National Semiconductor F4Q07 (Qtr End 5/27/07) Earnings Call Transcript

Jun. 7.07 | About: National Semiconductor (NSM)
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National Semiconductor Corporation (NSM)

F4Q07 Earnings Call

June 7, 2007 4:30 pm ET

Executives

Long Ly - Investor Relations Manager

Brian Halla - Chairman, Chief Executive Officer

Lewis Chew - Chief Financial Officer

Don Macleod - President, Chief Operating Officer

Analysts

Craig Ellis - Citigroup

Ross Seymore - Deutsche Bank

Louis Gerhardy - Morgan Stanley

Michael Masdea - Credit Suisse

Simona Jankowski - Goldman Sachs

Chris Danely - JP Morgan

Romit Shah - Lehman Brothers

Tore Svanberg - Piper Jaffray

Krishna Shankar - JMP Securities

Uche Orji - UBS Securities

Sumit Dhanda - Banc of America Securities

Craig Hettenbach - Wachovia Securities

Presentation

Operator

Good afternoon. My name is Mark and I will be your conference operator today. At this time I would like to welcome everyone to the National Semiconductor Q4 fiscal year 2007 earnings call. (Operator Instructions) At this time I would like to turn the call over to Mr. Long Ly, Investor Relations Manager. Mr. Ly, you may begin your conference.

Long Ly

Great. Thank you. I would like to again welcome everyone to our call today. Joining me are Brian Halla, Chairman and Chief Executive Officer; Lewis Chew, Chief Financial Officer; and Don Macleod, President and Chief Operating Officer.

The purpose of today’s call is to discuss National Semiconductor's fourth quarter fiscal 2007 results which ended on May 27, 2007. As a reminder, today’s call will contain forward-looking statements and projections that involve risks and uncertainties that could cause actual results to differ materially. You should review the safe harbor statement contained in the press release published today as well as our most recent SEC filing for a complete description of those risks and uncertainties.

Also, in compliance with SEC Regulation FD, this call is open to all and is being broadcast live over our investor relations website.

For those of you who may 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.

In today’s call, I will provide a recap of the fourth quarter financial results. Brian Halla will provide an overview of the company’s key initiatives and accomplishments. Lewis Chew will expand on the fourth quarter results and provide an outlook for the first quarter of fiscal year 2008, as well as comment on the leverage transaction announced today. Don Macleod will then discuss our products and business in more detail. We will take questions until approximately 2:30 p.m. Pacific Time.

The fourth quarter results were as follows: sales were $455.9 million, up 5.8% from $431 million in Q3 fiscal year 2007 and down 20% from $572.6 million in last year’s fourth quarter. Total revenues for fiscal year 2007 came in at $1.930 billion.

Gross margins were a record 62.5% in Q4, up from 59.8% in the prior quarter and 61.4% in last year’s fourth quarter. Gross margin percentage for fiscal year 2007 as a whole was 60.7%.

Operating expenses in the fourth quarter were $170.7 million. Interest income was $9.9 million, and the effective tax rate for the quarter was 28%. As a result, National posted GAAP net earnings of $90.1 million, or $0.28 per fully diluted share in Q4 fiscal year 2007. The fully diluted share count for the fourth quarter was $327.5 million shares.

I will now turn it over to Brian Halla for an overview of the company’s key initiatives and accomplishments. Brian.

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Brian Halla

Thank you, Long. As we emerge from the most recent business cycle, we do so with renewed optimism about our company’s ability to perform in future cycles. The trough of the cycle behind us, our margins dipped to 59% and then rose to the current level of 62.5%, despite factory utilization rates that spent the last three quarters of the fiscal year below 60%.

The product lines are robust and becoming more so and market conditions signal smoother sailing ahead. The ongoing financial performance of the company and our belief in our ability to sustain that performance in and out of cycles in the future gives us an opportunity to leverage our balance sheet upward for our shareholders and we believe a corresponding ability to easily service the debt with the flexibility to retire that debt as necessary.

With revenues up 5.8% quarter on quarter, we are comfortable that we’re in a growth phase with confidence that we can continue our momentum in the foreseeable future. With disti resales as a good proxy for the broad market and apparent good health in the targeted verticals that drive our business, we’re estimating growth in the current quarter, which has historically been a down quarter, to be up by 1% to 4% sequentially. The growth in gross margins has been driven mostly by a richer mix of higher performance, higher value-added analog products, which we’ve been talking about for some time, now starting to ship.

As a result of the increased value of the mix, we see ASP and margin increases. With even more value to come in the product areas, we’re starting to gain more traction with new products in such areas as power management, small display drivers, interface, audio amplifiers, precision amplifiers, and high-performance power efficient data converters.

During the quarter, we saw strength in the verticals. Taking handsets and portable devices in aggregate, we saw billings here up 16% sequentially in the quarter and bookings up 33% sequentially in the quarter.

Since we all tend to obsess about inventories, I’ll cover that now. With the backlog up as we enter this quarter, we also modestly increased our internal inventories to be able to address our customers’ ramp rates. In the distributor channel, driven by higher resales, inventories came down so in total we saw a net reduction in inventories and generally tight inventory conditions throughout. All of this should result in a fill rate for Q1 that’s at least consistent with the prior quarter, if not higher.

Having said all of this, as we enter Q1, we intend to modestly increase wafer starts with utilization rates to be around 60%.

Let’s talk about leverage. Our business model has now demonstrated our ability to not only withstand but to thrive in an industry downturn. We feel we’ve set the stage for top and bottom line growth. Given this high confidence in our business model and our prospects for continued growth, as well as the attractive rates in the debt markets, we decided the time was right for a capital structure realignment, which we announced this afternoon.

