National Semiconductor F3Q08 (Qtr End 2/24/08) Earnings Call Transcript

Mar. 6.08 | About: National Semiconductor (NSM)

National Semiconductor Corporation (NSM) F3Q08 Earnings Call March 6, 2008 4:30 PM ET

Executives

Brian Halla - Chairman, Chief Executive Officer

Don Macleod - President, Chief Operating Officer

Lewis Chew - Chief Financial Officer

Long Ly - Investor Relations Manager

Analysts

Analyst for John Pitzer - Credit Suisse

Analyst for Craig Ellis - Citigroup

Douglas Freedman - American Technology Research

Analyst for Uche Orji - UBS Securities

Chris Danely - J.P. Morgan

Ross Seymore - Deutsche Bank

Daniel Berenbaum - Caris & Company

Operator

Good afternoon. My name is Christian and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 FY2008 earnings call. (Operator Instructions) And now I would like to turn today’s call over to Mr. Long Ly, Investor Relations Manager. Please go ahead, sir.

Long Ly

Thanks. Welcome to National’s earnings 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 third quarter fiscal 2008 results, which ended on February 24, 2008. As a reminder, today’s call will contain forward-looking statements and projections that involve risks and uncertainties that could cause actual results to differ materially. You should review the Safe Harbor statement contained in the press release published today as well as our most recent SEC filings for a complete 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 third quarter financial results; Brian Halla will give an overview of the business environment and an update on the company’s focus and priorities going forward; Lewis Chew will expand on the third quarter results and provide the background to our outlook for the fourth quarter of fiscal year 2008; Don Macleod will then discuss our products and business in more detail. We will then take questions until approximately 2:30 p.m. Pacific Time.

The third quarter results were as follows; sales were $453.4 million, down 9.1% from $499 million in Q2 fiscal year 2008 and up 5.2% from $431 million in last year’s third quarter. Gross margins were 64.3% in Q3 compared to 64.4% in the prior quarter and up from 59.8% in last year’s third quarter.

Operating expenses in the third quarter were $164.5 million, down from $174.7 million in the prior quarter. Note that for this quarter, other non-operating expense of $5.4 million consisted of a drop in the value of employee deferred compensation investments that are held in a trust on behalf of the employees. A corresponding credit of $5.4 million is included in Q3 SG&A expense. This credit is simply the equivalent drop in the accrued liability on our books associated with the same deferred compensation. You can find a description of this deferred compensation plan and related disclosure on page 51 of our fiscal 2007 Form 10-K.

Now moving on to the rest of the income state, net interest expense was $15 million and the effective tax rate for the quarter was 18%.

As a result, National posted GAAP net earnings of $71.2 million, or $0.28 per fully diluted share in Q3 fiscal year 2008. The fully diluted share count for the third quarter was 255.5 million shares.

Included in the GAAP financial results this quarter are the following one-time items: first, a $19.6 million pretax charge related to a factory modernization effort previously announced on January 21, 2008; and second, approximately $11 million of discrete tax benefits realized in the third quarter.

I will now turn it over to Brian Halla for an overview of the business environment and an update on the company’s focus and priorities. Brian.

Brian Halla

Thank you, Long. In the next few minutes, I’ll recap the quarter just ended, our fiscal Q3 of FY08. I’ll try to hit some of the highlights as well as review the lowlights that had us re-guide a few weeks ago. I’ll talk about our response in this environment and recent management operational actions. I’ll cover briefly some corporate growth initiatives, a couple of which were announced in my keynote last week at the Global Electronics Forum in Osaka, and as best I can in this changing environment, try to give an outlook, at least from our perspective.

We ended the quarter with revenues of $453 million, down from the prior quarter’s $499 million. This was up 5% from the prior year. The margins on the lower number, however, came in at about flat with the prior quarter at 64.3%. The earnings came in at $0.28 GAAP including a restructuring charge of $20 million, partially offset by some one-time tax benefits.

We reduced inventories internally by $3 million to $146 million, which is about 82 days, and our distributor inventories continued to run below 10 weeks. Cash reserves are about $870 million and manufacturing wafer fab utilization was 68%, so much of the gross margin health beyond the improved manufacturing efficiencies was attributed to product mix and ASP improvement.

As we look at the conditions in the industry, the market for handsets and portable devices was weaker than we originally expected, particularly from customers serviced by Chinese distributors and a few, but not all, large OEMs. There was a lull in order patterns in the middle of the quarter with stronger patterns returning in the last six weeks of the quarter. Distribution resales were down seasonally but in general, our distis have maintained a cautious outlook relative to inventories, which has been supported by reasonably short lead times across our product lines and those of many of our competitors. The broad-based business was fairly stable; however, but not sufficient to offset the weakness highlighted earlier.

All else held equal, it’s still a good feeling to look at a peak to trough scenario where National Semiconductor's trough may well be gross margins above 60%.

