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Altera Corp. (NASDAQ:ALTR)

Q2 2006 Earnings Conference Call

July 24, 2006 4.45 pm EST

Executives:

Scott Wylie, Vice President of Investor Relations

Nathan Sarkisian, Senior Vice President, Chief Financial Officer

John Daane, President and Chief Executive Officer

Analysts:

Glen Yeung, Smith Barney Citigroup

Christopher Danely, JP Morgan

Masdea, Credit Suisse First Boston

David Wu, Global Crown Capital

Timothy Kellis, Stanford Financial Group

Steve Eliscu, UBS

Reuben Roy(?), Pacific Crest Securities

Seogju Lee, Goldman Sachs

Katherine Brooker(?), AG Edwards

Sumit Dhanda, Banc of America Securities

Tim Luke, Lehman Brothers

Jeff Palmer(?), Friedman, Billings, Ramsay

Presentation

Operator

Good day everyone and welcome to today’s Altera Corporation conference call. Today’s call is being recorded. At this time I would like to turn the call over to Mr. Scott Wylie, Vice President of Investor Relations for Altera Corporation. Mr. Wylie, please go ahead sir.

Scott Wylie, Vice President of Investor Relations

Good afternoon. Thank you for joining this conference call, which will be available for replay telephonically and on Altera's website shortly after we conclude this afternoon. To listen to the webcast replay please visit Altera's investor relations web page where you will find complete instructions. The telephone replay will be available at 719-457-0820. Use code 258712. Before we begin this afternoon's call I want to remind you that as we indicated in today’s release, we will offer our third quarter update on September 5th. This update will be issued via press release and will be available shortly after the market closes.

During today's call we will be making some forward-looking statements. In light of the Private Securities Litigation Reform Act I would like to remind you that these statements must be considered in conjunction with the cautionary warnings that appear in our SEC filings. Investors are cautioned that all forward-looking statements in this call involve risks and uncertainty and that future events may differ from the statements made. For additional information please refer to the company's Securities and Exchange Commission filings, which are posted on our website or available from the company without charge. After John and Nate conclude their remarks, we will take your questions. Prior to the Q&A session, the Operator will be giving instructions on how you can access the conference call with your questions. I’d now like to turn the call over to John Daane.

John Daane, President and Chief Executive Officer

Thank you very much, Scott. I would like to start this call with a recap of the stock option review that has been underway for the past several months. In early May, we announced that as a result of a self-initiated internal review of the company’s stock option practices, our board had established a special committee of independent directors to review the company’s historical stock option practices. In light of the review, we did not file our Q1 10-Q and subsequently were notified by NASDAQ that we were subject to delisting. We appeared in front of a NASDAQ listing panel on June 22 and requested that NASDAQ delay any listing action for several months, in order to allow us to complete our review and file any necessary re-statements.

We have not heard back from them at this point and obviously we remain listed on NASDAQ. And as a consequence of this filing delay, we had to suspend our share repurchase program. Prior to the suspension, we had repurchased 448,000 shares at a cost of $9.4 million. The special committee has reached a preliminary conclusion that there were differences between the measurement date and recorded dates for some grants issued between 1996-2000. As a consequence, we anticipate recording additional non-cash stock-based compensation charges for the years 1996-2005 and restating our financials for those periods. We do not anticipate a material charge to 2005. In light of the special committee’s progress, we have begun the process of preparing a 2005 Form 10-KA. The 10-KA will be the means by which we capture the restatement effects and once complete, will allow us to subsequently file our Q1 10-Q.

Given the multi-year nature of the restatement, the related accounting and auditing work is quite substantial. We are working expeditiously on these related tasks. The expense associated with the investigation and restatements was several million dollars in Q2 and we anticipate that continuing into Q3. Also as you know, Altera notified the SEC of the special committee’s review and we subsequently received notice that the SEC staff had opened an enquiry. We also received a subpoena from the Department of Justice. There are no new developments on either of these fronts to report. We remain in contact with both of these agencies. As for the lawsuits, they remain in the preliminary stage. I cannot comment further on those suits at the moment. It is anticipated that these re-statements will not affect the accounting for current or prior period sales. Since this is the case, we have announced sales results for the quarter. As soon as we can after the historical stock option practices and related accounting review concludes, we will give you a complete picture for Q2. As we go into the Q&A portion of this call, we will be happy to answer any of your revenue-related questions. We will have to defer other questions, however, until a later period of time. Let me turn the call over to Nate.