This action is entirely consistent with our ongoing primary objective of maximizing a return to shareholders, in this case by replacing shares outstanding with investment grade debt. We now have approval from our board to buy back in total $2.4 billion of our shares, of which $1.5 billion will be accelerated and Lewis will discuss that in a moment.

The same confidence in our business model gives us confidence in our ability to service this debt. This is a natural step for us to take. We’ve been assessing this with our board for some time now and all the stars seem to have lined up for today’s announcement; that is, a much more robust product offering starting to generate top and bottom line growth, further penetration into the broad markets and health in the target verticals, as well as confidence in our ongoing ability to generate cash to continue buy-backs and cover the retirement of debt as soon as that makes sense.

To briefly recap the full fiscal year, on the downside it turned out to be a longer inventory correction than many of us expected. On the upside, it was a year which tested the very fiber of National’s four-year repositioning and proved to us that life beyond 60-30-30 just keeps getting better.

It was a year where we continued to see the impact of our richer mix of higher value-added, higher margin, higher ASP analog products just starting to ship into the market, yielding continuous growth of our gross margins, despite a year of our factories being substantially under-loaded. So it was a year that now finds a stage for growth at the bottom and top lines and a year that showed us that our business model allows us to not only weather a downturn but to thrive during one and generate enough cash to allow us to continue to buy back shares and to clearly demonstrate that the time was right for leverage.

It was our fourth year of ROIC, or return on invested capital, maintained above 20%, which continued to demonstrate that maximizing both short and long-term returns to our shareholders is our primary objective.

Let me now turn it over to Lewis.

Lewis Chew

Thank you, Brian. In my portion of the call today, I will spend most of my time discussing the forward outlook, as I always do, but I will also devote a few minutes to provide some depth on the leverage transaction we announced today to rebalance our capital structure. It’s a very straightforward deal and a very good time in the market to do it, and hopefully my prepared comments will address any questions you may have, which means we can devote as much time as possible in the Q&A section of the call talking mostly about our business and the opportunities we see in front of us.

Let me start by touching on some of the key business trends that we encountered during the fourth quarter and then I’ll dovetail those comments into the outlook that we have for the first quarter.

Our total company bookings were up about 6% in Q4 over Q3 and the rate of orders ran pretty steady over each of the three months of the quarter. Some of the bookings increase was in the form of higher turns orders, which helped drive our revenue growth in Q4 and some of the increase went toward building our backlog.

In terms of our various channels, bookings in aggregate from our distributors were down for the quarter while bookings from OEM customers as well as from EMSs in aggregate were up for the quarter. The distributor booking patterns were pretty much in line with what we might consider normal seasonality and the higher orders we saw from our OEM customer base reflects the positive impact we are starting to see from our new product cycles, and Don Macleod will expand on this part of our story later on during his comments.

Also, the impact from foundry support for the cordless and super IO businesses, which we sold off some time ago, is now relatively insignificant, both in dollar terms and in trends, as the revenues related to this area were less than $3 million in both Q4 and Q3.

So let me expand a little bit on the distribution channel. During Q4, distributor resales, as Brian said, were up seasonally, which is consistent with the expectations we originally had coming into the fourth quarter.

Distributor inventory at the end of Q4 was down again in terms of absolute dollars, and I say again because we actually brought them down in Q3 as well. But since resales were up in Q4, the number of weeks of inventory were down compared to Q3 and now stand at below 10 weeks, which for us is relatively low by historical standards.

With all of this as a backdrop, we are projecting that our Q1 fiscal ’08 revenues will be up by 1% to 4% sequentially.

Our opening 13-week backlog is higher than it was in Q4 but it doesn’t account for the entire increase within our range. The higher end of our outlook is modeled on turns orders being higher in Q1, and this is tied to the low distributor inventory position that I mentioned a minute ago, combined with new product programs that are independent from the normal seasonal pattern we might typically see during the summer. And also within our revenue guidance, we are modeling that distributor inventory dollars will be down again in Q1.

Now I’d like to cover the rest of the income statement outlook, starting with gross margin. Gross margin continues to be a strong point for us. In Q4, our gross margin hit a new high of 62.5% and that includes the impact of $5.4 million of stock compensation expense in cost of sales. The improvement over Q3 was driven by ongoing improvements in our product portfolio combined with strong manufacturing performance.

During the fourth quarter, our in-house inventory went up by about $4 million, of which $2 million of that was in raw materials. By comparison, in the third quarter we burned off about $6 million of inventory during that quarter, so our factory throughput in Q4 was in fact a little higher than it was in Q3, even though fab utilization, as measured by wafer starts, was still below 60% in Q4.

In Q1, we will have a slight increase in wafer starts and ending inventories are expected to be roughly at the same level they are today. We anticipate that gross margin will continue to increase and come in above 63% in Q1 and this includes estimated stock compensation expense of roughly $6 million in cost of sales for the quarter, and I mean Q1.

By the way, total company stock compensation expenses in Q4 were $24.9 million, of which $5.4 million was in cost of sales, $7 million was in R&D, and $12.5 million was in SG&A expense.

We are estimating that total stock compensation in Q1 FY08 will be approximately $23 million to $24 million of which, in addition to the amount I highlighted earlier for cost of sales, $7 million would be included in R&D expense and $10 million to $11 million would be included in SG&A expense.

Total R&D expense in the first quarter, including stock compensation, is projected to range from $96 million to $98 million.

Total SG&A expense in Q1 is expected to range from $80 million to $82 million, and again including the impact of stock compensation.

