National Semiconductor Corporation’s (NSM) earnings for the third quarter ended February 2011 were 3 cents higher than the Zacks Consensus estimate of 24 cents.
National’s revenues disappointed, with a corresponding negative impact on the gross and operating margin lines. However, the tax rate was again lower, helping the company deliver numbers ahead of expectations. Investors were disappointed, though, as reflected in the 2.14% decline in National’s share prices in the after-market.
Revenue
National generated revenue of $343.9 million in the fiscal third quarter, a sequential decline of 11.9%, a year-over-year decline of 5.0% and just missing the low-end of management’s guided range of $344-359 million.
Revenue was 2.3% shy of the Zacks Consensus Estimate of $399 million. We expected somewhat better results from National, given the fact that Texas Instruments (TXN) reiterated its guidance earlier this week.
The second quarter running, National attributed the decline to 2 factors – the first being continued depletion of distributor inventories and the second a softer than seasonal mobile phone business.
Revenue by End Market
Industrial, mobile phone, and communications and networking were the largest contributors to National’s revenue in the last quarter. Management focus is on the mobile phone and communications infrastructure & networking markets.
Performance in other important markets, especially industrial were not discussed in much detail, possibly because National did not do particularly well there (TI expects industrial revenue to be flat in the fiscal first quarter ended March).
The mobile phone segment made up 25% of revenue. Segment revenue was down around 12% sequentially. National stated that there were some order push-outs, which impacted the business. However, order rates indicate that performance in this segment will pick up next quarter.
In addition to the benefit of orders that should have shipped in the second quarter, the 16% sequential increase in third quarter orders will help results here. National was very optimistic about future growth in this market, mentioning some design wins that were just beginning to make a contribution to revenue.
The communications infrastructure and networking market dropped 11%, but stayed at 13% of National’s quarterly revenue. The reason for the decline was attributed to a drop-off in demand from China (which had accelerated significantly in the last quarter). National also stated that it had won some European customers that would start making a contribution to revenue in the following quarters.
The industrial market, which generated an estimated 43% of total revenue, was down double-digits on a sequential basis and National stated that distributor inventory levels were higher than optimal. Most of the industrial business comes through distributors. However, National painted a rosy picture about its prospects in multiple areas of the industrial market (auto, LED lighting and industrial sensors).
Orders
National said that orders were flattish sequentially, which was encouraging, given the fact that this followed two quarters of sequential decline. Of course the fact that the book-to-bill remained below unity was disappointing.
Management was optimistic about order growth in the mobile phone market, which along with new wins in Europe are expected to generate stronger results in the next quarter. National expects orders to be up sequentially in the fiscal fourth quarter.
Operating Performance
National reported third quarter gross margin of 66.5%, down 238 bps sequentially and 84 bps from the year-ago quarter. The sequential decline was on account of utilization rates dropping from 68% to 58% during the quarter. With revenue strengthening and utilization expected to remain at these levels in the fourth quarter, National now expects third quarter gross margins to range between 66% and 67%.
Operating expenses of $129.1 million dropped 11.2% sequentially and 14.7% from the February quarter of 2010. However, the lower revenue level impacted National’s operating margin, which shrunk 267 bps sequentially, while expanding 343 bps from the year-ago quarter. All expenses increased as a percentage of sales, although the increase in cost of sales was the most significant, followed by R&D and then SG&A.
Net Income
National’s pro forma net income in the last quarter was $67.6 million (19.7% of sales) compared to $83.5 million (21.4%) in the preceding quarter and $59.6 million (16.5% of sales in the year-ago quarter.
Excluding restructuring expenses of $8.2 million in the last quarter, the pro forma net income was $67.6 million, or19.7% of sales, compared to $83.5 million (21.4% of sales) in the last quarter and $59.6 million (16.5% of sales) in the year-ago quarter. National’s GAAP net income was of $59.4 million ($0.27 per share) was down from $83.5 million ($0.34 per share) in the previous quarter and $53.2 million ($0.25 per share) in the comparable year-ago quarter.
Balance Sheet
National ended the quarter with cash and short term investments of $900.3 million, up $21.5 million during the quarter. However, National has a huge debt balance, which brings the net debt (total debt as reduced by cash) at quarter-end to $142.3 million, an improvement from the end of the second quarter. The debt-to-total capital ratio is quite high at 61.6%, although it is an improvement from the 64.0% at the beginning of the quarter.
National generated $59.3 million of cash from operations and spent $34.1 million on capex, or free cash flow at quarter-end of $25.2 million. The company also raised unsecured senior notes and paid off short term obligations. National paid $24.2 million in dividends, but did not repurchase any shares during the quarter.
Guidance
National expects fourth quarter revenue of $360-370 million (a 5-8% sequential increase). This is well below National’s five-year average sequential increase of 18.3% percent (including recession-impacted years). National also expects gross margin of 66-67% and R&D and SG&A of around $132-138 million, which indicates an operating margin in the 29.5% ballpark.
Our Recommendation
National has a Zacks #4 Rank, which translates to a short term Sell recommendation. We see a number of negatives, such as weak demand, continued market share losses and margin pressures impacting National’s business, although some areas (such as mobile and communications infrastructure) may be expected to pick up soon.
Although cautious, we are more favorably disposed toward peer companies, such as Fairchild Semiconductor (FCS) – Zacks #1 Rank (short term Buy recommendation), as well as Analog Devices (ADI) and Microchip Technologies (MCHP), both of which have a Zacks #3 Rank (short-term Hold recommendation).
ANALOG DEVICES (ADI): Free Stock Analysis Report
FAIRCHILD SEMI (FCS): Free Stock Analysis Report
MICROCHIP TECH (MCHP): Free Stock Analysis Report
NATL SEMICON (NSM): Free Stock Analysis Report
TEXAS INSTRS (TXN): Free Stock Analysis Report
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