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Altera Corporation (NASDAQ:ALTR)

Q4 2009 Earnings Call Transcript

January 26, 2010 4:45 pm ET

Executives

Scott Wylie – VP, IR

Ron Pasek – SVP, Finance and CFO

John Daane – President, CEO, and Chairman

Analysts

James Schneider – Goldman Sachs

Uche Orji – UBS

Srini Pajjuri – CLSA

John Pitzer – Credit Suisse

Adam Benjamin – Jefferies

Tim Luke – Barclays Capital

Brendan Furlong – Miller Tabak

Mahesh Sanganeria – RBC Capital Markets

Glen Yeung – Citi

Sumit Dhanda – Bank of America/Merrill Lynch

Hans Mosesmann – Raymond James

Chris Danely – JP Morgan

Auguste Richard – Piper Jaffray

Operator

Good day, everyone, and welcome to the Altera fourth quarter 2009 earnings results conference call. Today’s call is being recorded. At this time, I’d 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

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, and use code 258712.

During today's call, we will be making some forward-looking statements, and 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.

With me today are John Daane, our CEO, and Ron Pasek, Chief Financial Officer. Ron will open the call with a financial overview before turning the call over to John. After John concludes his 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 would now like to turn the call over to Ron.

Ron Pasek

Thank you, Scott. My commentary will cover our results for the fourth quarter and full year 2009, as well as guidance for Q1 and full year 2010. Revenue for the fourth quarter 2009 was $365 million, a sequential increase of 27% and a year-over-year increase of 16%. Q4 turns were in the low-50s range, which is better than our initial estimate, hence the higher than expected top line. Incoming orders were also strong, and our book-to-bill ratio was well above 1, which drove a significant increase in Q4, ending backlog over Q3.

On a sequential basis, we saw net increases in both our large and small customer categories, indicating broad-based demand strength. John will give you more details on the quarter’s sales dynamics in a few moments. Revenue for the fiscal year 2009 was $1.195 billion, a decrease of 12.6% from fiscal 2008.

Moving on to gross margin, Q4 gross margin was 68.4%, a sequential increase of 1.1 points, largely the result of fundamental improvements in cost of goods sold. In Q4, we saw very little sequential effect on gross margin due to vertical mix. Additionally, our operations team did a superb job controlling costs as well as responding a significant increase in customer demand throughout the quarter. Gross margin for the full year 2009 was 66.8%, essentially little change from 2008.

Operating expenses for the quarter ended at $130.3 million, an increase of $3.9 million or 3% sequentially. The increase in spending on the SG&A side was due to a higher than anticipated variable compensation, incentives and commissions resulting from the very strong top line, offset by some lower R&D spending. Our product development agenda remains on track.

For the year in total, operating expenses were down 4% versus 2008, representing the third year in a row where we have seen absolute dollar declines in operating expense. Within that total, R&D increased only modestly in 2009 despite the rollout of our 40 nanometer and other new products. SG&D decreased 8% or $21 million, which is a combination of our cost reduction initiatives, lower variable compensation, and lower volume spending.

Looking forward, the restructuring steps we implemented in 2009 are already producing benefits and are part of our ongoing management process to consistently deliver over time OpEx growth less than revenue growth, allowing us to generate continued operating leverage. However, we are far from finished with our focus on cost, and you will see that it will continue to be a key focus of ours on an ongoing basis.

Q4 other income primarily consisting of the net of interest income, and our credit facility interest expense was a minus $1 million. Our Q4 effective tax rate was 13%, largely as a result of a more favorable geographic mix of income for the quarter and the year, offset by some unfavorable discrete items.

Net income for the quarter was $103 million or $0.34 per diluted share, an increase of $0.06 over Q4 of 2008. For the full year 2009, net income was $251 million or $0.84 per diluted share, a decrease of $0.34 from the full year 2008.

On the balance sheet, cash and investment balances increased by $183 million to $1.5 billion. Cash flow from operating activities was strong at $176 million for the quarter. Inventory was up slightly, but down on a month supply on hand basis. Total pipeline month supply on hand at 2.5 months was comprised of 1.7 months for Altera and 0.8 month for distributors. This ending month supply on hand is well below our target of three to four months. Lastly, accounts receivable declined by $37 million primarily due to strong Q4 ending collections. Past due AR remains at historical lows.

Moving on to guidance for the first quarter. We expect to see revenue growth in the range of 5% to 10% sequentially. First quarter turns requirement looks to be in the mid-40s, the result of our very strong backlog position. First quarter gross margin will be mix dependent, most likely in the range of 67.5% to 68.5%.

Within Q1 OpEx, we are targeting R&D spend in the range of $66 million to $68 million, about flat with Q4, as we near the end of the incremental spend for this new product cycle. SG&A should come in between $59 million and $61 million. Other income for Q1 will remain in the minus $1 million range. Our tax rate will be between 14% and 16%, a slight increase due mostly to the impact of R&D tax credits. Share count will be approximately 303 million shares.

For the full year 2010, I want to reiterate the majority of the guidance we gave you at the analyst conference in November. Again for 2010, we expect gross margins to be in the 67% to 68% range. We expect R&D to be approximately $257 million and SG&A to be around $240 million. As John indicated in November, as things change throughout the year, there can be some variable in these numbers. We expect other income to be minus $2 million and we expect a tax rate of 14% to 16%.