As we come out of the trough of this past down cycle, the operating expenses continue to return to more normal levels in Q1 and we have another small step up ahead of us in Q2 for our annual salary adjustments company wide, and then we should see expenses level out.

The other income and expense line in Q1 should be relatively minor, around $1 million of expense.

Net interest will be an expense item now instead of income, and it’s a bit tricky estimating amounts this very first quarter that we incur the debt, since there are some moving parts that are still to be finalized in the near-term. But based on anticipated total debt of $1.5 billion outstanding for most of the quarter at investment grade rates, we are projecting gross interest expense of around $19 million to $19.5 million and gross interest income of around $9 million. This will then combine for net interest expense of around $9.5 million to $10 million.

The effective tax rate for Q1 is expected to range from 31% to 32%. The lower tax rate we saw in Q4 was due to some additional tax benefit and credits that we are not currently projecting into Q1.

Depending on various factors involving the accelerated stock buy-back, we anticipate that the weighted average share count in Q1 would go down by roughly 30 million shares. I’ll put a capital R on roughly, because ultimately that reduction in this quarter will go down depending on the price and the timing, but ultimately you can work your own math but $1.5 billion in buy-back will clearly account for more than 30 million shares and we’ll see more of that in Q2.

Let me now make a few comments about the leverage transaction which we described in a separate press release today and I won’t repeat all the details in that announcement but I will however use two key questions to guide my comments. One, why did we choose the structure that we did? And two, why now?

Why now is pretty clear to us. Brian actually touched on a lot of this himself. We just came through an industry downturn with gross margins bottoming at nearly 60% and very strong cash flows for the company. The business model that we’ve been developing for more than four years has now been stress tested through two industry cycles and has proven to be very robust. The underperforming businesses that we targeted for disposition are now gone and our debts are cleared for growth. Our product portfolio continues to improve and we believe it will drive strong growth and increasing profitability.

So with the confidence we have in our business model and our prospects for future growth, now is the right time to better optimize our capital structure and simply put, it’s a very natural next step for us to take.

The why this structure question is a little more complex, simply because there are so many avenues to choose in financial structures but at the end of the day, our answer is still clear; we believe this approach fits best with our objectives and is the most beneficial to shareholders over the longer term.

Using straight debt to replace common shares outstanding is very straightforward. Shares are retired using debt and that’s it. No overhang of potential future dilution from this approach we’ve taken. And the straight debt markets are pretty favorable right now, especially to a company of our caliber -- that means good interest rates by historical standards.

With regard to the balance sheet, we invested about $16 million in capital equipment during Q4 and we’re projecting Q1 capital spending to range from $30 million to $35 million. We ended the quarter with approximately 94 days of inventory and about 30 days sales outstanding in our receivables.

During the fourth quarter, we bought back $170 million of our stock, or nearly 7 million shares, and ended the quarter with $829 million of cash reserves. We now have about $2.4 billion of approved stock repurchase program, of which $1.5 billion will be executed through the accelerated stock buy-back in connection with the debt that we taking on. The accelerated buy-back will commence immediately and should be completed over the next five to 12 months.

The remainder of our approved buy-back should be completed over what I might call a reasonable period of time, maybe four to six quarters out. This is not a new topic for us. Over the last four years, we have steadily bought back stock each quarter, totaling to more than $2.5 billion worth in that time.

Now, wrapping up with a couple of key metrics we always look at, operating margin in Q4 was about 25% and return on invested capital for the quarter was 21%. Both of these figures include the impact of stock compensation, and for the full fiscal year 2007, our operating margin was about 26% and we exceeded 20% ROIC for the fourth year in a row.

On that note, I will turn it over to Don Macleod. Don.

Don Macleod

Thank you. Let me cover market and product trends as we saw them in the quarter. First, end markets; as we indicated, our overall company sales were up about 6% sequentially in the quarter. Sales to our largest end market, which is wireless handsets and other similar portable devices, were up about 16% in the quarter sequentially and represented just over 30% of our overall sales. This revenue growth was achieved through new products -- new products in power management, audio amplifier, and small display driver and interface areas.

Our growth arose from new design wins at a broad customer base in Europe, the Americas, Korea and China. By the way, bookings in the quarter from customers in this handset and portable device market also grew by about 33% sequentially in the quarter.

Sales to the communications network market also grew by about 15% in the quarter. We saw growth in both the wireless base station portion of this market, driven mainly by our data converter products going into 2.5G applications and in other communications networking applications with our high speed interface products.

Bookings for the overall communications networking market also grew about 15% sequentially in the quarter.

Sales to automotive, industrial, medical and other broader market categories were in aggregate flat sequentially in the quarter. We service many of these broader market customers through our distributors and note, as Lewis said earlier, we shipped less product into our distributors in the quarter than they resold as they further reduced inventories.

Now let’s turn to look at the quarter from the perspective of our product areas, and as a reminder, I use analog product definitions consistent with the Semiconductor Industry Association WSTS categories.

First, power management -- sales grew about 4% sequentially in the quarter. Sales to broader market switchers and regulators and application-specific power management products, mainly for portable devices, all grew at the same 4% rate.

For the amplifier category, covering both operational and audio amplifiers, we saw a 12% sequential increase in sales in the quarter. In the operational amplifier area, we continue to shift our portfolio to higher performance products. In this quarter, revenue growth came from precision and high-speed amplifiers and RF detectors for 3G mobile phones.

In the audio portion of the amplifier area, we also saw revenue growth coming from higher performance new products. Examples are audio amplifier sub-systems, where we integrate the audio and voice data converters with the amplifier; our boosted class D amplifiers, where we integrate a switch cap boost regulator to increase the output power; and ceramic speaker drivers to enable the thinnest form factor in portable wireless and other handsets, et cetera.

