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Article by DailyStocks_admin    (01-26-09 05:53 AM)

Filed with the SEC from Jan 08 to Jan 14:

National Semiconductor (NSM)
Relational Investors lowered its position to 25,131,618 shares (10.96%), by selling 2.6 million from Jan. 6 to 8 at an average price of $10.77.

BUSINESS OVERVIEW

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in Part I of Form 10-K “Item 1A: Risk Factors” and the business outlook section in Part II of Form 10-K “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements relate to, among other things, sales, gross margins, operating expenses, capital expenditures, R&D efforts, acquisitions of and investments in other companies, and asset dispositions and are indicated by words or phrases such as “anticipate,” “expect,” “outlook,” “foresee,” “believe,” “could,” “intend,” “will,” and similar words or phrases. These statements involve risks and uncertainties that could cause actual results to differ materially from expectations. These forward-looking statements should not be relied upon as predictions of future events as we cannot assure you that the events or circumstances reflected in these statements will be achieved or will occur. For a discussion of some of the factors that could cause actual results to differ materially from our forward-looking statements, see the discussion on “Risk Factors” that appears in Part I, Item 1A of this 2008 Form 10-K and other risks and uncertainties detailed in this and our other reports and filings with the Securities and Exchange Commission (SEC). We undertake no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaim any obligation to do so.



Overview

We are one of the world's leading semiconductor companies focused on analog and mixed-signal integrated circuits. Founded in 1959, we design, develop, manufacture and market high-value, high-performance, analog-intensive solutions that provide more energy efficiency, greater portability, better audio, sharper images and higher performance in electronic systems. We have a diversified product portfolio which includes products such as power management circuits, audio and operational amplifiers, display drivers, communication interface products, and data conversion solutions. Our portfolio of over 13,000 products is sold to a diversified group of end-customers. Energy-efficiency is our overarching theme and our Powerwise® products enable systems that consume less power, extend battery life and generate less heat. We target a broad range of markets and applications such as:



•


wireless handsets


•


automotive applications

•


wireless basestations


•


factory and office automation

•


networks


•


medical applications

•


industrial markets


•


photovoltaic systems

•


a broad range of portable applications









We benefit from an extensive intellectual property portfolio that includes more than 3,000 patents. We are focused on supporting the innovation needed for a strong new product development pipeline. For fiscal 2008, our net sales were $1.9 billion, our operating income was $509.1 million and our net income was $332.3 million.



A large portion of our sales come from analog products that are classified within the standard linear categories (as defined by the World Semiconductor Trade Statistics or WSTS). Standard linear products are defined by WSTS as amplifiers, data converters, regulators and references (power management), and interface products, representing the fundamental circuits that electronic systems need in order to deal with continuously varying signals of the real world, such as light, sound, pressure, temperature and speed. Within the standard linear analog market, our greatest strengths have historically been in the power management, amplifier, and interface areas. We focus on high performance opportunities within the standard linear market, as high performance integrated circuits both have the most stringent performance requirements, enabling us to add the most value to our customers, and tend to be more proprietary in nature, typically resulting in higher gross margins.



Approximately 98 percent of our revenue in fiscal 2008 was generated from analog-based products. Our operations are organized into two groups: the Power Management Group and the Signal Path Group. The Power Management Group is responsible primarily for designing and developing a wide range of integrated circuits that convert and regulate voltages to ensure that electronic systems operate to their fullest potential with the lowest overall power consumption or the highest energy efficiency. The Signal Path Group primarily supplies integrated circuits that handle the requisite analog technology for information or data as it travels from the point where it enters the electronic system, and is conditioned, converted and processed to the point where it is sent out. In addition to providing real world interfaces, these products are used extensively in signal conditioning, signal conversion (from analog to digital and vice versa) and high-speed interfacing applications.

National was incorporated in the state of Delaware in 1959 and our headquarters have been in Santa Clara, California since 1967. Our common stock is listed on the New York Stock Exchange under the trading symbol "NSM." Our fiscal year ends on the last Sunday of May and references in this document to fiscal 2008 refer to our fiscal year ended May 25, 2008. References to fiscal 2007 refer to our fiscal year ended May 27, 2007 and references to fiscal 2006 refer to our fiscal year ended May 28, 2006. Our fiscal 2008, 2007 and 2006 each were 52-week years. On our "Investor Relations" website, located at www.national.com, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, our proxy statement and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. All of the filings on our website are available free of charge. We also maintain certain corporate governance documents on our website, including our Code of Conduct and Ethics, Governance Committee Charter, Compensation Committee Charter, Audit Committee Charter and other Governance Policies. We will provide a printed copy of any of these documents to any shareholder who requests it. We do not intend for information found on our website to be part of this document or part of any other report or filing with the SEC.



Recent Highlights

Throughout fiscal 2008, we continued to focus on analog product areas, particularly higher-performance, higher-value areas where we are able to leverage the increasing need for energy efficiency. As a part of our business focus, we periodically identify opportunities to improve our cost structure or to divest or reduce involvement in product areas that are not in line with our business objectives, as well as pursue acquisitions or business investments to gain access to key technologies that we believe augment our existing technical capability and support our business objectives. For example, in January 2008, we announced that we would dispose of certain manufacturing equipment and reduce the workforce at our wafer fabrication facilities as part of an action to modernize our facilities and rationalize our capacity. In April 2008, we announced a workforce reduction, primarily in product line and support functions, as part of our effort to strategically align resources in connection with our focus on accelerating revenue growth in key market areas that require better power management and energy efficiency.



In June 2007, our Board of Directors approved (i) a $1.5 billion accelerated stock repurchase program; and (ii) an additional $500 million stock repurchase program similar to our existing stock repurchase program announced in March 2007. We entered into two agreements with Goldman, Sachs & Co. (Goldman Sachs) to conduct the accelerated stock repurchase program. See Note 12 to the Consolidated Financial Statements for a more complete discussion of these agreements. We also entered into a $1.5 billion unsecured bridge credit facility with an affiliate of Goldman Sachs and used the funds to finance the accelerated stock repurchase. See Note 9 to the Consolidated Financial Statements for a more complete discussion of the credit facility which was subsequently repaid. The $1.5 billion accelerated stock repurchase program was completed in December 2007 with a total of 58.0 million shares repurchased.



In connection with the accelerated stock repurchase program, we completed a public offering of $1.0 billion of senior unsecured notes in June 2007. The net proceeds from this offering were used to partially repay indebtedness under the unsecured bridge credit facility used to finance the accelerated stock repurchase. In July 2007, we entered into a $500 million unsecured term loan with a consortium of banks and used the funds to repay the remaining amounts outstanding under the unsecured bridge credit facility. See Note 9 to the Consolidated Financial Statements for a more complete discussion of the senior unsecured notes and the bank term loan.



In addition to the accelerated stock repurchase program, we repurchased an additional 27.9 million shares of our common stock during fiscal 2008 for $623.5 million as part of two $500 million stock repurchase programs: (i) the $500 million stock repurchase program announced in March 2007 and (ii) the $500 million stock repurchase program announced in June 2007. All of these shares were repurchased in the open market. For all of fiscal 2008, we repurchased a total of 85.9 million shares of our common stock for $2,123.5 million through both the $1.5 billion accelerated stock repurchase program and the two $500 million stock repurchase programs.