Going forward, we’ll continue to focus on high value, differentiated products. During the quarter and the previous quarter, our manufacturing team resized their equipment profile to eliminate some older commodity oriented equipment in favour of that which supports the newer products and wafer sizes, and overall gives us an improved cost structure more in line with our strategic vectors.

Most of the benefits will be realized starting in the quarter we’re in and those quarters to follow. An example of this reprofiling of our equipment set is to eventually replace existing 6-inch capacity with 8-inch wafer capability, where the additional chip yield per wafer serves to bring chip cost down substantially.

Additionally and without sacrificing our higher added value product strategic vectors, the management team has tightened up our operational expenses to be more in line with existing business conditions. As the order rates return to more normal patterns, these actions will deliver operating income payback.

Given the current environment, National will continue to hunker down and focus on key growth initiatives. We have announced our national 3.0 and power-wise initiatives and reorganized the company accordingly. The focus is on developing analog product that no one else has or hopefully can do, like the display technology we provide in the current iPhone.

Some of the output of this corporate focus is hitting the streets as we speak. During the quarter, we announced the world’s highest performance, lowest power consuming continuous time sigma delta analog to digital converter. That’s a lot of words to describe a small chip but just think of it as a key component in enabling high performance diagnostic equipment, such as ultrasound machines, to operate on batteries and could ultimately enable a doctor to review a fracture as simplistically as he listens to your heart today with a stethoscope.

In addition, we’ve been developing technology in exciting new areas, such as photovoltaic. Products such as National’s new power-wise photovoltaic boost technology previewed last week, which will officially launch later this year, will enable the efficiency of solar panels to be increased by as much as 10X under varying environmental conditions.

And we introduced our noise suppression technology. This is technology which is used to eliminate or suppress ambient background noise, such as that in restaurants or other noisy environments while one is trying to carry on a cell phone conversation. This product announced in my keynote speech last week in Osaka is the LNV-1088.

We are serious about the new direction of the company and you’ll find our employees working diligently on these initiatives, even as the economic pessimism surrounds us.

We’ve reorganized the corporation along strategic imperatives of higher added value circuits more strategically aligned with our key customers and requiring more collaboration across product lines.

So as to our outlook, the fear of economic uncertainty can cause consumers to, at a minimum, to be cautious of their consumption of cell phones and other goods. We know that orders returned to more normal levels towards the end of the quarter. We know that distributor inventories are very low. We know that our product portfolio continues to increase and it’s value-added to our customers.

What we don’t know is where the economy will take us in the near-term. What we do know is that given the backlog we have in place and the current levels of inventory, both internally and in our distributor channels, and based on the outlook our OEMs and distis project for their businesses, that we can bracket the current quarter based on assumptions about our turns business. That bracket will be a range of $440 million to $460 million in revenue.

Meanwhile, we’ll continue to work on more innovative circuits that are driven by the upcoming demands of healthcare, energy conservation, personal mobile devices, video production and transmission, and security and surveillance. We’ll continue to focus on growth with a profit that allows us to continue to invest in R&D that’s in line with our key customers strategic roadmaps. A business model that not only returns value to its shareholders but continues to allow us to bring unique, differentiated solutions to our customers.

Over to you, Lewis.

Lewis Chew

Thanks, Brian. During my part of the call today, I want to go into a little more detail on the things that impact our fourth quarter outlook, as well as some of the underlying key assumptions that are embedded in the revenue range that we’re guiding to.

As we said in the earnings press release, our bookings in Q3 were down from the prior quarter and were below our original expectations. Part of this bookings decrease came in the form of lower-than-expected turns orders, which were the main reason we had to revise guidance in early February.

But another consequence of the bookings decrease was that we ended Q3 with a lower 13-week backlog for Q4 than we had at the beginning of Q3. Now bookings were relatively slow for most of December and January and net turns were essentially zero in the middle month of the quarter as customers, mainly in the portable space, decided that they had plenty of inventory for the demand levels they were seeing.

Regarding order push-outs, although it’s not uncommon to have some of that type of activity in any quarter, we did see a larger amount of push-outs during Q3 than we expected and that was a factor in our revenue miss.

In the latter part of Q3, bookings in total, as well as turns, came back to more reasonable levels but were not enough to undo the weakness that we saw earlier in the quarter. Looking at the distribution channel, we saw distributor resale decline about 8% sequentially in Q3. This was heavily driven by the Asia-Pacific region, which had disti resales down by double-digits, as they were negatively impacted by lower demand from Asia and handset companies, as well as the holiday season.

By contrast, disti resales in the Americas and Europe combined were down by less than 5%, mainly due to holidays, which was actually consistent with our original expectations.

Ending distributor inventories for us worldwide were up slightly over the prior quarter but prior to this Q3, we had seen distributor inventories go down in four consecutive quarters. The number of weeks of inventory was still below 10 weeks as of the end of the third quarter.