Nathan Sarkisian, Senior Vice President, Chief Financial Officer

Thank you, John. Revenue increased 15% sequentially to $34 million in Q2, well ahead of guidance, buoyed by increasing demand for our new products and strong growth in our mainstream Stratix family as we improved manufacturing throughput. CPLDs were up sharply 25% and FPGAs increased 13%. As anticipated, all end application segments contributed to growth in the quarter, driven by healthy end market conditions and the ramp of new programs. All segments within Communications, Wireline, Wireless and Networking were up, with Wireline being particularly strong, driven by transmission. In 3G, results were good but growth was muted by a program transition which will also impact Q3. Consumer was very strong, as displays in the professional broadcast and studio sub?segments posted excellent results. Industrial growth was broad based with strength across most of the sub?segments.

Computer and storage increased on anticipated program ramps. Nearly all of our largest 18 accounts grew and they grew in aggregate. Mid-sized and smaller accounts also grew in aggregate. For Q3, we’re forecasting 0-3% sequential growth. I will now go through the factors that drive this forecast. First, we do look for some customers to draw down inventories in Q3 and anticipate some amount of backlog correction as well. In Q2, we caught up to most of the delinquency we had coming out of Q1 but given the tightness of supply we experienced in Q1, and for much of Q2, we believe some customers built inventory and some backlog that will now be cancelled. Results for our broad base of smaller customers were particularly good in Q2 and we think it likely these accounts will be soft in Q3. Similarly, we believe that some of the strong CPLD growth we experienced in Q2 resulted in inventory accumulation. In particular, we think that the CPLD inventory accumulation and the growth in the broad base of smaller accounts intersected in the industrial end market and that for these reasons, we believe the industrial sub segment will be soft in Q3. As you know, Q3 tends to be seasonally soft.

On the other hand, orders to resales in Q2 were quite strong, substantially above one. Turns required to hit our guidance are now in the low fifties, down from last quarter. Quarter to date results are good, with shipments tracking consistent to our guidance and orders to resales are significantly above one. Thus far, the rate of order cancellations and adjustments is in the range of normal and does not signal an impending inflection. And as we said in April, we have not fully resolved our supply issues and some parts remain on allocation, which should give us some uplift in the quarter. We think these factors net out as follows: we believe the downside and the anticipated decline in CPLDs will be roughly offset by the upside associated with catching up with the remaining delinquent backlog. That is, these factors will roughly offset each other. That leaves us with a good backlog position, strong quarter to date momentum and the early stages of a strong new product cycle, set against the backdrop of season Q3 softness which manifests itself most acutely in August.

All things considered, we feel comfortable with our guidance and we’ll give you an update on September 5th. Let me now turn the call back over to John.

John Daane

Thank you, Nate. Q3 revenues increased 14% sequentially as we benefited from both robust demand and new program ramps with our new and mainstream products, coupled with significant product shipments that relieved a bulk of the product allocation. We are on track for our fourth year in a row of solid revenue growth. By product classification, we typically expect both the new and mainstream categories to go and the mature products to decline. New products grew 50% sequentially and 139% YoverY. Each of our new product families grew sequentially with Cyclone II up 64%, Stratix II and Stratix II GX up 52%, MAX II up 64% and HardCopy up 25%. Mainstream products grew 15% sequentially and 32% YoverY. Stratix and Stratix GX grew 13% sequentially and Cyclone increased 10%. Mature products increased 5% sequentially due to growth from several older MAX families. As with 2004, we believe growth in the mature category is generally caused by inventory accumulation and although there is no sign of it yet, we expect a correction in CPLDs this quarter. Even with the continued growth plus demand of our new and mainstream products, we were able to accelerate product deliveries in the quarter and relieve much of the product allocation that plagued us in the first calendar quarter.

Some members of the Stratix, Stratix GX, HardCopy, Apex and Mercury families remain on allocation, but we expect to clean this up and return to normal lead times in the next few months. I expect HardCopy to have a strong quarter in Q3. There are several highlights I would like to expand upon. First, products introduced since 2002, the outcome of our change in product and market strategy, represented almost 50% of our revenues. Stratix, Cyclone, Stratix II, Cyclone II and MAX II each had a record revenue quarter in Q2. MAX II had phenomenal revenue growth and is 10% of our total CPLD sales. I believe MAX II is now driving the anticipated market share gains in the CPLD category. Stratix II is now solidly our third largest product family by revenue. Stratix II revenue is ahead of where Stratix was for a similar period of time, demonstrating our momentum and the FPGA market. We introduced a new power download combined with ultra small packages for MAX II, to address the growing CPLD opportunity in the battery operated phone and toy markets.