Finally, my priority as a CFO going forward will include further improving the cost structure, including a keen focus on improving business process, maximizing our free cash flow with a renewed focus on our cash conversion cycle, driving and supporting profitable growth, and as a result, further enhancing our business model creating attractive shareholder returns.

Before I turn the call over to John, let me express to you how pleased I am to be a member of this team. Altera has built a remarkable business model and further improved it in the last several years. The potential that Altera represents in terms of sales and profit growth combined with a deeply committed senior management group is what brought me here.

Enough said for the moment, I do look forward to meeting many of you in the coming weeks and months. Now let me turn the call over to John.

John Daane

Thank you, Ron. Q4 revenues increased 27% sequentially on broad end market growth. All of our markets performed better than anticipated due to a combination of new program ramps, improved end market demand, and an increase in customer take rate due to inventory depletion. The revenue leverage in our model enabled Q4 operating margin to increase 10% sequentially to 33%.

Our new product category increased 30% sequentially. All of our new products grew Stratix IV up 35%, Stratix III 72%, Stratix II 25%, Cyclone III 36%, Cyclone II 20%, Arria II 260%, HardCopy 16%, and Max II 26%. Revenue from Arria II, our second 40 nanometer family, approached $1 million in the quarter.

All of our end markets increased sequentially. Telecom and wireless increased 31% on the strength of 2G and 3G wireless, and telecom transport and access also brought geographic deployment. Industrial, military automotive grew 23%, with each market up double digits. Computer, storage, networking increased 14%, with networking as the primary growth driver. Other grew 35%, with consumer, broadcast, test, and medical, each up double-digit sequentially.

Our major customers have repeatedly told us that the sharp increase in demand is to support strengthening in their end business and that they are not building inventory. To gauge this, I would like to compare Q4 2009 to our recent prior quarterly peak in Q2 2008.

By product category, our new products increased 48%, while mainstream and mature products declined 27% and 37% respectively. Our mainstream and mature products are in decline, although this is more than we would normally expect. Put another way, all of our growth is in new products associated with production ramps of new customer systems, replacing ASICs and the ASSPs.

Again comparing Q4 2009 to Q2 2008, this time by market segment, five of our 11 end markets grew and six declined. As a new PLD market, automotive increased as prototype programs transitioned to production. Broadcast increased due to a strong high-definition equipment upgrade cycle ahead of the Olympics and World Cup this year.

Military grew because of our high design win penetration and relatively low market share. Wireless and telecom also each grew because of the communications infrastructure build primarily centered today in Asia. Networking, industrial, consumer, computer, storage, tests, and medical are all down, in most cases double digits.

The growth of telecom, wireless, military, automotive, and broadcast markets, all in new products, is logical. Nevertheless it is very possible that a component of the recent revenue increase is due to inventory build, and we have taken this into account in our Q1 forecast, as I will discuss in a moment.

Shifting to full 2009 year results, we believe we outperformed the ASIC market again. In 2008, Altera grew 8%, where Gartner reports the ASIC industry declined 4%. In 2009, we declined 13%, while Gartner’s November forecast has the ASIC industry declining 19%. We expect to similarly outperform the ASIC industry again in 2010.

By product category for 2009, our new products grew 16% and ended the year with 62% of revenue. FPGAs decreased 9% and CPLDs decreased 27%, as the market for CPLDs significantly declined. On the product front, 2009 was a seminal year as we purposely move to become the PLD technology leader with an early release of 40-nanometer Stratix and Arria families.

Stratix IV design wins have set new records for the company in the 1.5 years since introduction, and the revenue ramp remains the fastest in the industry to date. The next node, 28-nanometer, offers additional leverage to displace ASICs and ASSPs. We intend to again move quickly with 28-nanometer product introductions this year.

Moving to Q1, we are forecasting a 5% to 10% sequential increase. Telecom and wireless should increase, driven by wireless. Networking, computer and storage should increase across each of the submarkets. Automotive, industrial, military should increase, with military seasonally flat to down, but industrial and automotive up. The other segment should also increase. Overall, we are continuing to benefit from the trends in Q3 and Q4. New program ramps, improved end market conditions, and end customer inventory depletion resulting in a resumption of orders.

Our book-to-bill was over one in Q4, and turns required to make the Q1 guidance midpoint are in the mid-40% range, well below our historical high-50% range and below the Q4 low-50% figure. We believe the forecast of low turns requirement is prudent in light of our significant revenue uptick and the potential of customer inventory build. Although we have a few products where supply is tight, and in general, our inventory is low, a vast majority of our products and product lead-times remained stable and short.

In summary, the Q4 results demonstrate the importance of our multi-year dual focus of company cost reduction through simplification while aggressively moving to new process nodes with industry-leading products. Nevertheless, our work is not over. We will continue to focus on releasing next generation products to accelerate ASIC and ASSP replacement while continuing simplification initiatives to maximize shareholder returns.

Now let me turn the call back to Scott.

Scott Wylie

We would now like to take questions. Please limit your questions to one at a time so that we give as many callers as possible the opportunity to ask questions during the call. Operator, could you please provide instructions in full for questions?

Question-and-Answer Session

Operator

(Operator instructions) We’ll take our first question today from James Schneider with Goldman Sachs.