So as we move into quarter four, the revenue range of $440 million to $460 million that we are projecting has some key factors that I want to highlight. We are starting the quarter with lower opening backlog due to the weak bookings in Q3. We are expecting that total bookings in Q4 will be higher than Q3, based on a continuation of the level of activity that we saw in the last five to seven weeks.

As part of that, the net turns orders that we get from distributors should also be higher due to seasonal improvements in distributor resales. We also think that the amount of cancellations or push-outs in Q4 will be lower than it was in Q3.

So the low end of our range does assume that turns orders increase modestly from Q3 levels while the high end of our range assumes turns orders that get closer to what we might consider normal, such as what we saw back in Q1 and Q2.

Now let’s move on to gross margin and operating expenses. Q3 gross margin came in at 64.3%, which was better than we had projected and also was the second quarter in a row that we exceeded 64%. During the quarter, our product mix was stronger than we originally thought it would be and in addition, overall manufacturing efficiency, which includes spending controls over the holidays, was better than expected.

Fab utilization in Q3 was about 68% compared to about 65% in Q2, based on wafer starts. In Q4, based on the range of revenue that we are projecting, we expect gross margin percentage to range from the high 63s to the low 64s. As part of that gross margin range, our wafer starts will be roughly the same as they were in Q3.

We do expect to save several million dollars in both Q4 and Q1 from the fab capacity rationalization that we announced in Q3. These savings initially flow through standard inventory costs and will eventually show up as a positive impact on gross margin.

A good way to think about this is that if you hold sales and manufacturing levels constant into Q1 and Q2, for example, the gross margin would improve by roughly one to two percentage points. Actual results can vary, of course.

Now let’s cover operating expenses. In Q4, R&D expense is projected to range from $91 million to $94 million. SG&A expense is expected to run from $80 million to $83 million in the fourth quarter, and as Long pointed out earlier, the Q3 SG&A expense of $77.4 million included a roughly $5 million credit that was directly offset by a corresponding amount in other non-operating expense.

Other income and expense in Q4 is expected to be around $1 million of expense. Gross interest income is projected to range from $4 million to $6 million, which will be down from Q3 mainly because of lower interest rates. And gross interest expense is expected to be around $19.5 million, as declining interest rates also affects the portion of our debt that is variable rate.

Included in the projected Q4 gross margin and operating expense numbers I just provided are approximately $20 million of total stock compensation expenses, which can be broken down by category as follows: cost of sales, $4 million; R&D, $6 million; and SG&A, $10 million.

And finally, the Q4 effective tax rate should range from 31% to 32%.

So let’s cover the balance sheet. Our capital expenditures in Q3 were about $31 million and in Q4, our capital spending is projected to be around the same level as it was in Q3.

Our days of inventory at the end of Q3 was about 82 days, which is up from 77 days last quarter. Our days of receivables at the end of Q3 was around 31 days, down from about 34 days in the prior quarter, and our cash reserves ended Q3 at about $871 million.

Also, we bought back $120 million of stock during the quarter, so as we enter Q4, we have about $480 million of available buy-back authorization still remaining.

Operating margin in Q3 was about 28% compared to about 29% in Q2 and just to be clear, that Q3 number doesn’t include the restructuring one-timer.

And finally, return on invested capital for the third quarter was about 21%. All of these figures include the impact of stock compensation expenses.

Let me turn it over to Don Macleod. Don.

Don Macleod

Thank you, Lewis. So let me now provide more color on the drivers of our business in the quarter. As we said earlier, our 9% sequential reduction in sales was mainly driven by mobile phone and other personal mobile device customers. Sales to the networking market, which includes both cellular base station and other networking infrastructure customers, were flat sequentially. Shipments to large flat panel display and PC customers were also flat sequentially, while sales to industrial and other market customers were down slightly.

Looking back a little further to last year’s third quarter, our overall company sales were up year-on-year by 5%. However, sales to mobile phone customers were up about 20% over that same time frame. This market essentially provided all the incremental year-on-year sales growth for us.

We know that the mobile phone market is subject to seasonality with the post-holiday selling season order adjustments that we saw in January of this year. Over the years, we enjoy more growth here than any other large market that we as an analog semiconductor company participate in and I would remind you that in our recent November quarter, we also enjoyed 30% year-on-year revenue growth for this market, which is responsible for about a third of our overall revenues.

Our current business and new design win activity in the mobile phone and related personal mobile device area has many facets. The common denominator is our power-wise branding, where we aim to provide the highest analog performance with the most energy-efficient solution.

We can all relate to this in mobile applications where more and more features are being provided without compromising the battery power source and the small form factor. A few examples of the diversity of our design win progress in the personal mobile device area in the quarter are: Qualcomm announced a reference design and bill of material for a new mobile phone platform that incorporates an RF power management solution from us that gives the overall platform a 20% battery life increase over the predecessor.

