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National Semiconductor Corporation’s (NSM - Snapshot Report) earnings for the fourth quarter ended May 2011 were 4 cents higher than the Zacks Consensus estimate of 27 cents.

National’s revenues were strong, despite the disaster in Japan, enabling the company to exceed the guidance provided on the last earnings call. As a result, the gross margin remained steady and operating margin actually improved slightly. Additionally, the tax rate was again lower, helping the company deliver numbers ahead of expectations.

During the quarter, National announced its decision to merge with Texas Instruments (TXN - Analyst Report). You can see our detailed analysis here - TI Snaps Up National Semiconductor

Revenue

National generated revenue of $374.1 million in the fiscal fourth quarter, a sequential increase of 8.8% and a year-over-year decline of 6.1%, exceeding the high-end of management’s guided range of $360-370 million (a 5-8% sequential increase).

National’s results were encouraging, particularly given the fact that the Tsunami in Japan severely impacted its revenue in the last quarter, resulting in a 15% sequential decline in revenues from Japan. However, National benefited from a pickup in industrial demand, particularly in Europe and China, which more than offset the negative impact of Japan.

Revenue by End Market

Industrial, mobile phone, and communications and networking were the largest contributors to National’s revenue in the last quarter.

The industrial market, which generated 49% of total revenue in the last quarter, was up strong double-digits on a sequential basis. National generates most of its industrial business through distributors, where strong sell-through helped the business in Europe and China.

The mobile device segment made up 21% of revenue, which was a sequential decline of 8.6%. National mentioned a few volume customers that cut production in the last quarter, thus impacting its results. However, Taiwanese and Chinese handset players started ramping production, which partially offset this weakness.

Other mobile devices, primarily tablets are yet to gain critical mass at all except Apple Inc (AAPL - Analyst Report) according to National. Management stated that there was no major pickup in IC sales into these models.

The communications infrastructure and networking market grew 8.9%, but stayed at 13% of National’s quarterly revenue. Results were driven by the two largest China-based infrastructure companies. The situation in Japan actually helped National in this respect, since customers built inventories in anticipation of supply chain problems related to the disaster.

Analog products were 91% of revenue in the last quarter compared to 92% in the preceding quarter. Power management products, with a 49% share of total revenue was the largest contributor, followed by amplifier/comparator, with 22%, Interface 11%, Data converters 7% and other 2%. The product lines grew 6.6%, 8.8%, 8.8%, 13.7% and -19.4%, respectively, on a sequential basis. Non-analog products brought in the remaining 9% of revenue, growing 30.5% sequentially.

Orders

National said that orders were up around 21% sequentially and down around 18% from last year. The book-to-bill was over unity, after two disappointing quarters when it dropped below 1. National stated that bookings were slow in March, picking up in April before slowing down a bit in May.

Order growth was strong across geographies. Moreover, orders through distribution increased yet again, while OEM order growth declined due to softness at the handful of mobile phone customers mentioned above.

Operating Performance

National reported fourth quarter gross margin of 66.5%, flat sequentially and down 233 bps from the year-ago quarter. The utilization rate dropped just slightly from 58% to 57%, as the company burnt some inventory during the quarter. This was partially offset by higher revenue growth, particularly in the industrial business.

Operating expenses of $137.8 million increased 6.7% sequentially and declined 13.2% from the May quarter of 2010. However, the strong revenue growth resulted in a 7-bp sequential and 66-bp year-over-year increase in the operating margin. R&D increased very slightly as a percentage of sales, while S&A dropped slightly.

Net Income

National’s pro forma net income in the last quarter was $79.4 million (21.2% of sales) compared to $67.6 million (19.7%) in the preceding quarter and $79.2 million (19.9% of sales in the year-ago quarter.

Including restructuring expenses of $1.1 million and merger-related expenses of $14 million in the last quarter, National’s GAAP net income of $67.1 million ($0.26 per share) was up from $59.4 million ($0.24 per share) in the previous quarter and down from $79.2 million ($0.33 per share) in the comparable year-ago quarter.

Balance Sheet

National ended the quarter with cash and short term investments of $1.13 billion, up $233.2 million during the quarter. However, National has a huge debt balance, as a result of which the net cash position was $90.7 million compared to a net debt of $142.3 million at the beginning of the quarter. The debt-to-total capital ratio also improved to 55.1%, down from 61.6% going into the quarter.

National generated $146.5 million of cash from operations and spent $19.0 million on capex, generating free cash flow at quarter-end of $127.5 million.

Guidance

Given the soon-to-be-closed merger with Taxes Instruments, National did not provide detailed guidance for the next quarter. Management simply stated that both revenue and gross margin were likely to be in the same range as in the last quarter. Operating expenses are also not likely to increase, other than the usual seasonal variances. The weighted average share count is also likely to increase.

Our Recommendation

National has a Zacks Rank of #4, which translates to a short term Sell recommendation. We see a number of negatives, such as weak demand and margin pressures impacting National’s business, although some areas (such as industrial and communications infrastructure) appear to be improving. Additionally, since share prices are hovering around the takeover price of $25, further appreciation is unlikely.

Although cautious, we are more favorably disposed toward peer companies, such as ON Semiconductor (ONNN - Analyst Report) – Zacks #1 Rank (short-term Strong Buy recommendation), as well as Fairchild Semiconductor (FCS - Snapshot Report) and Microchip Technologies (MCHP - Analyst Report), both of which have a Zacks #3 Rank (short-term Hold recommendation).

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