The power down feature eliminates static power and with half of the dynamic power consumption of competing CPLDs, we have been winning high volume designs in terminals, toys and portable media players. We are now shipping three members of the Stratix II GX family, including the GX130, the industry’s largest shipping FPGA with integrated transceivers. Finally, we expanded market share this quarter with 13% sequential and 19% YoverY growth for FPGAs and 25% sequential and 23% YoverY growth for CPLDs. In Q3, with the exception of the industrial market, we expect normal seasonality in our end markets. We expect the industrial market will decrease as the broad base of customers in this segment scale back CPLD orders in order to reduce inventory accumulated in Q2. Note that this is a management adjustment, as we have yet to see a correction. Communications will decrease as modest growth in Networking is offset by the typical declines in Wireless and Telecom we see in the summer quarter. Computer and Storage will grow with continued new program ramps in the storage and office automation area and finally, our consumer market will increase.

In total, with a stable backlog, low turns requirement and generally normal end market seasonality, even with the expected CPLD inventory correction, I anticipate revenues will be flat to up 3% sequentially. Scott?

Scott Wylie

We would now like to take questions. Operator, would you please provide instructions and poll for questions?

Questions and Answers

Operator

Operator instructions. Our first question comes from Glen Yeung of Citigroup.

Q - Glen Yeung, Smith Barney Citigroup

Thanks, guys. Good numbers here. A question for you, John, maybe you’re thinking about normal end market seasonality. I know you work mostly through distributors, but as you think about what you’re hearing from the end markets, are there any sort of macro views that are coming back to you that cause you any concern here? It doesn’t sound like it from your guidance, but just double-checking.

A – John Daane

Generally from a macro perspective, the markets that we hear are soft are obviously PCs and we’ve heard chatter around the cell phone terminal market. But in general, the markets that we are serving, we don’t see any significant corrections either way. We just see business as normal. A lot of the infrastructure markets that we were supplying to are continuing to grow. We’re also benefiting from a very successful series of products that are continuing to ramp and a number of programs in a number of new markets. So with the exception of the CPLD area that we highlighted, we really don’t see any significant changes at this point.

Q - Glen Yeung, Smith Barney Citigroup

Then, John, you talked about book to bill being significantly above one. I wonder if you can give us a little bit of color around that? Even maybe quantifying what that is? And then comparing how book to bill looks now versus how it looked at the end of the quarter? I know it’s only a few weeks.

A – Nathan Sarkisian

First, just to make sure that everyone understands, we use the term orders to resales or book to bill and that refers to end customer orders versus end customer shipments. We kind of got away quite some time ago from quantifying that number, because I think at times it becomes so significantly above one that it becomes meaningless. In any event, when we say ‘significantly above one’ it’s more than a couple of pence. So I think it’s indicative of a strong backlog build.

A – John Daane

It was above one for calendar quarter Q2 and it’s been above one for this quarter to date as well.

Operator

We’ll go next to Christopher Danely, with JP Morgan.

Q - Christopher Danely, JP Morgan

Thanks, guys. I know you can’t give us numbers, but can you tell us the direction of either inventory or gross margins?

A – Nathan Sarkisian

Sorry, Chris, I’d love to be able to do that but we’re in a situation where that’s just not feasible at the moment.

Q - Christopher Danely, JP Morgan

No problem. Can you just go through the whole lead time issue again on your figures on the Stratix and the MAX products, where you saw lead times come in and where they’re still extended?

A – John Daane

Chris, the lead times for the MAX products, generally we ship a lot of products into the channel at the end of the first calendar quarter. We believe we relieved most of the pent up demand for that product in the first calendar quarter. We did, though, go into Q2 with a number of issues around some of our higher end FPGA families, including also HardCopy. We relieved really a bulk of the allocation on those FPGAs by the end of the second calendar quarter. There are some remaining products which are on allocation or have extended lead times. Those are generally in the area of a couple of members of Stratix, Stratix GX, HardCopy, some of our Apex family members and Mercury. As a note, you can see on our external website that there is an update as to what our normal lead times are and what these products and these members that I’ve mentioned see in terms of extended lead times. So you can always see a refresh of that and keep constant on it. Also note that the number of members that you would see on a website today is significantly lower than the number that you would have seen perhaps three or four weeks ago. Again, as we’ve been able to satisfy a lot of the product that was on allocation, we’re going to get a lot of product out into the channel in the quarter.

Operator

We’ll take our next question from Michael Masdea with Credit Suisse First Boston.