We also continued our dividend program in fiscal 2008, during which time we paid a total of $50.6 million in cash dividends. Subsequent to fiscal year end, on June 3, 2008, our Board of Directors declared a cash dividend of $0.06 per outstanding share of common stock, which was paid on July 7, 2008 to shareholders of record at the close of business on June 16, 2008.

Products

Semiconductors are integrated circuits (in which a number of transistors and other elements are combined to form a more complicated circuit) or discrete devices (such as individual transistors). In an integrated circuit, various components are fabricated in a small area or “chip” of silicon, which is then encapsulated in plastic, ceramic or other advanced forms of packaging and can then be connected to a circuit board or substrate.



We manufacture an extensive range of analog intensive and mixed-signal integrated circuits, which are used in numerous applications. While no precise industry definition exists for analog and mixed-signal devices, we consider products which process analog information or convert analog-to-digital or digital-to-analog as analog and mixed-signal devices.



We are a leading supplier of analog and mixed-signal products, serving both broad based markets such as the industrial, communications, computing, consumer, medical and automotive markets, and more narrowly defined markets such as wireless handsets, displays, personal computers and communications infrastructure. Our analog and mixed-signal devices include:



•


operational and audio amplifiers


•


communication interface circuits

•


power references, regulators and switches


•


flat panel display drivers and signal processors

•


analog-to-digital or digital-to-analog converters


•


radio frequency integrated circuits



Other product offerings that are not analog or mixed-signal include microcontrollers and embedded Bluetooth TM solutions that collectively serve a wide variety of applications in the wireless, personal computer, industrial, automotive, consumer and communication markets.



Our diverse portfolio of intellectual property enables us to develop building block products, application-specific standard products and custom large-scale integrations for our customers. Our high-performance building blocks and application-specific standard products allow our customers to solve challenging technical problems and to differentiate their systems in a way that is beneficial to the end user.



With our leadership in innovative packaging and analog process technology, we can address growth opportunities that depend upon the critical elements of efficiency, physical size and performance. We directly service top tier original equipment manufacturers (OEMs) in a number of markets and we reach a broader range of customers through our franchised distributors.



Corporate Organization

During fiscal 2008, our business operations were organized in two groups: the Power Management Group and the Signal Path Group. Each group is responsible for various product line business units. Many of our products in each group are part of our Powerwise® portfolio of products, which are parts that are deemed to be highly energy efficient relative to the function they are performing.



Power Management Group

The Power Management Group includes four different business units in the power management area: Advanced Power, Infrastructure Power, Mobile Devices Power and Performance Power. The Power Management Group also contains the ASIC & Telecom business unit.



Power management refers to the conversion and management of power consumption in electronic systems. Integrated circuits such as digital processors, analog-to-digital converters and light emitting diodes each require different power sources to operate efficiently. Power management integrated circuits convert and regulate voltages to ensure that electronic systems operate to their fullest potential while achieving the lowest overall power consumption. Our high-performance power management portfolio provides valuable solutions to our customers to solve design problems in space and energy-constrained applications from feature-rich handheld devices to large line-powered systems. We are focusing efforts on developing power management circuits for energy conservation applications.

CEO BACKGROUND
Name
Age* Principal Occupation and Business Experience
Director
Since


Brian L. Halla 61 Mr. Halla is the Chairman of the Board and Chief Executive Officer of National. From 1996 until the beginning of the 2006 fiscal year, he was also President of National. He came to National from LSI Logic Corporation where he was Executive Vice President of LSI Logic Products. He had also held positions at LSI Logic Corporation as Senior Vice President and General Manager, Microprocessor/DSP Products Group and Vice President and General Manager, Microprocessor Products Group. Prior to that, he was with Intel Corporation for 14 years, where his last position was Director of Marketing for Intel's Microcomputer Group. Mr. Halla is a director of Cisco Systems, Inc. 1996

Steven R. Appleton

48

Mr. Appleton is the Chairman of the Board and Chief Executive Officer of Micron Technology, Inc. From 1994 until 2007, he also served as President of Micron. Micron is a leading worldwide provider of semiconductor memory solutions for computer and computer-peripheral manufacturing, consumer electronics, CAD/CAM, office automation, telecommunications, networking, data processing, and graphics display. Mr. Appleton is a director of Micron Technology, Inc.

Gary P. Arnold 66

Mr. Arnold was Chairman, President and Chief Executive Officer of Analogy, Inc., a supplier of product design and simulation software, from 1993 (appointed Chairman in 1994) until 2000. Prior to that, Mr. Arnold was Vice President and Chief Financial Officer of Tektronix, Inc. and had also served as Vice President, Finance and Chief Financial Officer of National from 1983 to 1990. Mr. Arnold has a CPA certification and a B.S. degree in accounting and is a graduate of the law school at the University of Tennessee. Mr. Arnold is a director of Orchids Paper Products Company, Gulfstream International Group, Inc. and the privately held Fab-Tech Incorporated. 1989


MANAGEMENT DISCUSSION FROM LATEST 10K

This MD&A contains a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in Part I of Form 10-K “Item 1A: Risk Factors” and the business outlook section of this MD&A. These statements relate to, among other things, sales, gross margins, operating expenses, capital expenditures, R&D efforts, acquisitions of and investments in other companies, and asset dispositions and are indicated by words or phrases such as “anticipate,” “expect,” “outlook,” “foresee,” “believe,” “could,” “intend,” “will,” and similar words or phrases. These statements involve risks and uncertainties that could cause actual results to differ materially from expectations. These forward-looking statements should not be relied upon as predictions of future events as we cannot assure you that the events or circumstances reflected in these statements will be achieved or will occur. For a discussion of some of the factors that could cause actual results to differ materially from our forward-looking statements, see the discussion on risk factors that appears in Part I, Item 1A of this Form 10-K and other risks and uncertainties detailed in this and our other reports and filings with the SEC. We undertake no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaim any obligation to do so.



This discussion should be read in conjunction with the consolidated financial statements and the accompanying notes included in this Form 10-K for the year ended May 25, 2008.

•


Strategy and Business



We design, develop, manufacture and market a wide range of semiconductor products, most of which are analog and mixed-signal integrated circuits. Our goal is to be the premier provider of high-performance, energy-efficient analog and mixed-signal solutions. We are focused on the following:

•


providing high-performance, analog-intensive solutions that enable customers to effectively differentiate their products;

•


targeting our investments on high-growth and high-return markets, particularly by leveraging our strengths in creating energy-efficient circuits and solutions, many of which will fall under our PowerWise® brand;

•


strengthening and deepening our relationships with customers;

•


using our proprietary technologies to create and maintain our market-leading solutions; and

•


consistently delivering superior returns on invested capital to our shareholders.