James Schneider – Goldman Sachs

Good afternoon. Thanks for taking my question. I was wondering if you could comment on where distribution inventory dollars ended up in the quarter. And if you look back relative to historical levels, either the Q2 ’08 peak you mentioned or at other times, how that dollars of inventory indices actually compared to those prior peak levels? Thank you.

Ron Pasek

This is Ron. Our ending inventory for the quarter was about $97 million, I believe, net. And it was about flat to Q3.

John Daane

I think, Jim, specifically we do on the press releases list the distribution inventory on a month's supply on hand ending the quarter. So if you go back in time, you could compute I think the dollars specifically for every quarter if you wanted to for distribution. We don’t have all the numbers here right now, but that data is available. The other thing I’d point out, and I know you know this, but just for the general audience, we recognize revenue when our distributors ship the product to the end customer. So we really look at the distributor inventory as more of our own inventory, which is why we tend to report both numbers.

James Schneider – Goldman Sachs

Fair enough. And then maybe a follow-on. Just on the telecom business, John, can you give just your view on what you think your China wireless business will do for the full year 2010 versus ’09? And if you can comment on whether you think India 3G will be material at all this year, that would be great.

John Daane

Yes. So I think it’s very difficult for us to specifically comment for any of these vertical markets beyond one quarter. As we mentioned, we’ve typically been turning business in the mid-to-high 50% for many quarters, which means visibility is low. And I would expect it to remain so. In general, China is in the first year of a major three-year rollout of spending for 2G, 3G wireline network, as well as the backhaul, predominantly wireline in this case, for the mobile network. And so we would expect over the next several years, trend will continue to be strong, although there will be quarterly changes. And again, it’s hard for us to note today what those will be. India is going through a good 2G rollout. And we expect 3G will happen hopefully sometime this year, but certainly in the future.

And as we’ve talked about before, I do expect the communications is going to have sort of a strong three to five-year growth cycle, really not only because of China being in the year one of a three-year rollout plus India, but you’ve also got in Japan both KDDI and NTT have announced that they are going to move forward with LTE, which is the fourth generation wireless standard, as well as both Verizon and AT&T announcing that they plan an LTE upgrade. So the short answer is low visibility, can’t tell you exactly what’s going to happen for the rest of the year, even by quarter. But in the long run, I expect over the next three to five years a really good growth cycle in communications.

James Schneider – Goldman Sachs

Thanks very much. Welcome, Ron.

Ron Pasek

Thank you.

John Daane

Thanks, Jim. Next question, please.

Operator

We’ll take our next question from Uche Orji with UBS.

Uche Orji – UBS

All right. Thanks very much. John, can I just start off by clarifying something you said when you talked about some of the growth being due to inventory field? Your lead-times are short, your inventory on hand and distributors are kind of below normal. I just want to understand what you mean by that statement? What specifically are you seeing in the inventory field? Are there any specific markets or regions that are concerning to you?

John Daane

Yes, Uche, this is John again. Specific – I have been here nine years. We have had very strong up-cycles. We have also had periods of time where we’ve been on allocation. I’ve never seen to date any double ordering. And I think that’s because we tend not to be a commodity. So people tend to order what they want. The turns number has relatively been pretty stable over a long period of time in the high-50s, although we did the last quarter and this quarter forecast a lower number. Part of what I think is happening in the industry in a sense, capacity is tight and lead-times on some products at some companies have gone out. Customers have responded by putting or pipelining inventory or backlog a little bit further into the future – excuse me, not inventory, backlog further into the future. Just part of the reason why we are forecasting a lower turns rate.

The other thing is we have had a strong uptick in our business. And where you can analyze it and feel comfortable with the uptick makes sense because it really is in markets that should have grown and did grow because they are either new to PLDs or Altera is taking market share or in the area of communications. Obviously there is a very strong build going in Asia. There still is the chance that customers have increased the amount of inventory that they are taking on Altera product just to create above their stock. They tell us that they are not, but it’s always a potential and therefore we have to assume that it could be happening and take that into account into our numbers.

Uche Orji – UBS

I see. Okay, that’s clear. Let me just switch and ask Ron a question. Ron, you talked about getting your focus on costs through 2010. Are there any metrics you may want to share with us? I know you’ve kind of given out your business model, but in terms of specific things you might be doing on costs just kind of making sure I understand what (inaudible) in terms of the focus you are putting out cost in 2010.

Ron Pasek

I mean, nothing is off the table. I mean, our ratios of R&D to revenue, SG&A to revenue, internal metrics by each function internally, benchmarking against direct industry and semiconductors in general, it’s all there. I mean, it’s all being considered.

John Daane

I think within the first month, Ron has identified not only the areas that we’ve had before various for better optimization, cost reduction, simplification that also has figured out some new areas as well. So I think we’ve still got a lot of work to do in this company and we certainly welcome Ron because I think he is going to do a great job helping us get better.

Uche Orji – UBS

That’s helpful. The reason I’m asking the question is, when – I remember when you had I guess a CFO, you identified a number of projects, like 30 projects I think at a time and kind of give us a run-down as they progress. So, is that a kind of approach you are taking, Ron?

Ron Pasek

Yes. Plus, as I mentioned, I’m going to have a slightly different tact as well, which is focusing on generic business process where you see some inefficiencies and redundancies et cetera. So it’s not just focusing on specific cost, but it’s also looking at how efficient our processes are.