We won integrated power management units on a number of models, applications processor PMUs and wideband CDMA phones, LED Flash drivers and super RF power management devices at an enterprise handset provider.

We also saw further new model penetration of an Ericsson mobile platform’s 3G reference design containing our RF detector and our RF power management devices.

The personal mobile device market provides a growth platform for us, not just in power management products. We’ve discussed in past earnings calls our success in audio and small display -- in other words, the analog enabled human interface of these mobile devices.

In this quarter, we internally created a new organizational structure that focuses more of our resources on this fast-growing, personal mobile device area.

In our broad analog building block product areas, i.e. those not specifically focused on vertical markets, we are putting a lot more emphasis on higher performance new products and less on simply filling out our catalog of building blocks. In this context, we are also emphasizing high performance analog products that meet the criteria of a power-wise brand. Again, the lowest power consumption or highest energy efficiency at a given level of performance.

Two very visible examples of this are in recently announced capabilities. Brian already talked about our analog noise suppression microphone or reamplifier that uses one-tenth of the power of compatible solutions. He also highlighted our continuous time sigma delta data converter. Our highest performance 12-bit data converter uses 30% less power than the best competitive alternative. And by the way, this is the first production implementation of continuous time sigma delta technology in the industry.

These are examples of high performance products that are proprietary; i.e., they are not standards-based. They have higher average selling prices or ASPs, and are less easily commoditized.

Talking about ASPs, our overall company ASP was up about 5% sequentially and was also up about 5% year-on-year. This is a continuing theme for us -- building more analog value into our products, value that customers are prepared to pay for in the form of ASPs that also translate into higher margins. I refer back to our 64.3% gross margin for this quarter.

Conventional wisdom in this business suggests that a focus on faster growing vertical end use markets dilutes gross margins. Our trends have been otherwise, with our mobile phone and personal mobile device product sales up about 20% year-on-year in this quarter and now representing about a third of our overall sales, our overall gross margins are up from 59.8% in last year’s third quarter.

We also continue to complement our gross margin with operational improvements at our in-house manufacturing facilities. In January of this year, we announced broad actions to reduce cost in our wafer fabs, actions that were driven more by our 6-inch to 8-inch wafer conversion program than current business conditions. These actions, as Lewis already mentioned, when fully implemented by the beginning of the first quarter, i.e. our August ’08 quarter, should enhance gross margin by one to two percentage points at today’s revenue levels.

Operational improvement is for us a continuous process and the results are easy to measure in costs, in margins, and in ASPs.

What is less easy to directly measure on a day-to-day basis is the transition of our product focus. We talk less and less about the percentage of our revenues that come from analog and standard linear product areas. We don’t really have to, as about 90% of our revenues -- i.e., essentially all -- fit into the analog industry definition.

Our focus is now on revenue growth. Not just on demonstrating as in the past that we were becoming more of an analog company by getting out of or de-emphasizing non-analog product areas. That revenue growth is focused more on fast-growing end markets, examples are mobile phones and other personal mobile devices, where we are now subject to both seasonality and consumer spending behaviour. We have to live with that seasonality, as long as we see growth in the up parts of the season and the cycle.

I think since we’ve demonstrated in the second half of calendar ’07 that we can participate in that growth, and with improving gross margins, we can show the same upward revenue and earnings leverage when our business picks up in this cycle.

I would like now to hand it over to Long to moderate the Q&A.

Long Ly

Thanks, Don. At this time, I will ask the operator to open the lines to begin the Q&A. 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) Our first question is from the line of John Pitzer with Credit Suisse.

Analyst for John Pitzer - Credit Suisse

Thanks. This is [inaudible] for John. I guess first off, Don, given that ASPs were up nicely during the fiscal third quarter, and I believe this is in line with what you were expecting and had talked about on the last call, can you help us understand how you think about ASPs relative to market share? And how you may or may not use ASPs as one of the tools available to you in the context of maintaining or gaining share?

Don Macleod

I’ll take that question, since you asked it directly. The issue in this market I would say frankly isn’t a discussion about market share. If you look at the data for the overall analog industry for last calendar year, calendar year ’07 against calendar year ’06, we have a market that really isn’t growing. The WSTS data showed the actual analog space shrinking by just over 1% last year.

The issue for us is an opportunity where we can grow our position with a customer base in that market and our goal is to focus on products that earn higher ASPs through their complexity and uniqueness. And our goal is to add more system value in specific vertical markets, along with high performance building blocks that earn us those higher ASPs. That’s been a trend that you’ve seen over the years in our company and that’s not a discussion that’s focused on per se gaining market share in this market. We view the marketplace as growing at a relatively unattractive rate, so our space is to grow the value that we provide in that overall market to show a higher-than-market overall revenue growth.

Brian, do you want to add anything?