Here, we’re riding a growth wave as consumers demand more and better quality audio reproduction, especially for music from the handheld systems. We’re able to enhance the analog precision whether it’s from a speaker or headphone by cleaning up the digital signals at the most efficient battery power levels. These new audio products are higher performance and higher margin and are very often application specific.

Our data converter products saw sequential sales growth of about 8% in the quarter and this was led by sales to 2.5G wireless base station customers. Overall, analog standard linear product sales in the quarter grew about 6% sequentially and they represented 84% of our sales in the quarter, and this was unchanged as a proportion of our sales from Q3.

There were also no material changes in the mix of the product categories. Power management represented 46% of our sales; amplifiers, 25%; interface, 7%; and data converters, 5% of our sales in the quarter.

Bookings for our analog standard linear products in aggregate grew 8% sequentially in the quarter.

In the application-specific analog area, our sales in the quarter grew by 17%, and this was due to sales of display drivers with integrated power management for small form factor LCDs. Application-specific analog products accounted for 5% of our sales in the quarter and overall, all analog categories accounted in total for 89% of our sales in the quarter and this was consistent with the last quarter.

It’s nice to get back to revenue growth this quarter and to have a higher starting backlog to work with as we start the new quarter. It’s also nice to demonstrate that our growth is coming from new products, and especially new higher performance analog products that earn us higher average selling prices, or ASPs.

If I look at the incremental $25 million of revenue we reported for this fourth quarter, i.e. from the $431 million we reported in Q3 to the $456 million we reported in this fourth quarter, new products accounted for more than half of that growth. And here I use as a definition of new products those introduced in the last three years.

Our average selling price, or ASP, for our analog standard linear products, i.e. those that represent 84% of our sales, also reflects that improving higher performance mix of new products. Our Q4 ASP for our standard linear products in aggregate increased by 5% year on year and also 5% sequentially in the quarter.

The increasing ASP of our portfolio was also reflected in our improved gross margins. At 62.5% for the quarter, you will note that 100% of the incremental sales dollars over Q3 fell through to gross margin dollars in Q4.

Our analog standard linear units sold in Q4 was flat with the preceding third quarter, i.e. factory activity was very slightly up on Q3, so the higher ASP falls through to incremental gross profit.

We plan to modestly bring up wafer fab utilization in this first quarter towards around 60%, so we can look forward to continuing strong fall through rates in Q1. Beyond that, we plan to ramp up production starts of our new 8-inch module in Q2 at our Texas fab, which should give us additional cost improvements going forward. In overall terms, this will not increase our fab capacity as we eliminate older, fully depreciated equivalent 6-inch equipment.

Going forward, we have an opportunity to continue our revenue growth through what was in the past a seasonally slower summer first quarter. We have revenue opportunities in new mobile phone and portable consumer devices, which should continue the momentum into the following second quarter. As our distributors who service our broader market customers get closer to inventory equilibrium, we may also have an opportunity to see more meaningful growth from them.

To wrap up, our goal is to continue to leverage this incremental revenue growth with higher ASPs and to growing operating profit, just as we did in the recently completed fourth quarter.

So now, over to you, Long, to moderate the Q&A.

Long Ly

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

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Craig Ellis with Citigroup.

Craig Ellis - Citigroup

Thanks, guys and nice job on the gross margin. I just wanted to ask a clarifying question on handsets. A very strong bookings performance in the quarter -- can you go into a little bit more detail in terms of what you’re seeing at the OEM level there?

Don Macleod

Maybe I should take that. We actually saw a very strong business pattern in this quarter in the mobile phone and equivalent space. As you probably know, where we participate in this space is more in the added value handset, the handsets that have more features, i.e. bigger displays, brighter displays, better audio, stereo audio and handsets that obviously over time are getting thinner and thinner in form factor.

We’ve seen ramp-ups of new products in audio and power management and interface and display drivers in those but we’ve also seen pretty strong unit demand I would say in aggregate across that marketplace. I would say that that demand with maybe one or two exceptions is pretty broadly spread. Obviously there are a number of new products coming out in that space and some of our customers are ramping up a head of those products.

Operator

The next question comes from the line of Ross Seymore with Deutsche Bank.

Ross Seymore - Deutsche Bank

Also echoing congrats, especially on the margin side. The margins were better than you guys had guided to. Can you just talk a little bit about what the positive surprise was versus your guidance?

Lewis Chew

It’s actually pretty straightforward. We actually saw a little bit more strength in our product portfolio than we had modeled. Also, I would like to of course give credit to our manufacturing org, because the manufacturing efficiencies were also slightly better than we had modeled. By the way, I would want to make it clear that we do hold ourselves up to a pretty high standard. We always model fall-through at least in the 70s and in this part of the cycle, sometimes into the 80s.

I don’t think you would want to go into a quarter planning for 100% fall through and as Don pointed out, we had one of those rare quarters where we had quite a bit of fall through. He also mentioned that ASPs were up for the quarter in a quarter where our revenue grew 6% but ASPs were up. Clearly the portfolio continued to get better this quarter and help drive that incremental pop.

Don, do you want to add to that?

Don Macleod

Actually, I think a point of reflection on our gross margin this quarter; the area where we saw growth was new products and the areas where we saw those new products going was primarily in vertical markets, as we both said. I think our distributors continued to de-inventory or reduce inventories in the quarter. Conventional wisdom says that the margin opportunity in some of these vertical markets is actually less than, for example, the catalog type opportunities that you typically service through distribution.