Uche Orji – UBS

Right. And then just lastly, John, Stratix III, how are you tracking the revenue? Is it possible that could exceed $100 million in 2010?

John Daane

Uche, we are not in a position to forecast revenues by family. I do think we are doing very well in 65-nanometer. We would estimate that our market share in 65-nanometer is actually well above our market share overall, and FPGAs, we have about 34% market share in FPGAs. We would estimate in 65. We’re well ahead of that. And as we had been in the prior two generations, 130 and 90, that’s why we would expect as a company to continue to take market share.

Uche Orji – UBS

Thank you very much.

John Daane

Thank you very much, Uche. Next question, please.

Operator

We’ll take our next question from Srini Pajjuri with CLSA.

Srini Pajjuri – CLSA

Thank you. John, you mentioned that ASIC to – ASIC and ASSP to PLD transition has – is helping you in the near-term, obviously given the strong growth rates. I’m trying to figure out how much of this trend do you think is just a cyclical bounce or demand being better versus the secular trend of ASIC to a PLD transition?

John Daane

I think there are certainly both components in the business. We are seeing customers deplete inventory return to a resumption of orders. We are seeing in some markets customers say that the business trends are better. They are seeing an increase in backlog and an increase in orders. So I think that’s helping. But if you really look at the new product growth, that is all about taking market share from ASICs and ASSPs predominantly in the infrastructure markets. ASICs and ASSPs are still going to make sense for high volume market segments like games or phones or PCs, but if you increasingly look in the infrastructure, the volumes simply are not there for customers to get the return on investment to afford the non-recurring engineering charge to do the ASIC and nor will semiconductor companies be able to afford the design of the chip to develop an ASSP.

And so we are certainly benefiting from that trend. If you look at us over the last five years, and we’ve got lots of examples of this, we have outgrown our end customers. And I think the fact that we are growing at a faster rate than our end customers and end markets is direct evidence that we are taking market share as we become a larger proportion of the bill of materials in their systems with each new generation.

Srini Pajjuri – CLSA

Yes. I guess my question was more specific to the last quarter. I’m just wondering if anything out there is accelerating this transition. I mean, do you think the downturn or the 40-nanometer transition, do you think that’s helping you a bit more than in the last few years?

John Daane

Yes. Downturns actually help accelerate that trend. And the reason is, a down trend in the technology industry, most systems will go back and rationalize their R&D budget and therefore cut ASIC design programs. I mentioned a couple quarters ago a new market for us is becoming a multi-function printers is an example that used to be a core ASIC market where many of these companies are saying they can no longer afford the ASIC design. New market, for us, obviously was ASICs and before many other examples of that.

Likewise, I think in a downturn, many of the companies that developed ASSPs for the infrastructure markets will realize there is not an ROI and cut those projects. So we typically do see a design win momentum coming out of a downturn. Added to that fact, a lot of semiconductor companies will close plants and tend to obsolete older generations of technology ASICs and microcontrollers, and that opens up a lot of redesign effort where people simply move those designs over to programmable logic as well.

Srini Pajjuri – CLSA

Okay, great. And then one question on the gross margin side. Ron, you are still maintaining your 67% to 68% for the full year even though I guess you are starting off at 68%. My question is, is there any reason for the gross margins to tick down a bit here or is that being conservative here? Thank you.

Ron Pasek

Well, as you know, we only have visibility really into a quarter ahead of us. So I’m trying to give you guidance that I think is probably in the range of what we will beyond that and giving you what we’ve said in the past and what we – which is still higher than what we said we need to run the business. So –

Srini Pajjuri – CLSA

Great, thank you.

John Daane

Thank you very much. Next question, please.

Operator

We will go now to John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yes, good afternoon, guys. Thanks for the questions. I have a couple. First, Ron, I think in your prepared comments you talked about your target level of inventory being about three to four months. We are clearly below that at the end of December. Could you help us understand the plan to get back to target? Is that something we can expect in the March quarter or do you think it’s going to take you longer than that to get back to that target inventory level?

Ron Pasek

It kind of depends, but clearly we are trying to get back to around three months supply on hand. That would be an increase in dollars between $20 million and $25 million for the quarter. If demand stays strong, it may take longer than that, but that’s what we are contemplating right now. Clearly 2.5 is probably lower than we’d want to be.

John Pitzer – Credit Suisse

And then, John, understanding that you guys kind of have most favored nation status with your supply chain, especially the foundries, can you help me understand how you view capacity available to grow through the balance of the year? And I guess if we start to hear about wafer pricing going up, how do we think about your gross margins and your ability to match increasing cost with the increasing ASPs to your customers if that would come to pass?

John Daane

Okay. Capacity I think in the industry is extremely tight in the 90-nanometer through 40-nanometer process generations. And I think that is really across the overall industry. How that plays out for the rest of the year will – is hard to predict because it’s hard to know what the demand will be for the rest of the year. But it clearly is very tight right now, and we are – I think many companies are adding equipment through CapEx spends, there is a limit because the – and equipment manufacturers do have fairly long lead-time to make some of the equipment like steppers. So there is a limit to how much capacity can be brought on in the newer process generations. Right now, it looks tight and it looks tight for a while. We do have an excellent relationship with our manufacturing partners. They have been getting product for us.