Brian Halla

John, anytime -- anytime you equate ASP assertion or ASP aggressiveness with market share gains, all of that boils down to one word called commodities, and when we started our march back in 2002 of 60-30-30 and beyond, we emphasized that we would have a strategic de-emphasis of commodities and we continue to be true to that and we will stay true to that. And we are seeing now that the results of our proprietary process technology, our unique packaging capability, combined with innovative circuit solutions like power-wise and continuous time sigma delta can in fact give us a sole source position in the market and earn us not only the respect of our customers to whose products we add value, but we get paid for it.

Long Ly

Do you have a follow-up?

Analyst for John Pitzer - Credit Suisse

Just a quick follow-up; I guess Lewis, you did mention that sort of late in the quarter, bookings and turns business came back to reasonable levels. Is that sort of across the board, including Asia as well? What’s the right way to think about that?

Lewis Chew

The short answer is yes. The long answer is that the weakness we saw during the quarter wasn’t in all markets, so I think the more fair way to answer that is during the middle of the quarter when bookings dropped off, it was more pronounced in the wireless and personal mobile space, so therefore, there was more room to recover, if you will. But it is true that if we look at the bookings over the last five to seven weeks, they are running at what I consider to be a much more normal level, a level that was more in line with our original expectations back when we gave guidance at the beginning of the quarter.

Analyst for John Pitzer - Credit Suisse

Thank you.

Long Ly

Operator, let’s have our next caller, please.

Operator

Our next question is from the line of Craig Ellis from Citigroup.

Analyst for Craig Ellis - Citigroup

Hi, this is Ken [So] calling in for Craig Ellis. Going back on the fab shut-down, could you remind us what’s the quarterly savings and its impact to gross margins, [also] the timing of those savings? And what are some of the prospects for additional actions throughout the rest of the calendar year?

Lewis Chew

I knew that one was coming. First of all, just to clarify to the whole audience there was no fab shut-down. What we are doing is actually eliminating some under-utilized equipment and some of the personnel that were kind of connected to that capacity. So we have three fabs before the action and we have three fabs after the action, and in fact from a strategic standpoint, what we do know longer term is we are probably going to be converting more of that -- and again, just by way of background, two of those fabs are fundamentally 6-inch wafer fabs -- down the road, we have a strategic opportunity to convert some of that 6-inch to 8-inch, which is a huge cost benefit to us because then you don’t have to build an entirely new fab.

So we didn’t actually shut a fab. So in terms of the savings from the action, I think the way I characterized it in the press release was that we would expect to save kind of a sequential one point and then another point. So right now, what we are expecting to see is a substantial dollar savings this quarter but we are also adjusting our inventory costing to match that and you’ll probably see more of that benefit show up starting in Q1. And the scale of the improvement ultimately will be in the range of two points of gross margin in total savings. Not all of that will happen this quarter, though.

Analyst for Craig Ellis - Citigroup

Okay, and on capacity utilization, I noticed that it moved nicely but has been below 65% for the past six quarters. What is your expectation for the May quarter, as well as any other actions in front of us, that would be helpful. Thank you.

Lewis Chew

We are currently projecting fab utilization this quarter to be pretty consistent with what we reported in Q3. As I said, our current gross margin guidance is for -- includes an assumption that wafer starts will stay about the same.

In terms of going forward, that will probably depend on what the demand drivers look like. We continue to believe that inventory throughout the channel, including now even EMS’s, is relatively light based on historical standards so any upward movement in demand is likely to trigger an upward movement in fab loadings and therefore utilization.

But obviously I don’t have a forecast to give you right now for Q1 revenue, so I can’t really comment on what the utilization will be in Q1.

Long Ly

Thanks, Ken. Operator, let’s get the next question, please.

Operator

Our next question is from the line of Douglas Freedman with American Technology Research.

Douglas Freedman - American Technology Research

Thanks for taking my question. Clearly a lot of the growth has been coming in the wireless sector. Can you talk a little bit more in detail about what you are doing and where you think the growth will come from over the next three to five years?

Brian Halla

Doug, one of the things I said in my commentary was that beyond the personal mobile device area, which is incredibly important to us and as you point out, represents a lot of our growth, we also want to be first with the best in areas that will drive tomorrow’s semiconductor demand, and the ones I mentioned in particular beyond personal mobile devices are areas of healthcare, energy conservation including photovoltaic, video production and transmission, and security and surveillance. And we think each of these markets or new mega-trends has the potential of driving demand that could be as good as the demand we’ve seen in the past, driven primarily by productivity in IT tools, like the PC and the connected PC and the cell phone.

So we are just looking down the road a bit and trying to figure out what’s going to drive demand for tomorrow’s technology.

Lewis Chew

Doug, just to clarify your question, were you asking about growth beyond wireless or what types of products are we aiming at wireless?