Q - Masdea, Credit Suisse First Boston

Thanks a lot. It makes a lot of sense you guys are taking a little bit more cautious approach to the guidance and numbers, given what you think might be a little bit of over ordering. I guess the question I have is how do you correctly gauge the magnitude of it? How do you get about that? And also, can we still have some constraints even up – how do you try to avoid that happening in the first place if at all possible going forward?

A – Nathan Sarkisian

Let me work on your second question first. There were some perturbations in our supply chain, in the back part of last year as well as in Q1 this year. We think we have a good supplier base and even good suppliers on occasion can’t meet all of our demands. But I think we feel very comfortable with our strategy in that regard. The first part of your question again, how do we gauge how much is coming off…

Q - Masdea, Credit Suisse First Boston

Yes, the magnitude, so you don’t have a surprise there – how do you try to do that?

A – Nathan Sarkisian

We look a lot at top customers and of course we go through a lot of field input in that. We look for those customers’ trends of what they’re taking by product family. We counterbalance that against aggregate inputs from the entire field. We look at product trends by family, irrespective of customers. And we look at turns in backlog position and we try and put that together as best we can.

Q - Masdea, Credit Suisse First Boston

And you’re saying your turns number is lower on what you think of as the scrub backlog number? Or is that turns lower because the backlog might have some more in it?

A – Nathan Sarkisian

It’s lower turns on aggregate backlog at this point. That’s the number I cited.

Q - Masdea, Credit Suisse First Boston

Then the inventory – did you sort of give some suggestions there – I thought I might have heard that there might be a little more inventory potentially in industrial, I thought you mentioned. Is there any place else?

A – Nathan Sarkisian

That’s the place where we think it’s most likely at this point, Michael.

Operator

We’ll take our next question from David Wu, with Global Crown Capital.

Q - David Wu, Global Crown Capital

Can you help me, remind me, jog my memory a bit, about what is the supply chain constraint that you ran into, was that a back end situation of packaging, that kind of stuff as opposed to the front end which I guess if you look at the foundry situation looks like it’s clearing up a bit. The other thing I was wondering is this extended lead-time situation has been going on longer than normal. What accounts for this period of extended tightness and John, we’ve all been through the 2004-05 period. Can you just say one or two things about the differences between now and back then?

A – John Daane

I think there were quite a few questions in there. Let me try to get this for you, David. So we have had and we have characterized the issues surrounding manufacturing for us as a series of really one-time events which we would not have expected and do not expect to repeat. All combined, this caused a shortage in a number of different product lines for us, not all at the same time. In terms of the company strategy, we do think that the suppliers that we have as well as the amount of inventory that we would normally carry to be adequate, so in other words we do not expect this issue to repeat itself. In the five and a half years I’ve been here, this has been the only time that we’ve run into such issues and so we think that we have the right strategy, the right partners, and for that matter the right amount of inventory to make sure that we don’t run into this again. As I mentioned, it did hit different products at different periods of time so while it seems we have been on allocation for what has been six months or more, note that not all products have been on allocation that entire period of time. Really what we saw starting in December last year were some issues around some of our older MAX families that really turned into allocation in the first calendar quarter. As I mentioned earlier, we cleaned up the vast majority of that by the end of that quarter. Then as we moved into Q2, in late Q1 we ran into issues surrounding some of our high end FPGAs. A bulk of that we did take care of by the end of June. We still have some products that are on allocation, and we expect to take care of those in the next couple of months. In terms of 2004, we saw a build of inventory in some of our mature product lines. In hindsight, we should have said to ourselves, the build in some of the mature products that you would normally expect to decline as programs that customers have are normally phased out should signal an inventory build. We just didn’t – we kind of caught some of that at the time, but we didn’t catch all of that. Note, in this quarter, we did see a 5% sequential increase in our mature product families. As we did mention, the bulk of that was in some older CPLD families. A bulk of that was in the industrial market in the broad base. We would expect that to correct this quarter and really, that is just pure learning from 2004 and applying that thought and theory to what we’re seeing right now. In general, however, in talking to our larger customers and our distributors, we cannot identify any significant inventory positions of any of our larger customers in any of the other vertical markets, or even associated with FPGAs at this point.

Operator

We’ll go next to Timothy Kellis, of Stanford Financial Group.

Q - Timothy Kellis, Stanford Financial Group

I guess following along the same thing, I was just wondering if you could clarify your commentary on the guidance for the Q3 revenue growth. You stated that you think that one of the factors attributing to that guidance was customers drawing down inventory. Are you referring specifically to what you saw this quarter in the MAX II revenues? You’re not saying, in fact, that some of the Stratix and Cyclone II inventories grew faster than market demand and that you’re going to be drawing down on that inventory as well? And just again, if you could at all clarify at least with new products, on where you think the quarterly guidance is attributed to drawing down on that inventory versus maybe some weakness in end market, or you don’t see a weakness in your end markets for your new products.