A large portion of our sales comes from analog products that are classified within the standard linear categories (as defined by the WSTS). Beyond the standard linear categories, we also sell analog systems and subsystems that can be more specifically targeted at various applications. We look to create analog-intensive solutions that provide more energy efficiency, greater portability, better audio, sharper images and higher performance in electronic systems. Energy-efficiency is our overarching theme and our PowerWise® products enable systems that consume less power, extend battery life and generate less heat. Our leading-edge products include power management circuits, audio and operational amplifiers, display drivers, communication interface products and data conversion solutions. Approximately 98 percent of our net sales in fiscal 2008 came from our Analog segment, compared to approximately 95 percent in fiscal 2007 and approximately 89 percent in fiscal 2006. For more information on our business, see Part I, Item 1, Business, in this Form 10-K for the fiscal year ended May 25, 2008.

•Critical Accounting Policies and Estimates


We believe the following critical accounting policies are those policies that have a significant effect on the determination of our financial position and results of operations. These policies also require us to make our most difficult and subjective judgments:




a)


Revenue Recognition

We recognize revenue from the sale of semiconductor products upon shipment, provided we have persuasive evidence of an arrangement typically in the form of a purchase order, title and risk of loss have passed to the customer, the amount is fixed or determinable and collection of the revenue is reasonably assured. We record a provision for estimated future returns at the time of shipment. Approximately 54 percent of our semiconductor product sales were made to distributors in fiscal 2008, compared to approximately 55 percent in fiscal 2007 and approximately 51 percent in fiscal 2006. We have agreements with our distributors that cover various programs, including pricing adjustments based on resale pricing and volume, price protection for inventory and scrap allowances. The revenue we record for these distribution sales is net of estimated provisions for these programs. When determining this net distribution revenue, we must make significant judgments and estimates. Our estimates are based upon historical experience rates by geography and product family, inventory levels in the distribution channel, current economic trends, and other related factors. Actual distributor claims activity has been materially consistent with the provisions we have made based on our estimates. However, because of the inherent nature of estimates, there is always a risk that there could be significant differences between actual amounts and our estimates. Our financial condition and operating results are dependent on our ability to make reliable estimates, and we believe that our estimates are reasonable. However, different judgments or estimates could result in variances that might be significant to our operating results.



Service revenues are recognized as the services are provided or as milestones are achieved, depending on the terms of the arrangement. These revenues are included in net sales and totaled $25.1 million in fiscal 2008, $33.9 million in fiscal 2007 and $47.8 million in fiscal 2006.



Certain intellectual property income is classified as revenue if it meets specified criteria established by company policy that defines whether it is considered a source of income from our primary operations. These revenues are included in net sales and totaled $1.6 million in fiscal 2008, $2.8 million in fiscal 2007 and $5.3 million in fiscal 2006. All other intellectual property income that does not meet the specified criteria is not considered a source of income from primary operations and is therefore classified as a component of other operating income, net, in the consolidated statement of income. Intellectual property income is recognized when the license is delivered, the fee is fixed or determinable, collection of the fee is reasonably assured and remaining obligations are perfunctory or inconsequential to the other party.






b)


Valuation of Inventories

Inventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market. The total carrying value of our inventory is reduced for any difference between cost and estimated market value of inventory that is determined to be obsolete or unmarketable, based upon assumptions about future demand and market conditions. Reductions in carrying value are deemed to establish a new cost basis. Inventory is not written up if estimates of market value subsequently improve. We evaluate obsolescence by analyzing the inventory aging, order backlog and future customer demand on an individual product basis. If actual demand were to be substantially lower than what we have estimated, we may be required to write inventory down below the current carrying value. While our estimates require us to make significant judgments and assumptions about future events, we believe our relationships with our customers, combined with our understanding of the end-markets we serve, provide us with the ability to make reasonable estimates. The actual amount of obsolete or unmarketable inventory has been materially consistent with previously estimated write-downs we have recorded. We also evaluate the carrying value of inventory for lower-of-cost-or-market on an individual product basis, and these evaluations are intended to identify any difference between net realizable value and standard cost. Net realizable value is used as a measure of market for purposes of evaluating lower-of-cost-or-market and is determined as the selling price of the product less the estimated cost of disposal. When necessary, we reduce the carrying value of inventory to net realizable value. If actual market conditions and resulting product sales were to be less favorable than what we have projected, additional inventory write-downs may be required.


c)Impairment of Goodwill, Intangible Assets and Other Long-lived Assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable from the estimated future cash flows expected to result from their use and eventual disposition. Our long-lived assets subject to this evaluation include property, plant and equipment and amortizable intangible assets. Amortizable intangible assets subject to this evaluation include developed technology we have acquired, patents and technology licenses. We assess the impairment of goodwill annually in our fourth fiscal quarter and whenever events or changes in circumstances indicate that it is more likely than not that an impairment loss has been incurred. We are required to make judgments and assumptions in identifying those events or changes in circumstances that may trigger impairment. Some of the factors we consider include:

•significant decrease in the market value of an asset;

•significant changes in the extent or manner for which the asset is being used or in its physical condition;

•significant change, delay or departure in our business strategy related to the asset;

•significant negative changes in the business climate, industry or economic conditions; and •


current period operating losses or negative cash flow combined with a history of similar losses or a forecast that indicates continuing losses associated with the use of an asset.



Our impairment evaluation of long-lived assets includes an analysis of estimated future undiscounted net cash flows expected to be generated by the assets over their remaining estimated useful lives. If the estimated future undiscounted net cash flows are insufficient to recover the carrying value of the assets over the remaining estimated useful lives, we record an impairment loss in the amount by which the carrying value of the assets exceeds the fair value. We determine fair value based on discounted cash flows using a discount rate commensurate with the risk inherent in our current business model. Major factors that influence our cash flow analysis are our estimates for future revenue and expenses associated with the use of the asset. Different estimates could have a significant impact on the results of our evaluation. If, as a result of our analysis, we determine that our amortizable intangible assets or other long-lived assets have been impaired, we will recognize an impairment loss in the period in which the impairment is determined. Any such impairment charge could be significant and could have a material adverse effect on our financial position and results of operations.



Our impairment evaluation of goodwill is based on comparing the fair value to the carrying value of our reporting units containing goodwill. Our reporting units are based on our operating segments as defined under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The fair value of a reporting unit is measured at the business unit level using a discounted cash flow approach that incorporates our estimates of future revenues and costs for those business units. As of May 25, 2008 our reporting units containing goodwill include our advanced power, ASIC & telecom, data conversion, infrastructure power products, interface, mobile devices power products, non-audio amplifier and performance power products business units, all of which are operating segments within our Analog reportable segment. The estimates we use in evaluating goodwill are consistent with the plans and estimates that we use to manage the underlying businesses. If we fail to deliver new products for these business units, if the products fail to gain expected market acceptance, or if market conditions for these business units fail to materialize as anticipated, our revenue and cost forecasts may not be achieved and we may incur charges for goodwill impairment, which could be significant and could have a material adverse effect on our results of operations.

d)


Income Taxes

We determine deferred tax assets and liabilities based on the future tax consequences that can be attributed to net operating loss and credit carryovers and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, using the enacted tax rate expected to be applied when the taxes are actually paid or recovered. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which the net operating loss and credit carryovers and differences between financial statement carrying amounts and their respective tax bases become deductible. In determining a valuation allowance, we consider past performance, expected future taxable income and prudent and feasible tax planning strategies. We currently have a valuation allowance that has been established primarily against the reinvestment and investment tax credits related to our operation in Malaysia, as we have concluded that a significant portion of the deferred tax assets will not be realized due to the uncertainty of sufficient taxable income in Malaysia beyond the foreseeable future. Our forecast of expected future taxable income is based on historical taxable income and projections of future taxable income over the periods that the deferred tax assets are deductible. Changes in market conditions that differ materially from our current expectations and changes in future tax laws in the United States and international jurisdictions or changes in our tax structure may cause us to change our judgments of future taxable income. These changes, if any, may require us to adjust the existing tax valuation allowance higher or lower than the amount we currently have recorded; such an adjustment could have a material impact on the tax expense for the fiscal year.