Douglas Freedman - American Technology Research

No, that was it -- the growth beyond wireless was one of those, to sort of try to broaden the opportunities for the company so that all the growth was not coming from wireless. If we were to focus in a little bit more on near-term factors and things that are taking place in the market, there’s been some changes in some distribution strategies, yours included, actually, over the last several years. Can you discuss what you are seeing as far as your relationship with your distribution customer base? I know there was some concern how they took the increased pricing and just what you think is going to happen as far as your relationship for that more broad, industrial-based customer. I’m a little surprised to see that that business was down in the just prior quarter.

Don Macleod

I’ll take this. First of all, to clarify your point, Lewis mentioned our resales were down 8% in the quarter but really when you highlight the main contributor to that resale change quarter to quarter, he attributed that to our business that is conducted in China through distributors to third-tier handset manufacturers in that space.

I think if you were to take a look at the current business condition in distribution, in any discussion with our distributors in the Americas and in Europe, we will actually both agree that we both met our goals for resales in this current third quarter, so I think the business performed as expected, other than that situation that Lewis alluded to in Asia, which was fairly specific and I think we are now pretty much working our way through that.

But your bigger question was the relationship we have with distribution, and I think we’ve said before that our relationship with distribution let’s say up to about five years ago was really a commodity driven relationship, where National was seen as an effective, low-cost manufacturing partner for commodities and the main activity in distribution was demand creation in terms of them buying low and selling high those commodities in opportunistic markets.

Our relationship has changed. Most of our portfolio today is proprietary and the activity we work with, distribution is mainly focused on them discovering opportunities to design in those proprietary parts. The margin structure is very different in those situations. The margin structure is based on the value of the add and the work that they do versus the opportunity of buying low and selling high, and we support our distributors with our field sales and field applications engineering resources to help them drive these discovered opportunities through to closure and resale.

So I think we’ve gone through that concession. Our network now understands and works with us relative to where we want to go relative to that proprietary portfolio. There was a period a few years ago of friction where we were de-emphasizing those commodities and in a way, providing them with an opportunity to go elsewhere, but these are behind us and I think our relationship now on proprietary products is really very healthy.

Brian Halla

We mentioned in the commentary a couple of times that the broad-based business, which primarily comes from distribution, was stable. I’d characterize our relationship with our distributors as not only constantly getting better and more mutually gratifying but we have an increased dependence on our distributors going forward as we look at increasing our penetration of the broad-based markets. So I think the relationship is very good and we’ll depend on it more and more going forward.

Douglas Freedman - American Technology Research

Great. Thanks so much for taking my question.

Operator

Our next question is from the line of Uche Orji with UBS Securities.

Analyst for Uche Orji - UBS Securities

This is [Vilad] for Uche. I just wanted to get more color on your outlook for the handset market. You said that you saw weakness in Asia but I just wanted to clarify that the weakness is just limited to Asia, or you are just seeing the weakness across the broad market?

Don Macleod

Let me clarify that in a little bit more color than we’ve maybe kind of said up until now. We don’t see weakness in the end use market for mobile phones. I think two or three specific phenomena occurred over the end of the holiday selling season that affected our business, and simplistically, one that we saw most of was that a number of our customers had desires to achieve market share in the mobile phone space, I would say mainly in the higher end space in mobile phones, and obviously not everyone can gain 100% share so I think we saw some of our customers cutting back on some models towards the end of the calendar year and obviously adjusting their backlogs on us.

And on the other hand, Lewis mentioned I think the discussion in China where our customer base that we deal with again through distribution in China for third-tier handsets began to see slower up-tick in their phone models, I think really beginning in the October/November timeframe and obviously distributors then reflected that back to us in terms of lower demand rates for products that we would have been shipping in, had the backlog stayed in place.

I would really emphasize that we didn’t necessarily see a weak handset market. We just saw individual customers and models making adjustments based on I would say over-optimistic penetration plans for specific models, both in the phone space and in the -- you know, the phone and portable media player space.

Analyst for Uche Orji - UBS Securities

Okay. As a follow-up, when do you see a [inaudible] in your handset business and overall business?

Long Ly

Could you repeat that?

Analyst for Uche Orji - UBS Securities

When do you expect to see a recovery in your handset business and overall business as well?

Don Macleod

I’d just go back to the point Lewis made a few minutes ago that if we look at our order rates for the last five to seven weeks, we saw what we would call more normal order rates for our business, which obviously is heavily driven, as we said, by the mobile phone space. So I think to a great extent, that word recovery isn’t I think appropriate here -- just the adjustments that we took in the January timeframe were one-time adjustments to reflect backlog going into the new year after the holiday selling season and I think we’re now seeing more normal and typical levels of business.

Analyst for Uche Orji - UBS Securities

Thank you.

Operator

Our next question is from the line of Chris Danely with J.P. Morgan Securities.