A – John Daane

We would not anticipate new products to see a correction. There are a large number of new program ramps which are continuing. We’re prototyping a lot of products and also moving some of the prototyping sockets into volume production. So we would expect to see continued growth in that area. The success that we’ve had with MAX II, Cyclone II and Stratix II is really a result of, I think, very strong products and our approach to the end markets and diversifying our business. Where we saw some inventory build or what we believe to be inventory build at this point is in the broad base of industrial customers. These are very small customers and it is particularly with some MAX products, non MAX II which are in that mature product classification and are generally I believe, products are about 10-15 years old now. Additionally, we’re highlighting that as an area of obvious concern. We think there probably was this inventory accumulation, we think that should come out this quarter. So our guidance takes into effect that we would expect to continue to see new product growth as we’ve had a tremendous success with our 130 and 90 nanometer FPGAs. Additionally MAX II and HardCopy into that and then also some of the decline in some of the older CPLD families.

Q - Timothy Kellis, Stanford Financial Group

And what did MAX II do sequentially?

A – John Daane

MAX II was up…

A – Nathan Sarkisian

64%.

A – John Daane

Yes, 64%. And even with that tremendous growth in some of the older CPLDs and the fact that CPLDs grew, I think 25% sequentially, MAX II ended the quarter at 10% of our total CPLD sales.

Operator

We’ll go next to Steve Eliscu, with UBS.

Q - Steve Eliscu, UBS

Good afternoon. Based on your guidance you’re now looking at three of the last four quarters with high teens year on year growth. Do you now feel you’re at a sustainable level with that type of growth? Given some of the macro uncertainties we’ve seen in the past, where we come down off of those levels? Can you comment?

A – John Daane

Steve, I think that we have been consistently saying that we would expect a programmable logic market to grow in the high teens and with the addition of HardCopy as an opportunity for Altera and market share gains that we could get to 20% growth. So we would expect that this sort of phenomenon would happen for us, simply because of many things. We have the ASIC replacement, the ASIC market is substantially larger, many times larger than the programmable logic market. As costs for design activity continues to rise that will drive more and more people to use programmable logic as an alternative to realize and differentiate their system. Additionally we are now able to address microprocessor, DSP and analog capability with our products, which allows us to also build up new opportunities. As we’ve talked about, we’ve had a strategy to pursue a number of other markets, non-communications focused markets, which should be opportunities for us to continue to expand our business. Generally over the last several years, I think if you look at programmable logic you’ve seen very strong growth in the consumer as well as the broad industrial market. We’ve had a tremendous success in terms of really selling into new applications for programmable logic. I mean, I’d expect the programmable logic industry to actually see acceleration this year and in next year, many of the things that perhaps hampered the programmable logic growth in the last few years, such as the drag effect of the CPLD industry combined with some of the cannibalization that we have caused through having our low cost FPGA families, we feel is starting to end. So we again anticipate and should see and believe that we would see an acceleration with programmable logic revenues this year and in the next few years.

Q - Steve Eliscu, UBS

As a follow up on two of those items that are potentially hampering that growth right now. On HardCopy, can you give us an update on the sequential growth you saw last quarter and if we should expect to continue to see that growth for the rest of the year?

A – Nathan Sarkisian

Steve, HardCopy was up 25% sequentially. It is one of the products that I mentioned additionally that is still on allocation. I also mentioned in the script that I expect HardCopy to have a very strong third calendar quarter.

Q - Steve Eliscu, UBS

Right and the final thing is on consumer – you characterized the growth in the quarter as strong. But if you look at a year on year basis, we’re still down. When do we get to the point where consumer is actually growing on a year on year basis and growing also as far as the overall percentage of year end market composition? Or perhaps it’s growing faster than communications or industrial?

A – John Daane

It’s sort of swapped back and forth. We had a very strong consumer growth rate – I forgot what year it was. Then we saw industrial muted and then it swapped because the YoverY numbers become hard. If you have a really stellar year in one market, to show continued stellar growth as we really start to penetrate a number of applications, it becomes hard to do. We’ve sort of seen a leapfrog in some of these markets historically. We do expect communications to be up, we are gaining market share in a lot of new applications within that specific space. We have been also seeing growth in the broadcast sector, which we do classify in the consumer space. So we expect that area to grow again this quarter. I guess some of the questions around that, if I were to read into your question, Steve, is perhaps with flat panels being weak do we see any weakness in our consumer area. And we did take that into account when we did forecast the consumer number would be up in the third calendar quarter.