The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Although FASB Interpretation No. 48 (FIN 48), which we adopted at the beginning of fiscal 2008, provides further clarification on the accounting for uncertainty in income taxes recognized in the financial statements, the new threshold and measurement attribute prescribed by FIN 48 will continue to require significant judgment by management. If the ultimate resolution of tax uncertainties is different from what we have currently estimated, this could have a material impact on income tax expense.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

This MD&A contains a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in Part II of Form 10-Q “Item 1A: Risk Factors” and business outlook section of this MD&A. These statements relate to, among other things, sales, gross margins, operating expenses, capital expenditures, R&D efforts, asset dispositions, acquisition of and investments in other companies, and are indicated by words or phrases such as “anticipate,” “expect,” “outlook,” “foresee,” “believe,” “could,” “intend,” “will,” and similar words or phrases. These statements involve risks and uncertainties that could cause actual results to differ materially from expectations. These forward-looking statements should not be relied upon as predictions of future events as we cannot assure you that the events or circumstances reflected in these statements will be achieved or will occur. For a discussion of some of the factors that could cause actual results to differ materially from our forward-looking statements, see the discussion on risk factors that appears in Part II, Item 1A of this Form 10-Q and other risks and uncertainties detailed in this and our other reports and filings with the Securities and Exchange Commission. We undertake no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaim any obligation to do so.



This discussion should be read in conjunction with the consolidated financial statements and the accompanying notes included in this Quarterly Report on Form 10-Q for the period ended November 23, 2008 and in our Annual Report on Form 10-K for the fiscal year ended May 25, 2008.

Strategy and Business

We design, develop, manufacture and market a wide range of semiconductor products, most of which are analog and mixed-signal integrated circuits. Our goal is to be the premier provider of high-performance, energy-efficient analog and mixed-signal solutions. We are focused on the following:



•


providing high-performance, analog-intensive solutions that enable customers to effectively differentiate their products;

•


targeting our investments on high-growth and high-return markets, particularly by leveraging our strengths in creating energy-efficient circuits and solutions, many of which will fall under our PowerWise® brand;

•


strengthening and deepening our relationships with customers;

•


using our proprietary technologies to create and maintain our market-leading solutions; and

•


consistently delivering superior returns on invested capital to our shareholders.



A large portion of our sales comes from analog products that are classified within the analog standard linear categories (as defined by the World Semiconductor Trade Statistics or WSTS). Beyond the standard linear categories, we also sell analog systems and subsystems that can be more specifically targeted at various applications. We look to create analog-intensive solutions that provide more energy efficiency, greater portability, better audio, sharper images and higher performance in electronic systems. Energy-efficiency is our overarching theme and our PowerWise® products enable systems that consume less power, extend battery life and generate less heat. Our leading-edge products include power management circuits, audio and operational amplifiers, communication interface products and data conversion solutions. Approximately 98 percent of our net sales in the first six months of fiscal 2009 came from our Analog segment, which is comparable to 97 percent in the first six months of fiscal 2008. For more information on our business, see Part I, Item 1, Business, in our Annual Report on Form 10-K for the fiscal year ended May 25, 2008.

Critical Accounting Policies and Estimates

We believe the following critical accounting policies are those policies that have a significant effect on the determination of our financial position and results of operations. These policies also require us to make our most difficult and subjective judgments:


a)


Revenue Recognition

We recognize revenue from the sale of semiconductor products upon shipment, provided we have persuasive evidence of an arrangement typically in the form of a purchase order, title and risk of loss have passed to the customer, the amount is fixed or determinable and collection of the revenue is reasonably assured. We record a provision for estimated future returns at the time of shipment. Approximately 52 percent of our semiconductor product sales were made to distributors in the first six months of fiscal 2009, compared to approximately 54 percent

in the first six months of fiscal 2008. We have agreements with our distributors that cover various programs, including pricing adjustments based on resale pricing and volume, price protection for inventory and scrap allowances. The revenue we record for these distribution sales is net of estimated provisions for these programs. When determining this net distribution revenue, we must make significant judgments and estimates. Our estimates are based upon historical experience rates by geography and product family, inventory levels in the distribution channel, current economic trends, and other related factors. Actual distributor claims activity has been materially consistent with the provisions we have made based on our estimates. However, because of the inherent nature of estimates, there is always a risk that there could be significant differences between actual amounts and our estimates. Our financial condition and operating results are dependent on our ability to make reliable estimates, and we believe that our estimates are reasonable. However, different judgments or estimates could result in variances that might be significant to our operating results.



Service revenues are recognized as the services are provided or as milestones are achieved, depending on the terms of the arrangement. These revenues are included in net sales and totaled $9.4 million in the first six months of fiscal 2009 and $13.6 million in the first six months of fiscal 2008.



Certain intellectual property income is classified as revenue if it meets specified criteria established by company policy that defines whether it is considered a source of income from our primary operations. These revenues are included in net sales and totaled $1.0 million in each of the first six months of fiscal 2009 and fiscal 2008. All other intellectual property income that does not meet the specified criteria is not considered a source of income from primary operations and is therefore classified as a component of other operating income, net, in the consolidated statement of income. Intellectual property income is recognized when the license is delivered, the fee is fixed or determinable, collection of the fee is reasonably assured and remaining obligations are perfunctory or inconsequential to the other party.






b)


Valuation of Inventories

Inventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market. The total carrying value of our inventory is reduced for any difference between cost and estimated market value of inventory that is determined to be obsolete or unmarketable, based upon assumptions about future demand and market conditions. Reductions in carrying value are deemed to establish a new cost basis. Inventory is not written up if estimates of market value subsequently improve. We evaluate obsolescence by analyzing the inventory aging, order backlog and future customer demand on an individual product basis. If actual demand were to be substantially lower than what we have estimated, we may be required to write inventory down below the current carrying value. While our estimates require us to make significant judgments and assumptions about future events, we believe our relationships with our customers, combined with our understanding of the end-markets we serve, provide us with the ability to make reasonable estimates. The actual amount of obsolete or unmarketable inventory has been materially consistent with previously estimated write-downs we have recorded. We also evaluate the carrying value of inventory for lower-of-cost-or-market on an individual product basis, and these evaluations are intended to identify any difference between net realizable value and standard cost. Net realizable value is used as a measure of market for purposes of evaluating lower-of-cost-or-market and is determined as the selling price of the product less the estimated cost of disposal. When necessary, we reduce the carrying value of inventory to net realizable value. If actual market conditions and resulting product sales were to be less favorable than what we have projected, additional inventory write-downs may be required.