Chris Danely - J.P. Morgan

Thanks, guys. Just on the guidance, I realize that the last month has been pretty stable but in looking around at what your peers are saying and considering who wrong both of us were on the trends and business conditions last quarter, I guess I’m just wondering why assume there’s going to be higher turns when it doesn’t seem to benefit you guys to do that?

Lewis Chew

I’ll take that, Chris and for everyone else on the call, we certainly want to start by saying we don’t ignore history, so first of all the miss that we had this quarter, we called it by the numbers and in fact, as I said in my prepared comments, we had virtually zero fill orders in the middle month of the quarter, which we certainly didn’t model. So on the quarter we are heading into, Chris, we’re actually not expecting any sort of a snap-back, just to clarify that. What we saw in Q3 was lower turns orders as well as push-outs, cancellations, whatever word you want to attach to that. And there is some measure of that that we can actually dig into the underlying reasons for that we don’t think are going to repeat in Q4 because those adjustments are kind of made once and once they are made, they’re made.

And also, in terms of what we get as pull from the distribution channel, it is true that it’s reasonable to believe their statement that they think the resales will be up a little bit seasonally this quarter. And because inventories are so low, you can pretty much translate that seasonal increase into turns, unless you assume they are just going to continue to burn it right out of inventory.

So those are the two primary factors driving our -- let’s call it the lower to middle-end of our guidance. And as I said in my comments, if turns get to more normal levels, that will push us up into the range but I think the 440 does contemplate that there’s not some sort of a snap-back in the economy but simply the elimination of these negative activities we had in Q3, plus a seasonal pick-up from distributors.

Chris Danely - J.P. Morgan

Sure, and then my follow-up would be so you guys are pretty convinced we’re if not at the bottom, kind of bouncing along the bottom. I guess I’m just curious as to why you wouldn’t be using more cash to buy back stock right now while your stock is down.

Lewis Chew

With respect to the comment about -- I presume you are commenting on Q3 because I didn’t given any guidance on Q4. Is that what you are referring to?

Chris Danely - J.P. Morgan

Yeah, or if you can give us guidance on Q4, that would be great, for a buy back.

Lewis Chew

Sure. Yeah, I can see everyone out there on the call lining up to sell back to me now. In Q3, since we run a very tight ship here, we had two events. One was we announced the fab resizing in the middle of the quarter, and then we had to pre-announce the revenue, so in both those instances, Chris, we blacked ourselves out.

Chris Danely - J.P. Morgan

I see.

Lewis Chew

So we just don’t think it’s appropriate to be buying on the open market if we are in possession of potentially material information, so I think you can look at the Q3 number as clearly having been affected by that, not to mention the fact that you’ve got a week of Christmas thrown in there that there’s not a lot going on then too.

If you look at Q2 before that, you can see that we had much higher buying activity and I would definitely say to our credit, over the last three to four years, we’ve been very consistent in buying probably at a level higher than we did in Q3. But I am not going to give a guidance for Q4 though.

Chris Danely - J.P. Morgan

Okay, that’s fair. Thanks.

Operator

Our next question is from the line of Ross Seymore with Deutsche Bank.

Ross Seymore - Deutsche Bank

Thanks, guys. Just a couple of questions on the gross margin; in the quarter when the gross margin performed better than in your prerelease, you said it was because of mix. Was that just as much new products coming in or/and the things you didn’t sell? And I guess really what I’m getting at is, is there a wide range of gross margin where we should expect it to be seasonal going forward as wireless goes up that could negatively impact gross margin, or some dynamic like that?

Lewis Chew

It was both the strong mix as well as the manufacturing performance, so I don’t want anyone to think that we are dissing the manufacturing guys. The manufacturing performance including both things like yield as well as spending did come in better for the quarter and it is true that the mix continued to be very strong as the quarter went along.

Yes, as always, there is a range within the margin of products that we sell and I guess we’re our own worst enemy in that we give such precise margin guidance that people hold us to that standard. I looked enviously at Intel’s announcement the other day when they use words like plus or minus a couple of points, and it seems like you guys think that we can hold it within basis points.

But you know, both of those helped us in the quarter, the mix and the manufacturing performance were both good factors in Q3.

Ross Seymore - Deutsche Bank

Okay, and one clarification; on the utilization side, I believe you said it went from 64% to 68% from the second to the third quarter? Was that just as much because of what you were taking offline as it was the fact that your wafer starts were actually rising?

Lewis Chew

There were three factors in there, Ross. One was that we actually did start more wafers this quarter than in Q2, so that’s an obvious one. We actually started more wafers and our utilization number is based on wafer starts.

Two, we did have some equipment that we took offline that factored out of the denominator during Q3, but then offsetting some of that was we had new 8-inch capacity that was now coming online into the weighted average, if you will, from the Q2 -- if you’ll recall back in Q2, we had an 8-inch line that we launched. So all of those three things added together added up to our utilization going up by a few points during the quarter.