As you can imagine, we increased revenue 27% sequentially with not our original plan or thought going into the quarter. Clearly that meant we had to get a lot of extra products in order to make that 27%. And our manufacturing partners have been doing a great job of making sure that we are taking care of in getting the product in an expedited fashion. And that continues this quarter. So overall, we do have some chipset – couple chips generally – not families, just a couple chips where capacity is really tight and we are doing the best we can to get product very quickly. Generally everything else is okay, but our foundries are doing a good job.

Now on pricing, we tend to take a longer-term view. So we don’t tend to ask for really low pricing when the industry has a lot of capacity, and therefore we’ve never necessarily been the first company to have our pricing raised when capacity gets tight. I can’t promise or tell you what’s going to happen in the future. But if you go back and look at our numbers over a long period of time, really our margins have not changed or fluctuated with capacity. They more fluctuate really with end markets and that sort of business profile.

John Pitzer – Credit Suisse

And then my last quick question. When you think about the 28-nanometer ramp, you guys did a very good job on the R&D cost side, keeping things constrained to the 40-nanometer development. How do we think about cost around 28-nanometer and how that might ramp throughout the year?

John Daane

The overall 28-nanometer product spend is within the R&D numbers that we provided through the November analyst meeting that we did. Obviously Ron updated that a little bit today. So that’s already baked in. So we will also get some of that spend obviously in 2011 as well and although it is too early for us to be able to provide you with any information on a model for 2011.

John Pitzer – Credit Suisse

Great. Thanks, guys.

John Daane

Thank you very much. Next question, please.

Operator

We will go next to Adam Benjamin with Jefferies.

Adam Benjamin – Jefferies

Thanks, guys. I’m just looking for a little clarification on the comment in the prepared remarks the recent rise in the revenue due to potentially an inventory build. I’m just curious if you can comment on the fact that whether that’s just something that you guys are speculating on or that you’ve actually seen signs in the order trends or something that would indicate that you are seeing some semblance of inventory build in potentially some of your markets. Obviously your turns rate is lower. So maybe that’s something that you’re trying to point to here. So I was looking for some clarification. Thanks.

John Daane

Yes, certainly – just to go back, our customers are telling us that they are not building any inventory across the board. So whether we talk to a customer or whether we talk to a contract manufacturer, they are all adamant that they are not building inventory that this is – the uptick in business is really because of an increase and an end demand. And again, as I went back and compared Q4 to Q2 of 2008, there are reasons why our business is up strongly and those reasons are logical and they do make sense. It’s really is in new products and it’s really in markets where we have high penetration rate.

The markets are doing well themselves right now, or they are new markets for us and you would expect those to grow as prototype designs go to production. Nevertheless, I think in this environment where you are seeing prices rise on commodities like memories, you are seeing some companies. We’ve heard of companies in the analog sector is an example with extended lead-times. It is always possible in these environments and these cycles that customers are putting in a buffer stock. They probably won’t tell you that they are doing it because then they may not get the product, but nevertheless it’s possible. So therefore we are assuming that there could be that case going on. We have no evidence of it actually happening though.

Adam Benjamin – Jefferies

Got you. Thanks, John. And then just a clarification on that or a follow-up, obviously you’ve seen some pretty good revisions in the last couple quarters, better than your forecast at the beginning of the quarter. So if you can compare those periods to kind of where we are today and where we ended up in terms of potentially your customers over-ordering or potentially building inventory, which it seems like hasn’t happened yet. I was wondering if you can talk about those maybe in the last two or three quarters.

John Daane

To be honest, I’m not sure I understand the question.

Adam Benjamin – Jefferies

I’m just trying to get at where you are today versus the last couple quarters where you’ve seen pretty significant revisions to what you ended up doing at – when all said and done when you reported the quarter. What kind of tone you’re getting from your customers versus where you are today? If things have trended differently.

Scott Wylie

We guided to – if you go back to Q4, we guided to a lower turns rate because book-to-bill in Q3 was strong. And we did think that part of what we were seeing with the bookings is customers pipelining inventory a little bit longer into the future. And therefore in that environment, you should expect a lower turns number, because customers basically have extended their backlog.

What we really experienced in Q4 is the significant uptick in new orders, plus customers accelerating the backlog that they had on hand and asking for that earlier. And that’s why the revisions business was just getting stronger throughout the quarter. This quarter, again we are forecasting a number with a lower turns rate than we’ve seen historically. Really we are doing that because it makes sense to be a little cautious after a 27% sequential increase to say to yourself, there could be. You don’t know about it. Nobody has told us, but there could be an inventory component. So let’s just go with a lower number to be cautious and prudent. We will just have to see what transpires this quarter.

Adam Benjamin – Jefferies

Got you. Thanks for the clarification, guys. I appreciate.

John Daane

Thank you.

Operator

We will go now to Tim Luke with Barclays Capital.

Tim Luke – Barclays Capital

Thanks so much. John, a couple of clarifications. Essentially it seems that what you are alluding to is that because the lead-times in other areas may be extended, whereas in PLDs the lead-times are quite, I believe, at normal levels. That’s why you are seeing the potential for some inventory build. Is that correct?