c)


Impairment of Goodwill, Intangible Assets and Other Long-lived Assets

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable from the estimated future cash flows expected to result from their use and eventual disposition. Our long-lived assets subject to this evaluation include property, plant and equipment and amortizable intangible assets. Amortizable intangible assets subject to this evaluation include developed technology we have acquired, patents and technology licenses. We assess the impairment of goodwill annually in our fourth fiscal quarter and whenever events or changes in circumstances indicate that it is more likely than not that an impairment loss has been incurred. We are required to make judgments and assumptions in identifying those events or changes in circumstances that may trigger impairment. Some of the factors we consider include:

•significant decrease in the market value of an asset;

•significant changes in the extent or manner for which the asset is being used or in its physical condition;

•significant change, delay or departure in our business strategy related to the asset;

•significant negative changes in the business climate, industry or economic conditions; and •


current period operating losses or negative cash flow combined with a history of similar losses or a forecast that indicates continuing losses associated with the use of an asset.



Our impairment evaluation of long-lived assets includes an analysis of estimated future undiscounted net cash flows expected to be generated by the assets over their remaining estimated useful lives. If the estimated future undiscounted net cash flows are insufficient to recover the carrying value of the assets over the remaining estimated useful lives, we record an impairment loss in the amount by which the carrying value of the assets exceeds the fair value. We determine fair value based on discounted cash flows using a discount rate commensurate with the risk inherent in our current business model. Major factors that influence our cash flow analysis are our estimates for future revenue and expenses associated with the use of the asset. Different estimates could have a significant impact on the results of our evaluation. If, as a result of our analysis, we determine that our amortizable intangible assets or other long-lived assets have been impaired, we will recognize an impairment loss in the period in which the impairment is determined. Any such impairment charge could be significant and could have a material adverse effect on our financial position and results of operations.



Our impairment evaluation of goodwill is based on comparing the fair value to the carrying value of our reporting units containing goodwill. Our reporting units are based on our operating segments as defined under SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” The fair value of a reporting unit is measured at the business unit level using a discounted cash flow approach that incorporates our estimates of future revenues and costs for those business units. As of November 23, 2008 our reporting units containing goodwill include our advanced power, ASIC & telecom, data conversion, infrastructure power products, interface, mobile devices power products, non-audio amplifier and performance power products business units, all of which are operating segments within our Analog reportable segment. The estimates we use in evaluating goodwill are consistent with the plans and estimates that we use to manage the underlying businesses. If we fail to deliver new products for these business units, if the products fail to gain expected market acceptance, or if market conditions for these business units fail to materialize as anticipated, our revenue and cost forecasts may not be achieved and we may incur charges for goodwill impairment, which could be significant and could have a material adverse effect on our results of operations.






d)


Income Taxes

We determine deferred tax assets and liabilities based on the future tax consequences that can be attributed to net operating loss and credit carryovers and differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, using the enacted tax rate expected to be applied when the taxes are actually paid or recovered. The recognition of deferred tax assets is reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. The ultimate realization of deferred tax assets depends upon the generation of future taxable income during the periods in which the net operating loss and credit carryovers and differences between financial statement carrying amounts and their respective tax bases become deductible. In determining a valuation allowance, we consider past performance, expected future taxable income and prudent and feasible tax planning strategies. We currently have a valuation allowance that has been established primarily against the reinvestment and investment tax credits related to our operation in Malaysia, as we have concluded that the deferred tax assets will not be realized due to a tax holiday granted by the Malaysian government that will be effective for a ten-year period beginning in our fiscal 2010 and the uncertainty of sufficient taxable income in Malaysia beyond the foreseeable future. Our forecast of expected future taxable income is based on historical taxable income and projections of future taxable income over the periods that the deferred tax assets are deductible. Changes in market conditions that differ materially from our current expectations and changes in future tax laws in the United States and international jurisdictions or changes in our tax structure may cause us to change our judgments of future taxable income. These changes, if any, may require us to adjust the existing tax valuation allowance higher or lower than the amount we currently have recorded; such an adjustment could have a material impact on the tax expense for the fiscal year.



The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Although FASB Interpretation No. 48 (FIN 48), which we adopted at the beginning of fiscal 2008, provides further clarification on the accounting for uncertainty in income taxes recognized in the financial statements, the threshold and measurement attribute prescribed by FIN 48 will continue to require significant judgment by management. If the ultimate resolution of tax uncertainties is different from what we have currently estimated, the effect of such resolution on our income tax expense could be material. e)


Share-based Compensation

We measure and record compensation expense for all share-based payment awards based on estimated fair values in accordance with SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123 (R)). We provide share-based awards to our employees, executive officers and directors through various equity compensation plans including our employee equity, stock option, stock purchase and restricted stock plans. The fair value of stock option and stock purchase equity awards is measured at the date of grant using a Black-Scholes option pricing model and the fair value of restricted stock awards is based on the market price of our common stock on the date of grant. In determining fair value using the Black-Scholes option pricing model, management is required to make certain estimates of the key assumptions such as expected life, expected volatility, dividend yields and risk free interest rates. The estimates of these key assumptions involve judgment regarding subjective future expectations of market price and trends. The assumptions used in determining expected life and expected volatility have the most significant effect on calculating the fair value of share-based awards. For all options granted after December 31, 2007, we determine expected life based on historical stock option exercise experience for the last four years, adjusted for our expectation of future exercise activity. For options granted prior to January 1, 2008, we use the simplified method specified by the SEC’s Staff Accounting Bulletin No. 107 to determine the expected life of stock options. Expected volatility is based on implied volatility, as management has determined that implied volatility better reflects the market’s expectation of future volatility than historical volatility. If we were to determine that another method to estimate these assumptions was more reasonable than our current methods, or if another method for calculating these assumptions were to be prescribed by authoritative guidance, the fair value for our share-based awards could change significantly. If the expected volatility and/or expected life were increased under our assumptions, then the Black-Scholes computation of fair value would also increase, thereby resulting in higher compensation costs being recorded.



SFAS No. 123(R) also requires forfeitures to be estimated at the date of grant. Our estimate of forfeitures is based on our historical activity, which we believe is indicative of expected forfeitures. In subsequent periods if the actual rate of forfeitures differs from our estimate, the forfeiture rates may be revised, as necessary. Changes in the estimated forfeiture rates can have a significant effect on share-based compensation expense since the effect of adjusting the rate is recognized in the period the forfeiture estimate is changed.



We also grant performance share units to executive officers that require us to estimate expected achievement of performance targets over a two-year performance period. This estimate involves judgment regarding future expectations of various financial performance measures such as those described in the overview section below. If there are changes in our estimate of the level of financial performance measures expected to be achieved, the related share-based compensation expense may be significantly increased or reduced in the period that our estimate changes.

