lead times. So I think the kind of numbers we're throwing around now is sort of a physical bottom.

Now the only thing that could change is culturally there are some differences between regions on the weeks that they carry. So if any particular regions that tends to carry more weeks decides to adopt the more aggressive model of regions that carry lower weeks, that could cause a drop in our overall number.

Ross Seymore - Deutsche Bank

Just a clarification on the stock based comp expense you talked about popping up this quarter then trending down, was the trending down of a few million dollars over the aggregate of the next couple of quarters, or is that a per quarter drop of a couple of million bucks?

Lewis Chew

From a modeling standpoint it will be an aggregate of a few million dollars. I don't want to be too specific but if I look back over the last couple of years, it probably can drop by as much as $5.0 million from A to point end. But I'm not going to give you quarter by quarter but that's the scale that I see.

Ross Seymore - Deutsche Bank

What is your expectation for your own internal utilization in this upcoming quarter.

Lewis Chew

The utilization will probably stay somewhere in the neighborhood of the high 40s to the los 50s. And that's on an apples-to-apples basis. Obviously our utilization artificially jumps up a little bit when we're done with the Texas closure, so I'm not factoring any of that in.

Operator

Your next question comes from Analyst for John Pitzer - Credit Suisse.

Analyst for John Pitzer - Credit Suisse

Can you talk about your Q2 guidance in terms of what you expect for the end markets.

Don Macleod

We covered in my prepared comments the major end markets that National participated in in the quarter, and if you remember, the first market that we talked about was the very broad industrial market, which is about 40% of our sales. As we said, a lot of that marketplace is served through the distribution channel and the discussion about the outlook for that market is very similar to the answer that Lewis gave relative to distributor resales.

We are looking for distributor resales to improve over this quarter in front of us. I think we're looking for a nice improvement through September but we have no visibility beyond that.

And given the fact that we're not looking to change the inventory profile very much, we should expect to see our sales go by the level of resale activity in that quarter.

The mobile phone marketplace, which is about 30% of our sales, we do pretty much have a lot of that backlog in place for the second quarter so we are looking for that business to grow a little bit as well.

I think for the rest, the communications and networking market, I'm not sure we have a very strong view on the base station marketplace at this point in time other than adding that that business was certainly stronger for all of us in the first calendar quarter of this year, mainly due to activity driven by the China marketplace, which other people have talked about in the semiconductor space before.

So that gives you a rough flavor for what's behind the guidance that we gave you for revenue in the quarter. Clearly the big nut is the 40% of our business through the industrial broad marketplace served by distributors and I think we're fairly cautious about that one, other than the short-term outlook.

Operator

Your final question comes from Stacy Rasgon - Sanford C. Bernstein & Co.

Stacy Rasgon - Sanford C. Bernstein & Co.

Do you have any feeling on your broader market shares have trended during this quarter?

Don Macleod

I'll give you a very generic statement on that. I think if you look at our business and if you define it as pretty much this high-performance analog, or general purpose analog, or standard linear business, if you look at the data for that marketplace, and really the only quarterly market data for that market is what the industry, the WSTS data, came out with for the second calendar quarter, and if I look at our numbers, we are pretty similar in terms of our sequential growth for our August quarter versus the May quarter. And I compare that with slightly out of line but similar numbers for the June quarter calendar and the March quarter calendar issued by the industry, we showed similar growth. And as that market sure was the power management, it was the largest growth area in the general purpose analog space and that was also our largest growth area.

So I think we maintained our position in the marketplace from a share perspective and if you think about the fact that we really don't serve a large portion of the commoditized portion of these analog categories, I think we did particularly well.

Stacy Rasgon - Sanford C. Bernstein & Co.

On SolarMagic, I had a question on the pricing. First of all I just wanted to make sure the retail price is still $199 for the units that you are shipping.

Brian Halla

That's the manufacturer's suggested retail price.

Stacy Rasgon - Sanford C. Bernstein & Co.

I was curious on how you are thinking about going forward in terms of cost reduction for that module, and particularly to generate more demand out of it. Is that a line of thinking, do you anticipate the price of that coming down more in line with like the broader solar hardware cost?

Brian Halla

There is a lot of work going into cost reduction for the reason you articulated. Right now, if you look at the SolarMagic product we are selling, an awful lot of the cost goes into that module itself. And as I said, the cherry is getting the panel manufacturers to build into their panels in their junction box and that will give us an opportunity to substantially reduce cost by getting rid of the module, the package itself.

And in addition to that, we're also shrinking the PCB and we're looking at the integration of some the analog power management chips that are on the PCB. And so there is a pretty good road map of cost reduction that's being aggressively driven by the product line as well as our manufacturing group.

Stacy Rasgon - Sanford C. Bernstein & Co.

Any reason why the PCBs right now is being assembled in the U.S. versus Asia? Are there any concerns around IP or anything like that?

Don Macleod

I think we have U.S. manufacturing to help us get the initial quantities into the marketplace and it makes a lot of sense to be close to your manufacturer when you're developing a new product. And small quantities, too.

If you look at our manufacturing base today, from a back-end point of view, it's all in Malaysia and this where the SolarMagic panel is going to go over time as well.

Mark Veeh

Let me remind you that the replay is available on our Web site and thank you for joining our call today.

Operator

This concludes today’s conference call.

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Source: National Semiconductor Corp. F1Q10 (Qtr End 08/30/09) Earnings Call Transcript
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