Operator

We’ll go next to Reuben Roy(?) with Pacific Crest Securities.

Q - Reuben Roy(?), Pacific Crest Securities

Hi, thanks John. I just had a couple of quick ones on HardCopy. Can you give us an idea of what HardCopy is as a percentage of your revenue mix today? And also where you saw some of the strengths that drove the 25% sequential increase if you can break that out into revenue segments like you break your other revenues out into? Then finally, are you on track to ship HardCopy II later on this year? And is that part of the revenue that you’re going to get from HardCopy starting in Q3? Thanks.

A – John Daane

Yes, HardCopy II actually already has shipped. We’ve already seen revenue off that product and expect that to ramp very well. We’ve got a lot of very solid design wins from companies including now multiple design wins at any single company and in some cases multiple design wins within single platforms. So we’re very excited about the future of the product. HardCopy itself grew 25% sequentially. We don’t break out or I don’t have available the revenue growth by a particular market segment, but my gut would say it was probably in Storage and Communications and probably a couple of other areas, which will lead to the strong growth that we’ve talked about in the third calendar quarter.

Q - Reuben Roy(?), Pacific Crest Securities

And then, John, can you tell us what HardCopy is as a percentage of your revenue mix?

A – John Daane

Yes, it’s about 3% of sales right now.

Operator

We’ll go next to Seogju Lee, with Goldman Sachs.

Q - Seogju Lee, Goldman Sachs

Thanks. John, just in terms of the CPLD correction you expect in Q3, should we think that it’ll be substantially corrected in Q3, or do we think that it’ll continue into Q4? Any color there would be helpful.

A – John Daane

We’re anticipating most of the correction would happen this quarter. The assumption is the broad base of small accounts probably reacted to the shortages in Q1 and decided to establish a buffer inventory. Also hearing from other customers that other products were entering into allocation and the supply was tight. We would expect that now that they see that there is ample inventory available, both from ourselves and distribution on the MAX products, as we’ve always offered, we’re back to normal. Those customers would take this as an opportunity to reduce their orders and take rate in order to readjust their own inventory levels back down to a sort of a normal operating level. That’s our assumption. We don’t know exactly what will happen and we’ll have to of course see what transpires over the quarter.

Q - Seogju Lee, Goldman Sachs

And then as you look forward, in terms of the FPGA products you’ve had some of the mainstream products that were on allocation as well. To the best of your knowledge at this time, you don’t see any similar sort of inventory accumulations and customers etc?

A – John Daane

Right, that’s correct, Seogju. In fact, if you look at the families, we would expect the mainstream products that we have to actually grow. It’s mainly made up of 130 nanometer and we don’t think that those products have yet reached their peak. If you actually look at the growth figures, looking it up here, Stratix and Stratix GX were up 13% sequentially and Cyclone was up 10%. Not necessarily up dramatically, so we think that those are good, solid growth numbers. Some of it obviously associated with some catch up, particularly with the Stratix and Stratix GX area. But we haven’t seen anything that we can identify at this point as being unnatural in those product areas.

Q - Seogju Lee, Goldman Sachs

Last question, just in terms of 65 nanometer products, since Xilinx have introduced their product family, you’ve started to talk a little bit about yours but there’s no formal introduction there yet. Just as you look going forward, your competitiveness there, how do you think your product stacks up? That’d be great. Thanks.

A – John Daane

We haven’t announced our 65 nanometer product yet and as I think everybody probably knows by now, we tend to not talk about a product in the financial update sections until we’ve announced it to the customer base. So I can’t really go into any details. We have talked about it publicly with customers as well as the press, in terms of some of the innovations that we’ve done. We think that we will have a superior and really a vastly superior product in terms of power consumption and performance over the competition. We think this is critical because high end FPGAs integrate a large number of transceivers and therefore are now starting to consume a large amount of the customer’s power budget within their system by having a much more competitive product from a power consumption standpoint, while still maintaining performance density, costs and other features that customers want. It will grant us a really superior position from a product differentiation point of view in 65 nanometer. So our product isn’t available today, as you know, but we think that the wait will be well worth it from the customer’s perspective.

Operator

We’ll take our next question from Katherine Brooker(?) of AG Edwards.

Q - Katherine Brooker(?), AG Edwards

Could you just tell us the percentage of your production currently on 130 nanometer and 90 nanometer?