The reality is that we were able to achieve these margin results in the fourth quarter with a strong portion of that coming from vertical markets and I think the opportunity in the future is for us to complement that even more as we expand our broader market coverage for those catalog products that do actually have better margins long-term.

Long Ly

Ross, do you have a follow-up?

Operator

Your next question comes from the line of Louis Gerhardy with Morgan Stanley.

Louis Gerhardy - Morgan Stanley

Good afternoon. Nice job. Could you just repeat the bookings by end market? I only got the handset number. And then, in terms of the handset booking strength here, how much of this perhaps came from your key customers who collectively might have been gaining share? Was that an important factor here?

Don Macleod

We gave two numbers about end market bookings. One of them was the handset and portable device area, where we said bookings grew 33%, and the other was the overall communications networking market, where we said bookings grew about 15%.

I think to follow up on your question on the handset market, as you well know this market is dominated by about five players who have about 80% of the market. There are some newer players coming into those markets and obviously we support them as well.

I think most of you know who is performing well and who is not in the overall handset market. We’re not going to talk about specific customers.

Operator

The next question comes from the line of Michael Masdea with Credit Suisse.

Michael Masdea - Credit Suisse

Thanks a lot. Two questions; I guess the first one might be a strange question but given your utilization down here and given your margin structure where it is now, which is obviously very impressive, do you feel like you’re being aggressive enough on the revenue and unit and market share side? Because it seems like you’ve got so much room to be pretty aggressive and take more share and still have really good profitability.

The second question, maybe for Brian or Donnie, on the -- everybody seems to be doing the leverage up and buy back stock now and you are probably not the last. There’s probably more to come but what about on the M&A front? It seems like with more and more people converging around 60% gross margin that it might get a little bit more competitive out there, especially when utilization levels normalize. Should we or will we start to see anymore M&A? Thank you.

Brian Halla

Let me take the second part -- in fact, I’ll take the first part and then Donnie can add to it. M&A is always a possibility and we certainly constantly look at that. As you know, we’ve continued to make investments or buy companies that have critical mass and have intellectual property to offer, such as our recent acquisition of a German company called Xignal that gives us a continuous time sigma delta data converter.

In terms of larger M&A activity, all these analog companies are pretty expensive right now but who knows what’s going to happen. We think that in terms of being aggressive that we have been aggressive kind of behind the curtain on ASPs and on value-added that is now starting to show in organic growth, both at the top line and the bottom line. And that’s the products that for the last two or three years that we’ve really been making sure that they are a good strategic fit, that they are not a “me too” product, that they are not a second source product. We’ve really held the line there and made sure that we have the commitment to the commodities.

So if not going after opportunistic commodities even when the prices go up is looked at as not being aggressive, we’ll continue to do that because we think that over both the short and the long term, that’s going to add more value to our shareholders. Donnie.

Don Macleod

Maybe Lewis will want to pick up on leverage.

Lewis Chew

So you want me to hit the question about, of aggressive utilization margin piece, or --

Don Macleod

Okay, I’ll pick up. I think the question you asked about filling our factories and seeking more market share, market share per se isn’t our objective at the end of the day. One of our objectives in our factories is to be consistent with our return on invested capital objective, i.e. not to over-invest and then compromise our ROIC objective long-term.

Actually, if I look at market share data, our industry publishes the data every month and if I look at the data for this calendar year in the standard linear space, which is about 85% of our sales, we’ve gained share in that complete aggregate space every month through April of this year. So I’m pretty comfortable that our market share objective has been met, although we are being very selective about the business we pursue to get that market share.

The commodity business is behind us, which was a negative on our market share. We’re out of that. That’s history now and I think I’m very pleased with the way we’re working to fill our factories with the right kind of product, not just the volume.

Long Ly

Next question, Operator.

Operator

There’s a follow-up question from Craig Ellis with Citigroup.

Craig Ellis - Citigroup

Thanks for giving me the follow-up. I wanted to touch base on just the level of capital intensity and utilization. How should we think about CapEx to sales this year, given that we’ve been in that 55 -- range? I know you’ve got some good growth prospects in front of you but it would seem to be setting up as a light CapEx spend year.

Lewis Chew

I think we have now shown that we will as a company consistently run below 10%. I think there was a time three years ago when Brian first trotted out the 60-30-30 business model, which was great for us, I attached to that a target of keeping CapEx below 10. Realistically now, we’re probably a company that runs more like 7 or 8, and in a down year like the year we just had, it’s actually below 6 for the year, I believe.

We’ve actually run models to see what our sustaining level of maintenance capital is. It’s a pretty small number but let’s now keep in mind that in the context of analog, we still see ourselves as very leading edge analog and there will always be capital investments that we make for new capabilities, whether they be new processes or yield improvements or whatever.

But longer term, I definitely see us modeling CapEx that doesn’t come in at the 10% range. It’s probably more like 8% and in down years like we’re in now, gets down into the 5s.

In terms of fiscal year ’08, you’re right -- coming off of the trough we’re in, we don’t really need to invest a whole lot of money in capacity per se, so I think that gives us a lot of flexibility in terms of what we invest in and we will be directing more of our investment towards new capabilities. In some cases, that might be, for example, a high-end analog tester which enables some of our high-performance products. But in the grander scheme of things, high-end testers in analog don’t cost what high-end testers cost in digital. So I think we can readily afford that.

I think that’s probably what I would model, Craig. Is that enough for you?

Operator

The next question comes from the line of Simona Jankowski with Goldman Sachs.