Overview

We focus on providing leading-edge analog solutions with a large portion of our sales classified within the analog standard linear categories, which the WSTS defines as amplifiers, data converters, regulators and references (power management products), and interface products. In the first six months of fiscal 2009, approximately 98 percent of our total sales came from our Analog segment, compared to 97 percent in the first six months of fiscal 2008. We believe that the success we have achieved in these markets has been driven by our understanding of the analog markets and our circuit design capabilities, especially as they pertain to energy efficiency that is enabled by our products. Our success has also been due to our innovative packaging and proprietary analog process technology, as well as our comprehensive manufacturing supply and logistics network.



Although net sales were lower in the second quarter and first six months of fiscal 2009 compared to sales in the second quarter and first six months of fiscal 2008, we achieved a higher gross margin percentage in both the second quarter and first six months of fiscal 2009 compared to the same periods in fiscal 2008. Our performance in gross margin percentage is attributable to ongoing improvement in our sales mix of higher-value analog products, as well as continued improvements in manufacturing efficiencies and execution relative to the level of factory utilization. We continue to direct our research and development investments on high-value growth areas in analog markets and applications, with particular focus on power management and energy efficiency where our PowerWise® products enable systems that consume less power, extend battery life and generate less heat.

CONF CALL

Mark Veeh

Thank you. I’d like to welcome everyone to National Semiconductor’s second quarter fiscal year 2009 earnings call. Joining me on the call today are Brian Halla, Chairman and Chief Executive Officer; Lewis Chew, Chief Financial Officer and Don Macleod, President and Chief Operating Officer.

In today’s call I will provide a recap of the second 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 second quarter results and provide the background to our outlook for the third quarter of fiscal year 2009. Lastly, Don Macleod will then discuss market trends and products in more detail. We will then take questions until approximately 2:30 p.m. Pacific Standard Time.

As a reminder, this call will contain forward-looking statements that involve risk factors that could cause National’s results to differ materially from management’s current expectations. 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.

Also in compliance with SEC Regulation FD, this call is being broadcast live over our Investor Relations website. For those of you who 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.

Now moving on to our second quarter results as follows.

Sales were $422 million, down 9% from $466 million in the previous quarter and down 15% from $499 million in last year’s second quarter. Gross margins for the quarter were 65.6% down from 66% in the prior quarter and up from 64.4% in last year’s second quarter.

Operating expenses in the quarter were $164.1 million down from $174.7 million in the prior quarter. Note that for this quarter other non operating expense of $12.3 million consisted of a drop of the value of employee deferred compensation investments that are held in a trust on behalf of the employees. A corresponding credit of $12.3 million is included in Q2 SG&A expense. This credit represents the corresponding change in the liability associated with the employee deferred compensation plan due to the change in the market value of these securities. You can find a description of this deferred compensation plan and related disclosure on page 53 of our fiscal 2008 form 10K.

Also included in our GAAP financial results this quarter was a $28.1 million expense for severance and restructure primarily associated with severances in connection with our previously announced actions on November 12, 2008.

So now moving on to the rest of our income statement, net interest was $14.9 million and the income tax expense for the quarter was $23.5 million. Included in this number is approximately $7 million of discrete tax expense that has been highlighted in today’s press release. As a result, National posted GAAP net earnings of $33.9 million or $0.14 per fully diluted share in Q2 fiscal 2009. The fully diluted share count for the second quarter was 234 million shares.

Before I turn it over to Brian I would like to remind everyone that our fiscal third quarter 2009 will contain one additional week versus the company’s physical 13-week quarter.

With that I will now turn it over to Brian.

Brian Halla

Thank you Mark. Good afternoon everyone. A lot has changed since most of us met in September in New York for our annual analysts meeting so let me try to ease into this commentary by making an assumption about why you decided to join us today on this call.

First, obviously you would like to find out what is happening in our business given this environment and if National has been affected by this environment how so and what are we doing to respond? And what does all this say about our future? Finally, what is our company’s progress against our National 3.0 initiatives?

I’ll try to respond to these questions and others by using a metaphor of one of my favorite spaghetti westerns, The Good, The Bad and the Ugly. I’ll add a category that I’ll call the best.

So let’s start with the good. Of course you are all entitled to your own assessment but National Semiconductor over the years has become a very good company. We have rock solid fundamentals. I believe in many ways we have gotten ahead of our peers with our repositioning of the company last year to National 3.0.

Also as a result of our corresponding focus on new emerging markets which I will discuss in a minute, we have successfully abandoned the silicone by the pound commodity markets and dramatically improved the value add of our technology and building block products.

The disproportionately healthy trends of those products within our portfolio is a testimony to that decision. We have become quite profitable as a company as the result of the success of our five-year 60/30/30 march and corresponding repositioning of our company into a pure play high performance analog company. These profits allowed us to achieve five straight fiscal years of ROIC above 20%. We have outstanding engineering and manufacturing resources and last month’s action allowed us to cut costs and at the same time put the right level of resources of the company firmly behind the arrowhead we call National 3.0.

So let’s talk about the bad. After achieving peer group status as a high performance analog company, one thing became quite clear immediately. This sector appears to have been under performing for some time. By that I mean the stock prices of all these companies haven’t moved in five years. The PE ratios of these companies have been knocked down from the 30’s to the low teens even before the current market meltdown.

The popular market demand drivers such as the cell phone have seen ASP erosion unable to be offset by the volume growth of those products. So National a year ago last fall decided to move on beyond the easy money and we were determined to meet the new mega trends which would become the volume drivers in the next cycle with systems and application solutions. Solutions which would be derived based on innovation within and collaboration across our analog, standard and linear product lines. This focus is now beginning to bear fruit.

So that brings us up to the ugly. What started as a sub-prime debacle which many of us through would be an inch and a half wide and a mile and a half deep and leaving our consumers largely unaffected has now begun to have its deleterious consequences on consumer confidence worldwide?

We put in place cost cutting actions which included a nearly 5% reduction in headcount, consolidation of some design centers which primarily supported the more traditional standard linear product lines and we reallocated resources strategically to support our new thrust.

Going forward National is also using additional aggressive variable cost controls in the areas of restricted discretionary spending and selected shut down and official vacation days. The tea leaves are right now difficult at best to try to read. So going forward we are guiding down approximately 30% plus or minus depending on the level of turns orders received during the quarter.

Some of you may be trying to compare this recession with the most recent bursting of the dot com bubble in 2001. That was a relatively short-lived recession. It was a period of time in which consumers kept consuming and U.S. semiconductor and system suppliers had to hunker down and ride out the time it took for the excess inventory in the channel to work itself off.

This is not that type of recession as it was not caused by excess inventory in the channel. Instead, consumers have all but stopped consuming. For those of you asking when this cycle is behind us tell me when consumer confidence will return. When this credit return is the lubricant that drives the world’s economic engine as we knew it, so this is not a hunker down recession. This is a time to invest recession.

Which brings us from the good, the bad and the ugly to the best. This is the best possible time for National to put even more emphasis on the transition to National 3.0. The old demand drivers as we knew them will not pull us out of this recession. The semiconductor industry has always seen the major up cycles driven by new markets and new demand drivers. The first boom cycle was the DRAM driven market which replaced ferrite core magnets in the back of mainframe computers. The second cycle was driven by the PC. The third cycle by the connected PC or the Internet and the one behind us driven by cell phones and many consumer goods and gadgets.