A – John Daane

Yes, I have that here somewhere. 90 nanometer was approximately 13% of revenues and 130 nanometer was about 34% of revenues. Those are both the FPGAs, because remember MAX II is in 180 nanometer.

Operator

We’ll go next to Sumit Dhanda, Banc of America Securities.

Q - Sumit Dhanda, Banc of America Securities

John, you know, last quarter when you got on the conference call you talked about the fact that you were worried that there was some level of over ordering and you were planning on guiding more conservatively. You have since done a similar sort of forecasting exercise. I guess my question is, surely you did better than how you forecasted. Could you give us an idea of whether you really saw a significant cancellation and how much of that backlog is still on aggregate entering the quarter?

A – John Daane

Sumit, just to go back, we had guided 7-10% growth. That guidance was based on our ability to ship and meet the – because we were on allocation, our ability to ship product to the marketplace. So we had said that the 7-10% would be constrained and that we would end up pushing business out into the third calendar quarter. The fact that we got to 14% is because we were able to work with our supply chain and move a lot more product into the second calendar quarter than we had anticipated. We wanted to be conservative there because sometimes shipments into the channel late in a quarter do not necessarily get turned around to the customer base. Some of our product does require programming and does take a little bit of time to get back out the door. In terms of the backlog, we have not seen any significant changes to the backlog to date. That is, we have not seen any significant cancellations and push outs other than the normal activity that we see within a quarter.

Q - Sumit Dhanda, Banc of America Securities

Okay. Then the final turns number for last quarter, Nate, I know you guided somewhere in the low sixties. What did you finally finish on, if I could ask, if you have that number handy?

A – Nathan Sarkisian

Sumit, you recall that the last quarter we talked about including in our turns and backlog calculations, some of the backlog that’s part of end customers demand pool or consigned to inventory strategies with distribution. And including that inventory naturally reduces our turns requirements. We guided to turns in the mid-fifties for Q2 and came in at the high fifties.

Operator

We’ll go next to Tim Luke, Lehman Brothers.

Q - Tim Luke, Lehman Brothers

Thanks. Sorry, Nate, you said that the Q3 outlook was basically good but there is a program transition in Q3 which is going to lead to somewhat lower Q3, which partially impacted, you suggested, also Q2. One of your big European customers has been saying that there was an inventory work down at one of their big customers in Q3 and they expected the same thing in Q3 to impact their outlook. However they were expecting a better than seasonal Q4 given some order visibility that they have. I was wondering if you had any color on the Q4 wireless order outlook?

A – Nathan Sarkisian

Tim, we’re not going to provide specific insights into Q4 at this point. It’s just too early to call. I will say that we would not refer to inventory rebalancing on the part of a customer as a program transition, so those two docks are disconnected.

Q - Tim Luke, Lehman Brothers

Okay. With respect to your guidance, you were guiding industrial down and the comm area, you said, networking up, wireless and wireline down with overall comm being up? Is that right? Or flat?

A – Nathan Sarkisian

Overall comm being down.

Q - Tim Luke, Lehman Brothers

Being down. Computer and Storage, could you give any color there?

A – Nathan Sarkisian

Computer and Storage would be up based on continued ramps in program and the storage as well as office automation areas.

Q - Tim Luke, Lehman Brothers

And despite the flat panel weakens, you think that the broadcast can help your consumer business to be up overall, is that correct?

A – Nathan Sarkisian

Broadcast as well as other consumer related products that are non flat panel related, yes.

Q - Tim Luke, Lehman Brothers

You also commented, Nate, or perhaps John, on legal expenses. I think you mentioned it were a factor in Q1 and you expected that to go forward. Do you have any color there or how we should frame that? Or how you had framed it in the past?

A – Nathan Sarkisian

Well, we’d given in our update in early June that (inaudible) several million dollars worth of legal expenses – we’ve essentially given no more precise quantification of that acknowledging that there were several million dollars in Q2 and that we’d anticipate a like amount in Q3.

Q - Tim Luke, Lehman Brothers

John, normal seasonal for you for Q3 would be what sort of range?

A – John Daane

I think this has, in the last several years, been our sort of normal range that we’ve seen in the third calendar quarter. Again, nothing quite ever seems normal in any given year, but if you look at programmable logic, the third calendar quarter is typically our slowest.