Simona Jankowski - Goldman Sachs

Thank you. You’ve done a pretty remarkable job on the gross margin side, but it’s been a little bit difficult for us to determine your go-forward growth trajectory, given all the cyclicality in the business and some of the recent restructuring, so can you maybe just tell us how you’re thinking about your opportunity going forward and specifically what types of things you see in the pipeline as far as whether specific customers or design wins, et cetera, that can give us a bit of a better handle?

Lewis Chew

Let me start with that and then I’ll turn it over to Brian and Don to add on to, but if we strip apart and take out some of these businesses we’ve disposed over the last several years, you look at our standard linear revenue, which we’ve given you guys enough transparency to figure out on your own, the [inaudible] on that has actually been pretty decent. I would suggest that it’s actually been running in the double-digit range.

For ourselves, as you know, we don’t give a long term growth rate per se but we certainly say a couple of things; one, nearly half of our revenue is in power management and power management is the strongest growing area in standard linear, and we do expect to at least keep up with the market there; and two, as we grow we do think that we have a good leverage story as well. So from a modeling standpoint, we’re not setting ourselves up for needing to be a 15%, 20% growth company. We’ll take it if we can get it but it isn’t like our core business hasn’t grown.

Going forward, I think starting from this quarter it will be pretty clean because as I mentioned in my prepared comments, the foundry businesses are now down to below $3 million. So you can take the numbers we’re at today and you can start holding us accountable for growth off that base and you can see what we said, right? We grew 6% this quarter sequentially and we’re guiding up 1 to 4 and none of that no longer has any kind of masking from disposed businesses. And in longer term, we’ll have to see. We’re coming out with hundreds of new products every year, almost all of them targeted solely in the high value analog space.

Brian Halla

The other thing, Simona, we have put a lot of effort into trying to anticipate what some of the new emerging markets are going to need in the area of energy and surveillance and security and medical applications. We believe that those will start to bear fruit as those companies now that used to be electro-mechanical are all finding themselves in the semiconductor business. To that end, we have increased our field application resources dramatically over the last year-and-a-half and we now have 1,700 assigned accounts, where an assigned account is an account where somebody wearing a National Semiconductor badge visits them and helps them with circuit designs and what not.

So we think that the future is very bright, particularly after we get through this traditionally slower summer period. Donnie, did you want to add?

Don Macleod

I’ll just make one point, Simona. If you look at our growth this quarter, the main element of growth was really one vertical market, the mobile phone handset and devices of that kind. We’ve talked in the past about that being a declining percentage of our business over time. Well, in actual fact, this quarter that market represented just over 30% of our sales in the quarter, so the vertical markets have a complementary place in our growth going forward. Perhaps given the success we’ve seen in some of our design wins this quarter, perhaps they may have a bigger role as we continue to maintain our high-value space in that marketplace.

As we’ve always mentioned, on the other end of the spectrum we have the broad market opportunities in interface and data conversion. I’ve said many times we actually grew our data converter business 25% last calendar year over the year before, according to the market researchers. And we grew our interface business in the mid-teens percent last year, according to the market researchers, Databeans being the example. Clearly we have the complementary broad market on one side and I think we have a good position in vertical markets that actually performed even better this current quarter and looks like it could continue to perform through the rest of this calendar year, because many of these markets have a seasonal nature and our products in the wireless handset and other similar portable device markets are in new products that are just coming in to the market.

So I think you’ve got to look at both these sides of the equation as our growth drivers.

Operator

The next question comes from the line of Chris Danely with JP Morgan.

Chris Danely - JP Morgan

Thanks, guys. My question and follow-up would be where do you expect utilization rates to trend throughout the fiscal year beyond Q1? Would you care to raise your margin target? Also, if you could just talk about your longer term operating expense targets too in SG&A and R&D.

Lewis Chew

We typically don’t give out longer term utilization because quite frankly right now, we have about a six-week lead time at National and we’re maintaining our logistics and supply chain management group is very well run. So we’re not even doing starts right now for Q2.

I think a couple of things you should look at is one, that almost all of us mentioned that disti inventories are relatively low right now. By historical measures, we’ve almost never in my recollection been solidly below 10 weeks like we are now, so if the broader markets, which have been actually fairly tame so far, pick up at all, we will need to increase utilization to service that. So that’s one driver right there. Remember, disti makes up about 55% to 58% of our revenue, so it’s not a small piece of the equation.

And then two, we are actually entering the summer which is normally seasonally down for us, as Brian mentioned. But as we head into the so-called Christmas season, it’s likely that we would have to ramp up there as well. We’re also trying to do a better job of profiling our inventory so we can respond for upside demand.

I’m trying to give you enough color for you to draw your own model because honestly we don’t have some utilization number for Q2 that we’re just holding back on. We will wait until we get partway through this quarter before we decide on Q2. But we do know that inventories out there are relatively low.

By the way, nobody has asked any questions yet on EMSs, but at some point here the EMSs, which really just serve as a path through for some of our OEMs, they are going to have burnt off all of their excess inventories as well. When we looked at our EMS bookings in Q4, they are still not back to where they were just two quarters ago, and that’s usually a pretty steady number. So that tells me that there’s still some room to go for them to finish their activity but we are fine with that right now. They didn’t hurt us this quarter.

Operator

The next question comes from the line of Romit Shah with Lehman Brothers.

Romit Shah - Lehman Brothers

Thanks, guys. Just some clarification on how to model gross margins going forward. Lewis, is it fair to assume that you’re comfortable with the inventory levels here at roughly 90 days, so incremental margins going forward in the 65% to 70% range?

And then, as a follow-up, Maxim announced last month that they were exiting the data converter market and I think they were saying that the space just became too competitive and the market size is fairly small. If you guys could share your perspective on the standalone data converter market. Thank you.