Never has a new boom cycle been launched only by the prior cycles innovation or demand drivers. So National’s strategy is to drive our own recovery by being early in building solutions to support the needs of the new mega trends. Let me keep going on the best.

This is the very best time to be a leader in power efficient solutions such as our PowerWise high performance circuits. We are focusing these circuits and systems such as our recently announced SolarMagic which can return up to 50% of the power to the solar power stream suffering from shade or debris. We can use these same power efficient circuits to manage battery technology to make electric cars more viable. We also focus these circuits on driving much more power efficient LED lighting systems. This same family of PowerWise products will enable medical instrumentation which can distribute healthcare into the home instead of the current centralized model which bears characteristics similar to the old mainframe computer’s centralized compute model.

These are the same power efficient circuits that can also allow data centers to consume much less power for servers and corresponding air conditioning and reduce CO2 emissions by millions of tons in the process.

Improvements in personal productivity through personal mobile device enhancements and new innovations in sensor technology are now also targets for our company’s R&D dollars going forward.

So we will move on from the bad and the ugly with PowerWise driven solutions to the new mega trends we believe will drive the next cycle for our industry and we welcome our peers to follow. This is not a hunker down recession. It is time for our industry to drive its own recovery.

Over to you Lewis.

Lewis Chew

Thanks Brian. So as you have all heard by now the revenue outlook we are guiding for the third quarter is down about 30% sequentially plus or minus depending on turns. The punch line is our opening backlog was down significantly and our guidance is not anticipating any snap back in turns orders in the quarter.

So on my portion of the call today I will provide more depth on the basis for this revenue outlook and then I will discuss the implications of how we run the business model technically here in the near term until the level of business picks back up again.

When I refer to the business model I am mainly referring to a few, key topics. Factory activity which impacts gross margin and inventories, operating expenses which we are planning to bring down and cash management. Later on in this call Don MacLeod will talk more about our growth initiatives.

So let me move on to discussing the basis for the revenue outlook beginning with how the second quarter transpired. When I look back at the first few weeks of September we were getting a relatively decent amount of new orders. Recall also that we started off Q2 with a higher opening backlog. But near the end of September we saw a steep drop off in order rates across the board as the economy was deteriorating and our customers as well as distributors began to behave much more cautiously.

Then in early November we saw yet another decline in the level of orders as companies made even further adjustments to what they planned to build in for the holiday season. Ultimately our total bookings in Q2 were more than 30% below what they were in Q1.

This decline was also reflected in turns orders which are orders placed with delivery requested in the same quarter. We started off Q2 with good turns orders for the first few weeks, but for the remainder of the quarter net turns all but disappeared as any new turns orders were essentially offset by negative turns due to push outs and cancellations. The largest market we serve is the wireless handset market and this is where we saw the largest adjustments. In other words bookings drop off and negative turns activity.

We also saw decreasing order rates in our distribution channel where resale’s were down sequentially in Q2 by nearly 10%. In a more typical year the distributor resale’s would be up seasonally in our November quarter. Turns orders from the distribution channel were positive but were lower than we had originally expected at the beginning of the quarter.

Distributor inventory dollars were down quarter-over-quarter and weeks of distributor inventory at the end of Q2 were about 9.5 weeks. Based on the input we received, we anticipate that distributor resale’s will likely be down again in Q3 and distributor inventory dollars will be reduced even further.

So with all that background it boils down to the fact that opening backlog is down significantly and this is the main factor driving our revenue outlook for Q3. Turns orders are difficult to predict with precision in this economy. How is that for an understatement? So our revenue outlook assumes a modest amount of turns, below the level we saw in Q2. We are also assuming that overall booking rates will continue to run at suppressed levels in Q3 until our customers gain more confidence and visibility in the real level of in-demand. With the significant decline in revenue here in the short-term we are lowering our manufacturing activity significantly.

Our wafer fab utilization was about 66% in Q2 and we are planning to drop that to below 40% in Q3. Our inventories grew by about $6 million in Q2 mainly because of the revenue miss but in Q3 we are planning to hold inventory flat to slightly down.

Our gross margin was about 65% in Q2 and that is expected to drop to a range of 54-55% in Q3. This decline in gross margin is mainly due to the lower capacity utilization as we currently manufacture well over 90% in house.

We will control our production spending through a combination of ways including factory shut downs, work furloughs and shift reductions. We will continue to improve the overall cost structure in a way such that gross margins will be incrementally better at comparable revenue levels when business picks up again.

In November we announced an action to reduce headcount and lower the company’s operating expenses on a go forward basis. The total targeted savings from this action is about $12 million per quarter. In addition to that headcount reduction we are also using other more temporary ways to control expenses in the third quarter such as shut down days and restrictions on discretionary spending.

So here are the estimated expenses for Q3 and in these projections I have now incorporated the impact from all of our cost saving measures for Q3 as well as any offsetting impact from the extra week that falls into the quarter this year.

R&D is anticipated to range from $80-82 million. SG&A is estimated to range between $78-80 million. Earlier in the call you heard Mark explain the credit we had in the Q2 SG&A which I am not projecting to repeat in the Q3 SG&A.

Other income expense is estimated at $1 million of expense. Interest expense net is projected to run from $16-17 million and this is higher than the $15 million we had in Q2 mainly because of the extra week in Q3. So the net interest expense should decline in Q4.

The income tax rate is projected to range from 30-31%. Embedded in the figures I covered are stock compensation expenses of approximately $21 million in Q3.

Here is a breakout by the various line items impacted. Cost of sales $5 million, R&D $7 million and SG&A $9 million.

Let’s move onto the balance sheet.

Our capital expenditures in Q2 were about $35 million. In Q3 we anticipate capital spending will be around $20 million as we continue to work on the 8” conversion projects in our Texas and Scotland wafer fabs.

Our days of inventory at the end of Q2 were about 97 days, up from 86 days in Q1. The actual inventory dollars were up about $6 million from $149 million to $155 million and as I mentioned earlier we plan to hold inventory dollars slightly down in Q3.

Our days of receivables at the end of Q2 was about 27 days, which was at the low end of our range due to the timing of sales being higher in the earlier part of the quarter.

Our past reserves ended Q2 at $786 million compared to $693 million in Q1 as we generated significant cash from operations during the quarter.

During Q2 we bought back $23 million of stock which is lower than what we have typically done in past quarters and that is because we are managing our cash a bit more conservatively to give us more flexibility in light of the ongoing global credit crisis.

Operating margin in Q2 was about 24% down from 29% in Q1 and this excludes the impact of the one-time severances and SG&A credit and return on invested capital was about 17% in Q2 versus 23% in Q1. Both of these measures include the impact of stock compensation expense.

So in the near term it is clear the drop in revenue levels have a negative impact on our operating margins. I have already discussed some of the key things we are doing to lower our expenses and reduce our production. At the same we have continued to prioritize the company’s investments to focus on selected markets that have good potential for growth and which play to our strengths in energy efficiency?

To talk more about that here is Don MacLeod.

Donald MacLeod

Thank you Lewis. First I’ll talk about our progress on some of our National 3.0 initiatives. Then I’ll talk about market and product related trends that are reflected in our results in the quarter.