John Daane

That was our premise in the – early in the fourth calendar quarter and certainly remains a premise now. Our lead-times are generally normal. We do have some products which are tight, simply because our inventory numbers are much lower than they have been historically. But we certainly would not believe that our lead-times are a cause for people to want to establish buffer stock. They haven't moved out enough that people would be panicked in order to go and say, let’s put buffer stock of Altera product in place. They really would have to be doing it based on an industry call rather than an Altera-specific, or for that matter, I would guess even a PLD-specific event.

Tim Luke – Barclays Capital

Separately, I think you said that you are going to introduce 28-nanometer this year. Could you just expand a little bit on that? I think – could you just compare how long the timeline is to move and announce 28-nanometer versus the historical move to newer node clutches from moving from 65 to 40. And I also think that you said the HardCopy is now 16%. Was that up quite a bit in the quarter?

John Daane

Yes, HardCopy did grow in the quarter, and I will go back and get the exact percentage as – I am doing this.

Scott Wylie

16%.

John Daane

16%. Thanks, Scott. In terms of – I'm sorry, Tim, I forgot the –

Tim Luke – Barclays Capital

The 28-nanometer.

John Daane

I’m sorry. 28-nanometer, we are probably right now on roughly about a two-year product introduction. Historically you’ve seen the PLD industry on about a 2.5-year cycle. I think that’s been pulled in a little bit more. So you’re roughly probably going to see new generations out of this every two to 2.5 years. PLD companies, I think, also probably over the last ten years have been more aggressive adopters of new process technology. I think you used to see that the microprocessor companies and memory companies were the most aggressive.

Now what you’re really seeing is microprocessor, CPU [ph], and PLD companies are all trying to get to the new process node as quickly as possible, generally because particularly I think anything programmable – Moore’s Law provides an advantage because we can make the product cheaper and be able to take it out to a broader market. But the problem for the rest of the industry that’s making application specific products is that the costs of the new node goes up, in many cases exponentially, and that really limits then the markets that they can pursue. And so as ASICs and ASSPs decline, as a number of them have been for many years, we can certainly move into that vacuum and enjoy that growth.

Tim Luke – Barclays Capital

That's in this year announcement and you expect to lead the industry as you did with 40, or do you think it’s going to be fairly similar?

John Daane

To be honest, I do not know because I don’t know what the product plans for the competition. We simply plan to be, stay on the aggressive end of new process introductions, which if you go back in time and remember, in the 130 through 65-nanometer generations, that was not our plan. Our plan was to be a little bit more of a follower and innovate in architecture and software. We’ve added to software and architecture. We want to also be technology leaders. And we did that in 40 and we’re going to do that again in 28. I don’t know whether it will be earlier than the competition or not.

Tim Luke – Barclays Capital

Thanks. Congrats on your execution.

John Daane

All right. Thank you very much, Tim. Next question, please.

Operator

We’ll go next to Brendan Furlong with Miller Tabak.

Brendan Furlong – Miller Tabak

Thank you, and good afternoon. Question, could you talk to what happened between when you had your mid-quarter update and obviously the four weeks later – three or four weeks later when you significantly beat that update, what happened in terms of end markets and what have you?

John Daane

Two things, Brendan, specifically happened. Number one is, business continued to improve over December and we received more customer expedites. And obviously where we had product available or in the pipe (inaudible), we were able to satisfy those turns. Number two, December is always hard to call because of the holiday period at the end of the quarter. So you are not quite sure where the contract manufacturers or customers themselves are going to cut off early in order to minimize inventory that they are carrying or not. So we base some of our assumptions off of what we’ve seen in prior years. Obviously this year in December turned out to be extremely strong.

Brendan Furlong – Miller Tabak

Was most of upside in the final few weeks from new products?

John Daane

I don’t have a breakdown, to be honest, by product category. We tend to look at that only on a quarterly basis.

Brendan Furlong – Miller Tabak

Understood. And I guess my last question related to that would be, did most of the expedites come from the Asia-Pacific region?

John Daane

I don’t even know if I could say that that is correct or not. I don’t know where in particular the strength was at the end of the quarter. I don’t have that breakdown, I’m sorry.

Brendan Furlong – Miller Tabak

That’s fine. I guess – and then my last thing would be, given the 27% sequential growth and another strong quarter expected here, would it be prudent, if you will, and if it’s a risk of some double ordering or over-ordering, whatever way you want to put it, that we have a more front end loaded year than normally, in terms of revenues?

John Daane

I have – as we mentioned earlier, because we really have a low visibility and that’s not new – I mean, that’s something that’s normal for us. We tend to turn – our turns are normally in the high-50s, mid-50s. Visibility is just low. And so therefore we are really going to take it one quarter at a time as we have historically, and so I really have nothing I can provide you to as far as guidance for the rest of the year.

Brendan Furlong – Miller Tabak

Excellent. Thanks a lot.

John Daane

All right. Thank you very much. Next question, please.

Operator

We’ll go next to Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria – RBC Capital Markets

Thanks. Hi, John. Another inventory question. If you – I understand that all your OEMs are saying that they are not building any buffer, but you have to be conservative and assume that that is something. So can you give us an idea to which market – end market is likely to have that buffer if you compare to historical trend that this particular market is in? What would you – of the $365 million you did in December, what would you think that amount will be somebody’s holding? Is it $20 million, $30 million, $10 million, some kind of idea? I’m assuming that that’s the amount you are basically handicapping your March quarter guidance by.