Lewis Chew

It’s always tricky to comment on competitors on our call but in that specific example, they were talking about products that were like 65 mega-samples at, I don’t know, 10-bit resolution. We have stuff that runs a giga-sample at 10, 12 bits so certainly for us, we absolutely see data converter and certainly the high performance, high speed data converter as a growth opportunity area for us. And that’s probably as much as we can say about what Maxim wants to do with their converter business.

Brian Halla

You should do your homework to find out exactly why Maxim checked out of the data converter business, but for us we think it’s one of the fastest growing market segments, particularly when data converters that consume very, very low power find themselves in mobile devices used for such things as ultra wideband transmission. But we’re fully committed to the data converter market and the more people want to drop out, the better.

Lewis Chew

Going back to your original question about incremental margins in inventory, I think it is true that from a dollar level standpoint, we are relatively comfortable with our inventory. We have a very solid track record of basically never having inventory write-offs and clearly the lifecycle of our products today, with 89% of our revenue being analog and 84% of that being standard linear, it’s really more a matter of factory loading than it is a perishable shelf life type issue.

In terms of incremental margins, what I would guide everyone on the call is we hold ourselves to a standard of incremental margins, especially at this phase of the cycle, at least in the 70s -- meaning that for every incremental dollar of revenue, we would expect to see in the 70%-plus range fall through to gross margin.

I just realized that I never answered Chris Danely’s question on the gross margin target. As we’ve always done, even though certainly you could draw your own conclusion that more than 65 could be possible, since we have not yet hit 65 we are not going to set a new target. I think 65 would be great for the company. I think what we’re showing in this downturn is that we are not smoking anything funny when we talk about those kinds of margins.

So I think longer term, we’ll see how that goes. Right now, as Brian said in his opening comments, we are heading fully into the growth phase of our mindset and that growth is very heavily targeted on new products that drive the margins up. So you can kind of get -- and going to Mike Masdea’s question, you get growth and margins together as opposed to a tradeoff.

Operator

The next question comes from the line of Tore Svanberg with Piper Jaffray.

Tore Svanberg - Piper Jaffray

Good afternoon. Lewis, you said inventories in the channel are now below 10 weeks. How long can they realistically stay down there before they have to come back up? If so, when will you expect that to happen?

Lewis Chew

Normally we would expect it to happen as we head into the Christmas quarter, which for us is the November quarter. We actually -- if you guys go back and look at the transcripts of what the three of us said at the beginning of this quarter, we actually had anticipated that inventories would be relatively flat. So it was kind of a little bit of -- I’ll call it an upside from a forward-looking standpoint that they burned off some inventory. Part of that too I think is that the distis themselves continued to A, be cautious and B, take advantage of the fact that a lot of us have fairly short lead times. But the normal time when they would start building some of that up would be in Q2.

Again, since the distributor part of our business serves the broader market, I want to be careful not to tie that too much to these kind of consumer cycles. I know I get over and over the question about whether or not there is some permanent shift in who holds the inventory and I do think there is some piece of that equation. But the good news is with the inventory in the channel being relatively tight, then there’s a lot less downside and a lot more upside, is the way I would look at it.

Operator

The next question comes from the line of Krishna Shankar with JMP Securities.

Krishna Shankar - JMP Securities

Congratulations on a good quarter. My question was on the wireless. With bookings up 33%, does that reflect demand from one particular customer or a new customer, for example, such as the iPhone? Or is that a broad-based pick-up in the handset build?

Don Macleod

Krishna, we said bookings in the handset and portable device market were up I said over 33% and it was 33% in the quarter. The reality is what are we booking now? We’re booking for delivery for products that go through the summer and really into the early part of the seasonal holiday build, which is September. What we are seeing is customers putting backlog in place for product ramps that take place in that window of time, which is over the summer and into the early part of the holiday period.

In good years, we typically see our customers in the mobile phone handset business placing backlogs on us for the early part of that strong fourth quarter and this year is the same, with the addition of some new products that they are ramping with.

Operator

The next question comes from the line of Uche Orji with UBS.

Uche Orji - UBS Securities

Thanks and congratulations on your margins. Just one question for Lewis; when you talk about this new product, is there any way of defining for us how much of the portion really of sales this quarter was new product? You know, if that’s also a way for us to kind of think about the pipeline of this because this seems to be where we’ve seen the upside surprise really coming.

When I look out for where this growth is coming from, do you think you are winning new sockets from existing customers or orders for new products for which it is all -- in the sense of trying to understand are you getting designed in place of some existing players within the sockets that you are winning? That’s the first question and I’ll have a follow-up.

Lewis Chew

Uche, I’ll definitely give you credit for figuring out that as people ask questions, they are probably getting cut off with no chance to follow-up because you’ve jammed a lot into that one. Anyway, so for everyone else out there who we normally go back and forth, Operator, don’t cut the guy off until after he’s done, all right?

Operator

Yes, sir.

Lewis Chew

Thank you. Let me talk first about the new product revenue, and by the way, we’re making a big deal about new product revenue because as a management team, we want to make a big deal about the things we’re focused on internally and we haven’t in any recent times disclosed how much our revenue comes from new products. It is a significant number. We think it will grow. Don already said that more than half of the revenue dollar growth this quarter came from new products, and as a reminder we define new products as those released within the last three years.

I do think that our new products will be a big driver of our growth going forward but we also know that we have a lot of existing products that were released before that three-year window that we can get more traction with. So I wouldn’t want to say that all of our growth is going to come from new products but the point of new products is since most of our new products have generally a higher ASP and higher margin, that’s where we address the issue that Mike Masdea brought up, which is do you have to trade off growth for margin? In our case, because we are continuing to come out with these new products, I think we’re okay on that front.

