National Semi's Broad Turnaround

| About: National Semiconductor (NSM)

National Semiconductor Corp.’s (NSM) earnings per share for the fourth quarter ended May 2010 came in 5 cents over the Zacks Consensus Estimate of 28 cents.

The earnings surprise was fueled by very broad-based revenue growth across end markets, geographies and most analog product lines, as well as a leaner cost structure.


National generated revenues of $398.5 million in the fiscal fourth quarter, a sequential increase of 10.1%, a year-over-year increase of 41.9% and better than management’s guided range of $375-$390 million. The Americas region was up 13% sequentially, followed by Japan, which grew 11%, the Asia/Pacific, which grew 9% and Europe, which grew 8%. Direct sales to OEMs grew at a slightly lower pace than sales to distributors.

Revenues by End Market

Industrial, mobile phone, and communications and networking were the largest contributors in the last quarter.

The industrial market, which generated 45% of total revenues, grew 11% sequentially. We expected the company to report strength in industrial, given the upbeat outlook provided by Texas Instruments (NYSE:TXN) earlier this week. The company’s power management products continue to do very well here and National is taking measures to expand beyond the traditional markets of the U.S. and Europe to emerging markets, such as China.

The mobile phone segment is also a big contributor, with a 25% revenue share. Segment revenues increased 12% sequentially. However, even more encouraging is the 14% increase in orders and the growing backlog, which indicate that the market has bottomed. Consequently, the momentum in this business should continue. The strength in the last quarter stems from design wins secured in the latter half of 2009, which have just started going to production. Additionally, management has taken steps to ensure that there was nothing left on the table. Consequently, National picked up some business that it may not have pursued in the past.

The communications and networking market generated 12% of revenues. The lower-than-expected revenue growth of 5% was mainly on account of slightly weaker demand at Chinese infrastructure companies.

Operating Performance

National reported fourth-quarter gross margin of 68.8%, up 149 bps sequentially and 1,057 bps from the year-ago quarter. Gross margin expansion was fueled by higher volumes, better absorption of fixed expenses, cost efficiencies and a more favorable product mix. The gross margin expansion may be expected to continue, as the Texas fab is closed down and cost structure further reduced. Additionally, there is more leverage in the operating model, so higher revenue will also positively impact margins going forward.

Operating expenses of $158.7 million increased 4.9% sequentially and 34.8% from the May quarter of 2009. However, the operating margin expanded 348 bps and 1,266 bps from the previous and year-ago quarters, respectively.

Operating margin expansion is again related to leverage, as despite the increase in expense dollars, expenses actually declined as a percentage of sales. The declines were led by SG&A expenses (down 217 bps sequentially), followed by COGS (down 149 bps) and R&D (down 145 bps).

Net Income

The pro forma net income in the last quarter was $79.2 million (19.9% of sales) compared to $59.6 million (16.5%) in the preceding quarter and $47.1 million (16.8% of sales in the year-ago quarter.

As there were no special items in the last quarter, the GAAP net income was same as the pro forma income of $79.2 million ($0.33 per share), which compares to income of $53.2 million ($0.22 per share) in the previous quarter and loss of $63.7 million ($0.28 per share) in the year-ago period.

Balance Sheet

National ended the quarter with cash and short term investments of $1.03 billion, up $158.4 million during the quarter. However, the company has a huge debt balance, which brings the net debt (total debt as reduced by cash) at quarter-end to $250.5 million, a slight improvement from the end of the third quarter. The debt-to-total capital ratio is very high at 70.2%, although it is a slight improvement from the 72.3% at the beginning of the quarter.

National generated $156.7 million of cash from operations and spent $17.4 million on capex, taking the free cash flow at quarter-end to $139.3 million. The company also raised unsecured senior notes and paid off short term obligations. National paid $19 million in dividends, but did not repurchase any shares during the quarter.


National expects first-quarter revenues to be up 3-5% to $410-$418 million. The company did not provide guidance for margins or EPS.

Maintain Neutral

We currently have a short term Hold recommendation (Zacks rank 3) on National Semiconductor shares, as we do not expect much movement in prices. We believe the company’s debt position weighs on the shares, so even with a gradually improving environment, investors are likely to remain cautious.

Moreover, the attractive analog market has brought stiffer competition over the years, so investors have treated companies, such as National, Maxim Integrated Products (NASDAQ:MXIM) and Intersil Corp (NASDAQ:ISIL) as defensive plays.

Of course, some companies, such as TXN, Linear Technology Corp (NASDAQ:LLTC) and Semtech Corp (NASDAQ:SMTC) continue to see stronger demand and show superior execution. Consequently, Zacks ranks of 1 or 2 have been allotted to these shares, signifying a recommendation to accumulate.