John Daane

So – I think you have to go back and start with the comment that I’ve made that our customers are telling us that they are not putting buffer stock in. So therefore, since you start with that, if they are and we are assuming for a minute that that may be happening, it’s impossible for us to pinpoint it on an industry or a particular customer or a particular geography because it’s just blanket assumption that we are making without having any data to support it.

But again, in light of a 27% increase and in light of a 27% sequential increase for what is a pretty good sized company, you should be a little prudent going into the next quarter and make sure that you are not just getting caught up in the euphoria. And we are just trying to be a little bit conservative going into this quarter. I think the guidance is still very strong. So again, we have no evidence of any customer anywhere going any buffer stock or for that matter any contract manufacturer. We are just trying to be a little bit cautious after such a strong quarter, and again even with the strong guidance this quarter, that there may be some inventory build going on.

Mahesh Sanganeria – RBC Capital Markets

Okay. So another question in terms of you – you said on the telecom and wireless side, the strength came from both the wireless and telecom was telecom much stronger growth in the December quarter and going forward you said growth is coming from wireless. So can you give us some quantification around that, little bit more color on how was Q4 and how is Q1?

John Daane

Yes. Telecom has a really strong quarter in calendar quarter Q4. You are seeing a couple things there. One is, PTN equipment deployment. You are seeing access equipment deployment. You are also seeing general backhaul upgrades for the mobile networks on a worldwide basis because the smartphones are starting to saturate the networks. And you’ve seen those announcements out of AT&T and Verizon, and you’ve also seen those announcements in other countries as well.

So we certainly had a very strong quarter in telecom, although wireless was up nicely in the quarter as well. This quarter, we expect it to be wireless. And again, I think the other thing to point out in Q4 is I did make the comment that we see strong demand in communications in Q4 really for broad end market deployment. So in other words, this was not just equipment for deployment in Asia. We also saw an uptick in Japan and we saw an uptick for equipment bound for Europe and North America as well.

Mahesh Sanganeria – RBC Capital Markets

Is it fair to say that telecom growth in Q4 was – I mean, in terms of percent growth was almost twice the wireless and it’s reversing in Q1, like it’s mostly coming from Q1?

John Daane

No, I don’t think we could – we can say that. And specifically again, we’re not breaking – in a position to breakdown telecom versus wireless percentages last quarter. But – I'm just looking at the data to see if I’ve got some numbers. I think to be honest, both were up double-digit percentages last quarter. So both were up nicely. Again, telecom a little bit more than wireless. This quarter we would expect wireless to carry more of the load for the increase.

Mahesh Sanganeria – RBC Capital Markets

Okay. Thank you very much.

John Daane

All right. Thank you very much. Next question, please.

Operator

The next question comes from Glen Yeung with Citi.

Glen Yeung – Citi

Thanks. John, you made a comment earlier that (inaudible) was holding up some of the capacity growth. Is that something that you are proceeding, or is that something that your foundry partners telling you?

John Daane

No, Glen, I was – I'm not – and thank you for asking that. I’m not making a call on the semiconductor equipment industry. If you understand the complexity of some of that equipment, you understand that the lead-times are going to be very long just for developing that equipment. But at the end of the day, I just use that as an example. I don’t know what the true lead-times are. I don’t know which particular pieces of equipment are the bottlenecks. What I can’t tell you is if somebody wanted to add a tremendous amount of capacity today, it would be difficult to do so simply because of the lead-times for the equipment. I know what our major foundry partner is doing and know what they are putting in place. Obviously they have significantly increased their CapEx spending plans for this year. We applaud that. And so far they are taking care of us.

Glen Yeung – Citi

Okay. Thanks for that clarification.

John Daane

All right. Thank you very much, Glen. Next question, please. Oh, sorry.

Glen Yeung – Citi

Just one more, which is – just asking about the inventory focus that you seem to have here, which I think is quite good actually, and that same inventory focus that we may or may not be seeing at your customers. If you would look at that attention to inventories today versus the past cycles over the last ten years, is your sense that there is more or less or the same amount of focus on trying to manage inventories here?

John Daane

I think generally everybody is trying to minimize inventories, both for cash, conservation, as well as just it’s an unknown industry right now. So I think in general, most management teams will be a lot more cautious today than they were in 2008, or for that matter even if you go back into the ‘90s or year 2000. Nevertheless, in cycles in semiconductors, when business does get strong, I have seen people put buffer stock in place. And what happens I think in any industry is you need to learn from history and apply that, because some of those lessons do repeat. And so we are trying to apply that thinking in terms of seeing this happen in some past cycles. Nevertheless we have no data to support it today, as we mentioned, and again I would assume because everybody we are talking to would be very cautious and would be trying to minimize their inventory build.

Glen Yeung – Citi

Very good. Thanks, John.

John Daane

All right. Thank you very much, Glen. Next question, please.

Operator

Next question comes from Sumit Dhanda with Bank of America/Merrill Lynch.

Sumit Dhanda – Bank of America/Merrill Lynch

Yes. Hi, John, a couple questions. The commentary around the wireless segment in particular a little more bullish than actually what your peer group or others within the industry have offered up both in terms of how you did in Q4 and then into Q1. Anything specific that you think might be helping out either in terms of geographic exposure or program ramps et cetera that you could share with us?