Beyond that, I really can’t give you a percent of our revenue that comes from new products because we have not yet to date disclosed that number.

Don, do you want to add anything more?

Don Macleod

Two points, just to reinforce the point that Lewis made; obviously the scarce constraint in our business is analog designers. We’re focusing our designers on new products that have as a mandatory requirement higher ASP. To get those higher ASPs, we need higher performance features designed into the products and the process that builds them, and that’s not a process that we just started yesterday. We’ve been implementing this for the last three years and some of the results of that are coming through in the new products that are hitting the market.

But to go back to the point about are we winning at the expense of somebody else, actually many of the new products that are shipping are new applications. I talked about the handset market and similar markets to that to what you’re seeing and repeating the point is better displays, bigger displays, more information going on these displays, better audio, 3D audio, whatever -- all the different kinds of audio features, and these are the features that the consumers are buying in the new models that are driven by National Semiconductor silicon. So these are not replacing somebody’s products; they are new products with new solutions and new enhancements, so I feel good about the trend in that.

It’s not that these products are necessarily coming in turns, bookings. They are coming in both turns and our normal booking patterns because many of these OEMs have pretty good planning cycles and they know what they want to build going forward.

Uche Orji - UBS Securities

My follow-up, if I look at the coms business, your base stations, you mentioned the strength in 2.5G. Can you give us any thoughts as to how you see that market developing for the rest of the year? And if you have any thoughts as to 3G, specifically in China as well, if you think that’s -- any color you can give us as to how the dynamics plays out for the rest of the year between 3G, 2.5G would help.

Don Macleod

Well, a quick answer to that one; last quarter in our earnings call, we referred to the fact that we saw increased bookings out of China as the early infrastructure on TD-SCDMA base stations was putting in place where we have a very good interface design position. Clearly that business continues.

This quarter, we saw more business than we expected come out of what you might call the 2.5G type infrastructure where our customers came in, in fact in some cases to expedite additional product, mainly our data converters, through the quarter. That was a surprise for us.

So clearly you can figure the market itself out but the short-term dynamics in both 3G and 2.5G appear to us to be very good in the quarter, and the China business will continue as the pre-Olympic installation of TD-SCDMA is taking place through the rest of the year.

Long Ly

Operator, let’s move to the next question.

Operator

The next question comes from the line of Sumit Dhanda with Banc of America Securities.

Sumit Dhanda - Banc of America Securities

Lewis, if you could just clarify what the expectation is for the remaining $900 million or so as part of the $2.4 billion in buy-back in terms of the timeline and when we would see that flow through the model?

Lewis Chew

Sure. I’ll try to give as much clarity as I can, which will probably be as clear as mud, but even in the past what we’ve done is try to let our actions speak louder than my words, which are sometimes too many. In the last three years, I don’t think we skipped a quarter. Now we are going to do an accelerated stock buy-back, so that will take precedence. We still see ourselves as a company even after taking on this leverage, generating very large sums of excess cash per year considering our lower capital intensity.

So I think what we’ll do is continue to have buy-back programs but for right now the ASP takes precedence. What I’ve said is look four to six quarters out and you can draw your conclusions. You can actually run a chart of what we’ve been buying every quarter the last three years and draw your own conclusions. But we’re not going to stop. We have already telegraphed to the market that we’re not likely anytime soon to be a microchip in terms of paying 70% of our earnings in dividends, or whatever the number is, and so as we generate excess cash, we have been very responsible over the last three years returning that to shareholders and we’ll continue to do that. And now we have another lever to pull because as Brian mentioned, we have the flexibility to retire debt and so we’ll retire debt as we see fit but absent that, it will be going towards stock buy-back.

So how’s that for clear as mud?

Sumit Dhanda - Banc of America Securities

That’s good enough. Thanks.

Operator

The next question comes from the line of Craig Hettenbach with Wachovia Securities.

Craig Hettenbach - Wachovia Securities

Thank you. Don, could you discuss order trends in the digital TV market? As that market has gotten larger, are there any implications in terms of pricing playing in that space?

Don Macleod

Just the digital TV market is not one per se that we talk about. If I actually look at the, what you might want to call 10-inch and above displays, that’s the business that we’ve taken a more cautious posture towards addressing. Clearly the economics of that business don’t always allow us to achieve desirable margins unless we really have unique products, so we focused on these rather than being a bigger player in the larger TV market.

Where we do see a lot of opportunity is in the interface area where we move information around, for example, in studio broadcast and other solutions. We are first into the marketplace with what are call 3G, 3-gigabit solutions in that space to equip the studio broadcast infrastructure for HD-TV. At the NEB show recently just last month, we demonstrated the first full suite of 3-gig products for that infrastructure and we’re looking for that to build as we go forward and then ultimately for the consumers to buy the products that use this 1080P capability. So we see this as a big opportunity but in the base, if you want, display market today we’re fairly cautious about the opportunity to enjoy our margins there.

Craig Hettenbach - Wachovia Securities

Got it. Thanks.

Long Ly

Operator, we have time for one more question.

Operator

Yes, sir, you do have a follow-up question from the line of Uche Orji.

Uche Orji - UBS Securities

My question has been answered. Thank you.

Long Ly

Let’s take one more caller.

Operator

(Operator Instructions) At this time, there are no other questions in queue. Are there any final remarks?

Long Ly

Okay, so with that we’ll end the call today. Let me remind everyone that the replay is available on our website. Thanks for joining our call.

Operator

Ladies and gentlemen, this does conclude today’s conference call. You may now disconnect.

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