Q - Tim Luke, Lehman Brothers

And therefore – but you’re saying that you’re going to be below normal seasonal this quarter, because of the imagery work down in industrial, but…

A – John Daane

We’re seeing some better growth out of some of the other markets than perhaps we would normally see. I mean, if you typically look at a year this is typically sort of a flat to low single digit growth quarter. Again, you know, for those that have tried to develop any correlation over history on any particular quarter, note that you can get an average but the deviation around that average is very, very high because of course every year we’ve had different issues that have come up, either because of end markets or because of inventories or various other issues that have developed. The only thing I think you can establish is that the third calendar quarter is typically the weaker of the four quarters and as Nate has talked about in the past, is typically a little bit more back end loaded because of the summer vacations that we see in July and August, in Europe as well as in August in Japan.

Operator

We’ll go next to Jeff Palmer(?) with Friedman, Billings, Ramsay.

Q - Jeff Palmer(?), Friedman, Billings, Ramsay

One clarification, one question. On the CPLDs, John, did you say that about 50% of the CPLD revenue was MAX II?

A – John Daane

10% of the CPLD revenue is MAX II.

Q - Jeff Palmer(?), Friedman, Billings, Ramsay

Then so the over ordering was more the old traditional MAX products?

A – John Daane

Correct.

Q - Jeff Palmer(?), Friedman, Billings, Ramsay

Okay, and then the question. When you first rolled out Stratix, you gave some great metrics about how design wins were going and your revenue has now tracked to some of those trends, which is positive. Could you give us some color on how Stratix II is trending right now in terms of design wins and how you see revenue going?

A – John Daane

Stratix II is pretty strong in terms of new design wins. We believe we continue to gain market share as well as to establish ourselves with positions in new markets and as I mentioned in the script, Stratix II and Stratix II GX were up 52% sequentially and that Stratix II is ahead of Stratix for revenue for a similar period in time in the two products’ lives. I think that Stratix II is ahead of Stratix is another strong indicator that we have continued momentum in the high end FPGA marketplace.

Q - Jeff Palmer(?), Friedman, Billings, Ramsay

Would it be fair to assume then that Stratix II design win momentum is ahead of where Stratix I was at the same time? From launch?

A – John Daane

I would assume that. I haven’t gone back and looked at the design win data recently. I would throw out though that last quarter was an all time record for Altera in terms of design wins. It was, I think, an all time record by about 25% higher than the next quarter. It was in the script that we mentioned last quarter and we can get that data specifically for you, but we have been over the last several years, seeing quarter in quarter out, generally on higher quarters the trend line has been up and again in some recent quarters, we’ve really seen some very, very large numbers. I guess that speaks to success in all the product lines in particular, also with Stratix II.

Q - Jeff Palmer(?), Friedman, Billings, Ramsay

Last question if I could, John, now that you’re pretty much the standalone only structured ASIC guy out there, can you talk about what you’re seeing in the marketplace? Are you finding more customer engagements? Are you finding customer engagements easier that in the past when you’ve had customers that are different competitors there?

A – John Daane

I think the customer engagements are getting easier because people are starting to understand the advantages of structured ASIC over pure ASIC alternatives as we’ve mentioned in the past, the fact that we have design wins and have revenue today from other semiconductor suppliers I believe speaks to the value proposition of the structured ASIC marketplace. I think that we have less competition today. Generally the competitors that we had in the past, we didn’t really see that much. We heard about them, but I think Altera was really having a bulk of the market success and a lot of that is because of the design methodology. The fact that you can start with an FPGA, prove out your design – it’s much lower cost entry point than doing any of the other standard cell based or structured ASIC designs, it allows customers to get to market very quickly and then also the fact that we have an automated conversion process allows them to achieve cost reduction without having to invest any engineering effort in the design conversion, which I believe is a tremendous advantage over the competition. So we see the product as being very strong, we expect the product to continue to grow and as we mentioned in the past, the other advantage of HardCopy is that it also wins for Altera, a large number of high end FPGA sockets for customers who believe that they may indeed want to convert because their program will be very successful and sometimes never do. So as a company we enjoy extra FPGA revenue if you will, or sin designs really from the competition because we have a differentiated product line.

Operator

Ladies and gentlemen, at this time we have no more questions in the queue. I would like to give you a final opportunity to ask a question by pressing star-one. Gentlemen, we have no more questions in the queue. Mr. Wylie, I’d like to turn the conference back to you for concluding remarks.

Scott Wylie

Thank you, Lisa. Before we end today, a reminder that Altera will appear September 6 at the Citigroup Global Semiconductor Conference in New York. This concludes Altera’s conference call, thanks for your participation and interest.

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Source: Altera Corp. Q2 2006 Earnings Conference Call Transcript (ALTR)
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