Ross Seymore - Deutsche Bank

Why did utilization go up in the quarter? Or why did you do more wafer starts, given that you guided originally down 1% to 5%?

Lewis Chew

That’s a very good question. I’m glad you got that out there in the open, Ross. Remember that in Q2, for the revenue that we did in Q2, which was 499, we burned off $18 million in that quarter. So remember that in Q2, we were already running at a manufacturing level way below our revenue level and even at that time, I remember you asking me “Hey, Lewis, well, what does this mean?” and I think ultimately that ended up being a good cushion for us because then, with the revenue dropping 9% in Q3, the manufacturing organization did not have to drop down production like you might have seen in past cycles.

So this quarter, we only burned off $3 million in inventories, so that $15 million delta in the burn rate helped us out on the utilization.

Ross Seymore - Deutsche Bank

Thank you.

Operator

Our final question is from the line of Daniel Berenbaum with Caris & Company.

Daniel Berenbaum - Caris & Company

Thanks. Brian, I think you mentioned that National’s trough gross margin may well be above 60% -- maybe help us gauge the downside risk a little bit. Can you give us some color on what could pull gross margins down below 60% in terms of either revenue level or mix, and how does the model generally scale if the business environment continues to soften?

Brian Halla

Well, when I said trough I was trying to anticipate that that may well be the lowest that we would go in this cycle, and maybe that’s another way of saying we do think that we are somewhere near the bottom.

I think -- I’ll go back to what Donnie said, that cell phone demand continues and cell phone demand growth in the marketplace continues. We had some isolated, model-based challenges in the quarter but we think that the business overall is fairly stable. And as we said in the last five to seven weeks, business returned to more normal patterns.

I’d say -- I’ll also refer to what Lewis said, that we troughed, we bracketed our turns expectations -- the worst we could see in turns and the best we could see in turns, and that gave us the 440 to 460, so I feel fairly confident that we’ve not got our act together such that in just about as bad a situation as we’ll get, that we’ll still have a gross margin that starts with a six.

Daniel Berenbaum - Caris & Company

Okay, great. Thanks.

Long Ly

Operator, are there any other questions out there?

Operator

We do have a follow-up question from the line of Chris Danely with J.P. Morgan.

Chris Danely - J.P. Morgan

Thanks, guys. I just wondered if I could just shoot in a few quickies here at the end of the call. Can you talk about your OpEx trends after this quarter? Should we expect them to rise, be flat -- are you looking to cut, enhance? Can you just give us a little commentary there? And then I have a couple of follow-ups.

Lewis Chew

Chris, do you want me to clarify for everyone that that’s not how you pronounce your last name, or do I start calling you Chris Danelly or however he said it?

Chris Danely - J.P. Morgan

Well, I’m already a Jewish guy named Chris, so that probably causes enough confusion, but yeah.

Lewis Chew

He never mispronounces Ross Seymore though, so I don’t know why, but anyway --

Chris Danely - J.P. Morgan

He’s taller and better looking than I am.

Lewis Chew

Probably. That’s not hard to be, though. The OpEx going forward, I think our attitude right now is to try to keep OpEx under control. What we see in the OpEx guidance aside from that one-timer in SG&A that obviously doesn’t repeat next quarter, we are trying to hold it relatively flat, subject to just annual inflation from salary increases and stuff like that.

Clearly as we’ve talked about in the past, the biggest focus of the company right now is on growth while preserving the margins and all that. And I don’t want to make it sound like the classic are you going to grow into your expenses. Our expense ratios right now are still reasonable enough such that we can generate operating margins in the high 20s. We’d like to see those get into the 30s but I think we need some growth to get there.

So we don’t currently have any major plans to cut per se. There always is a piece of expenses that we can flex from a variable standpoint, including you know, incentive compensation and all that. But that’s why this is one of these topics I’m just going to have to keep giving you guidance every quarter, with the attitude that we’re going to try to hold things relatively flat.

Chris Danely - J.P. Morgan

That’s fine, and then, did you guys say that the disti sell-in was less than or more than the sell-out?

Lewis Chew

Sell-out was less than sell-in, because disti inventory went up very slightly in the quarter.

Chris Danely - J.P. Morgan

Okay and the last question is what’s CapEx and depreciation for the quarter and for the fiscal year?

Lewis Chew

CapEx for the quarter was $31 million, depreciation was roughly 34; and for the next quarter, those two numbers will be roughly the same. I don’t actually have all the previous three quarters, so that will give you the year right there.

Chris Danely - J.P. Morgan

That’s fine. Thanks, guys.

Long Ly

All right, so I guess with that, we’re going to end the call today. If you would like a replay of the call, it’s available on our website. Thanks.

Operator

Ladies and gentlemen, this concludes the Q3 FY2008 earnings call. You may now disconnect.

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