First our new initiatives focused on the energy efficiency and energy conservation mega trend. Our most visible initiative here is in the area of solar energy efficiency. Our SolarMagic solution. We are on schedule to realize first sales from this initiative in the first half of calendar year 2009.

We just completed our second set of major field trials with a market leading U.S. based solar installer. In these trials we are further validating the benefits of our SolarMagic solution. In modest trading situations our SolarMagic recaptures over 50% of the energy loss in effective solar panels and can demonstrate greater than 30% energy gains for the whole array on sunny days. This is actually a greater energy gain than demonstrated in the first set of our field trials.

To enable us the market launch and product proliferation of our SolarMagic solution we have hired a team of experienced business development and sales executives from the solar industry. We plan to hire additional experienced sales and channel staff to enable the market roll out in the U.S. and Europe over the first half of calendar 2009.

Another energy conservation area of focus for us is in powering LED lighting. Here our design win momentum is continuing. As of the end of Q2 we had double the potential future revenue of our design win pipeline over the equivalent of revenue at the end of the last quarter.

We have design wins at about 150 customers across an increasing spectrum of applications from automotive lighting which covers forward lights, rear lights and break lights; small format backlighting for displays; street lighting; projector and entertainment lighting.

We have also been designed into our JP LED backlighting solutions a newly launched notebook PC’s from Sony and Dell through a Korean display provider.

We are also seeing early market acceptance for our new dimming solution from traditional lighting companies as they transition to LED applications.

Calendar year 2009 should see good revenue momentum for National Semiconductor in this LED lighting space as all these applications proliferate.

Another new energy efficiency opportunity for National Semiconductor is in the area of battery charging. Here I’m not just talking about the traditional, plug in the wall charger for portable systems. On one hand we are working with OEM’s to enable them to bring to market wireless charging solutions, i.e. inductive charging solutions for portable devices such as mobile phones that do not require wires to charge the battery.

We solved the earlier efficiency and heat generation obstacles with our new non-contact power supply system solution that is now sampling to customers. The newly formed Wireless Power Consortium is working on setting standards to ease the development of a wireless charging infrastructure to enable us to potentially move away from the wasteful charger in every box solution that exists today.

More tactically in the battery charging energy efficiency area in the quarter we won a design with a leading Japanese battery OEM to replace existing digital cell camera charging solutions with a much more compact and efficient solution that is expected to ramp up in production volumes in the middle of calendar year 2009.

In addition we are focused on evolving our SolarMagic technology to provide system solutions for much faster and more accurate charging for large lithium ion battery packs in electric vehicles. Our energy efficiency and PowerWise expertise has many potential applications. It is in fact our current jewel at National. The challenge is to apply that expertise to new fast growth market opportunities.

Even in today’s large volume mobile phone market the challenge is to find faster growing and value niches and not get seduced by the increasing commoditization in the high volume portions of that market.

In the last quarter Rim launched two new Blackberry models, the Storm and the Bold phones, and a number of our power management devices included. Specifically, the Storm includes another win for our power management unit that significantly improves the efficiency of the 3G transmit power amplifier.

In addition, we can now add Broadcom to the list of mobile phone chip set reference design providers who recommend our analog power management units in their complete reference design. By the way, I mention Qualcomm, Erickson and others at our last analyst presentation at the end of September.

Beyond energy efficiency and personal mobile devices another mega trend that is a focus for us is in sensing and detection applications. In the past we have viewed sensor products and applications as being somewhat outside the domain of our standard linear catalog portfolio. Our amplifiers may have taken input from various sensor types but we would leave it at that.

As our focus now moves to more application specific signal path system solutions we are much more interested in enabling the whole solution including the sensor that inputs to the analog front end. For example the amplifier or data converter.

In the quarter we launched a new web based customer application called Web Bench Sensor Designer that enables customers to best match their sensor needs to the appropriate National Semiconductor building block or system solution. To do this we have partnered with key sensor suppliers in a new way for us and in doing this we find ourselves talking to a whole new customer base.

In this new sensor application area is an example of an earlier application specific capability in our new bio sensor analog front end evaluation board which is now being evaluated for solutions in the home and security area. These fast growth applications and market areas such as solar energy efficiency improvement, power LED lighting solutions, new battery charging applications including those for electric vehicle applications, personal mobile devices and sensing and detection systems are all good examples of National 3.0 type initiatives that will distinguish us in the future as a very different company than our standard linear, catalog building block or broad market heritage.

Moving onto my second topic, market and product trends you saw in the quarter. In our largest end market which is for mobile phones and other personal mobile devices again accounting for about 30% of our sales in the quarter, we did not see the usual strong seasonal up tick that we experienced in past years.

Our sales to that market were down 10-12% sequentially and our sales to the traditional top five mobile phone customers were also down about 15% in aggregate while our sales grew to the two most visible Smart Phone providers.

Based on current backlog and customer forecasts we expect to see a greater than normal seasonal reduction in shipment rates to these top five mobile phone customers in our post-holiday season third quarter. Sales to communications and networking customers, which accounted for about 12% of our sales in the quarter, were flat sequentially and were up about 13% on last year’s second quarter again driven by infrastructure build out in China and outgrowing wireless station business with the two largest local Chinese customers. Here we also expect a slower third quarter as we await new orders from the recently awarded Phase II TDS CDMA contracts in China.

Looking at our business trends in other markets such as the industrial, automotive, medical and military/aerospace markets which in aggregate make up about 35-40% of our sales shipments were down about 10% in the quarter. Here sales in to distributors were the main factor with Europe being impacted most. In Europe our business to automotive customers in particular slowed down as customers implemented factory shut downs.

From a product perspective there were no material changes in the mix of our revenues by industry product category in the quarter. They all showed reductions of roughly the same rate. Average selling price, or ASP, increased again 6% year-over-year and was about flat sequentially. Here we were able to offset the negative sequential impact of the weakened Euro against the U.S. dollar with continuing portfolio value improvement.

This also contributed to our margin in the quarter which although offset by lower capacity utilization of factories kept our gross margins above 65% and if you will note Q2 of last fiscal year on revenues of $499 million, i.e. 15% higher than this second quarter, our gross margin was 64.4%.

So to wrap up our business model fundamentals held up well in a quarter where customer demands slowed down at an unexpected rate. Going forward we are also looking at an anemic backlog of customer orders and uncertain customer demand forecasts going into what is already traditionally for us a seasonally slow quarter.

We have taken action to keep the integrity of the business model. We have already actioned significant fixed and variable cost reduction efforts. In the meantime we will invest and reallocate more and more of our R&D and business development dollars in our National 3.0 initiatives and look for the resultant differentiated revenue growth from these initiatives when we get to the upward stage of this industry and economic cycle.

Over to you Mark for Q&A.

Mark Veeh

Thanks Don. At this time I will ask the operator to open up the line to the question-and-answer session. We will answer questions until approximately 2:25 p.m. PST to allow time for our listeners to transition over to our competitors’ updates starting at 2:30 p.m. Please limit yourselves to one question and one follow-up so that we can accommodate as many people as possible. Operator can we please have our first question?

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