RealMoney Silver - NSM Beats, but Guidance Lackluster

NSM Beats, but Guidance Lackluster
By Gary Dvorchak
RealMoney Contributor
12/6/2007 7:39 PM EST

Updated from Dec. 5 with earnings results

Although "Gnat Semi" reported a good quarter, beating earnings by a couple pennies, the stock is trading down after hours on lackluster guidance. National Semiconductor (NSM) reported EPS of 33 cents, 2 cents ahead of the consensus, on in-line revenue of $499 million.

Gross margin performance was decent at 64.4%; it's a closely watched indicator due to the company's heritage as a commodity parts manufacturer. NSM continues to execute on its plan to upgrade the product line to more value-added parts, thus enabling the better pricing discipline that sustains the margin. The company's penetration across the spectrum of wireless handset offerings -- from entry level phones to the newest Blackberry -- resulted in strong growth in this segment, which is now their largest end market. In contrast, sales into distribution were flat, as distributors continued to draw down inventories for the fourth straight quarter.

Despite good results, management felt compelled to guide fiscal third quarter revenue to a -1% to -5% decline sequentially, which brings the high end of the range below the current Street estimate of $495.6 million. (Naturally, lower volume will push down gross margins for the quarter as well.) Although turns (orders received and shipped within the quarter) picked up in the last four weeks of the quarter, a pronounced slowdown midquarter is making management cautious.

Bookings ended up declining for the quarter, and open backlog was lower than three months earlier. Management is attributing most of this to seasonality, as OEMs come off the holiday-season build, but they were willing to admit that some concern about the economy is creeping into their outlook.

Fortunately, NSM is not the commodity producer of yore. Margin performance in the face of slowing volumes and poor fab utilization (65% this quarter) indicate good pricing power, and the potential for good leverage in an upturn that drives utilization into the 80s or 90s ... when it comes. Nonetheless, NSM is viewed as a DEW (distant early warning) marker for the semi group, due to its off-month reporting cycle. Right now, the DEW is indicating a looming slowdown in semis.

Preview

With analog parts at 91% of revenue, National Semiconductor (NSM) has effectively diminished the wild cyclicality that used to infect its business. (The analog segment is much more stable than other semiconductor segments.) Nevertheless, the semi industry may be starting a new downcycle right now, so all eyes will be on "Gnat Semi" for a tell as to the direction the semi business will take in the next few months.

For the second quarter of 2008, the Street is looking for the company to earn 31 cents per share on $499 million in revenue, which represents solid sequential growth of 5%, but, of course, the order flow and book-to-bill ratio will dominate investor attention.

National Semiconductor is highly leveraged to handsets nowadays, and while there is some market concern due to difficulty at Motorola (MOT) and Ericsson (ERIC) , the company's exposure to higher-end multimedia phones should cushion any volatility.

National Semiconductor does have intriguing margin expansion potential. Gross margins this quarter are expected to be in the mid-60 percentile, not a highly inspiring performance. However, fab utilization is only around 64%, so a pickup in volume in the out quarters could provide material upside to margins.

Longer term, analysts will pick on management to provide better visibility to a higher sustainable revenue growth rate. Over the last five years, National Semiconductor has compounded revenue at only a 5% rate. Granted, this low rate is partially a function of the jettisoning of low-margin commodity parts, and a focusing on high-performance parts at the expense of catalog parts. Going forward, however, investors will demand more growth. Expect a fair amount of commentary on future growth drivers, including efforts in energy efficiency -- "a gigatrend," they are calling it -- and more multimedia capability.

The call starts at 4:30 p.m. EST.