John Daane

Sumit, this is John again. I really cannot compare us to either peers or other companies in the industry because I don’t what they are seeing. We did see in Q4 strength in GSM, which is a second generation technology as well as in WCDMA. We would expect that to continue. You would expect to see sometime this year TD-SCDMA for the fourth round for China. And you would expect sometime this year to see hopefully maybe India do something in 3G, but hard to know. So at this point, we are seeing good strength. And again, it’s really broad geographic deployment. It’s not just one particular country.

Sumit Dhanda – Bank of America/Merrill Lynch

Okay. The other question I had for you is, is there anything you could share in terms of the aging of your backlog, how that might have changed, for example, your 26 to 13-weekl backlog ratio? Has that trickled up only slightly or has that moved up significantly in the last quarter or two?

John Daane

I’m not sure of the numbers that you are referencing, but what I can tell you is book-to-bill was over 1 in Q4. Generally customers are ordering product at the last minute, with request dates for delivery that day, so most of our orders tend to be well within lead-time. But that’s normal every quarter. Customers are trying to minimize inventory. So they try to order it the last minute, and that’s the trend that we continue to see just obviously with our larger backlog because we are seeing more demand across more customers and more markets.

Sumit Dhanda – Bank of America/Merrill Lynch

Okay. And then I know you sort of tried to answer this question, but you clearly scrubbed your guidance into Q1 to account for a potential inventory build. Anything you can share in terms of whether you are judging your numbers down 5%, 3%, 10%, anything in the ballpark of what you’ve decided to adjust your numbers by, that you could share with us?

John Daane

Nothing that I can provide other than the turns rate we are just taking down on an assumption that customers may have pipelined a little bit longer and again there could have been some inventory build. That’s the assumption. We could be right or we could be wrong. It’s just hard to know at this point.

Sumit Dhanda – Bank of America/Merrill Lynch

Okay. And my last question, the last couple of quarters you’ve talked about how much your 40-nanometer product has contributed in terms of dollar revenues. I’m not sure that you shared the number this quarter. Could you share it with us in terms of what it contributed in Q4?

John Daane

I think 40-nanometer between Arria and Stratix families was between 4% to 5% of revenue.

Sumit Dhanda – Bank of America/Merrill Lynch

Thank you so much.

John Daane

All right. Thank you, Sumit. Next question, please.

Operator

We’ll go now to Hans Mosesmann with Raymond James.

Hans Mosesmann – Raymond James

Thanks, and congrats on the quarter. Regarding 29-nanometer, do your software tools already support the 28-nanometer? And if so, what specific products are you going to introduce 28-nanometer first?

John Daane

Hans, as you’re probably aware from following us for a long period of time, we tend to talk and we give a rough timeframe of when we’re going to do products by process generation. But until we’ve actually announced the product, we tend not to talk about the particular details. And so we would wait until we’ve actually formally announced the product or products, the software availability and all the features before we want to get into the details. So at this point, all I’d say, as we did in November, is that this year is a heavy focus on 28-nanometer in terms of deliverables. And most of the R&D team is now working on 28-nanometer as they have been for a while, but cannot provide you any more specific details than that as of now.

Hans Mosesmann – Raymond James

Okay. Thank you.

John Daane

All right. Thank you very much, Hans. Next question, please.

Operator

Our next question comes from Chris Danely with JP Morgan.

Chris Danely – JP Morgan

Thanks, guys, and my congrats on getting back here by the peak revenue. Can you give us your thoughts on your expectations for end market order in Q1? Can you just give us your thoughts on 2010 relative to end markets?

John Daane

Chris, it’s really hard for us to know exactly what’s going to transpire this year. And that’s no different than any year. And so, as has been our practice for quite a few years, we’ll just take this one quarter at a time. Long-term, as I mentioned earlier, we feel very comfortable that in the next three to five years, we’ve got a very good communication cycle going on because of the number of operators in a number of different geographies that have announced plans to do upgrades of their networks, both on the wireline and wireless side. And obviously that’s a great market for programmable logic.

The military market, we have a low penetration rate. As the military is focusing on security information and communications that obviously plays very well into programmable logic, we think our design wins combined with a low market share in a growing marketplace for electronics is going to mean strong growth there for several years. Industrial automation is another good market for us based on the fact there are a lot of factories are going through in automation cycle to network the equipment to provide safety, which is something that the EU has mandated to, that is requiring an upgrade cycle, and then plus our growth in things like video surveillance, plus other markets like broadcast and automotive where we should see some good strong growth over quite a few years.

So, hard to predict what’s going to happen in Q2, Q3, or Q4 of this year, but over the long-term horizon, I do think we are in some pretty solid markets, which are going through a number of changes and upgrades. And again, if you think of these markets, they are all infrastructure-related, volumes are low, and really they can no longer afford ASICs and nor can semiconductor companies afford to develop ASSPs. So we really are the product of choice and should enjoy some pretty good traction over the next several years.

Chris Danely – JP Morgan

Great. And then one more question on the end markets. So you guys changed around your end market breakout I think about a year ago, but you talked about some good comparisons versus now versus the previous peak. Can you share with us which of your end market revenues are above the 2008 peak revenues at telecom, wireless, auto, industrial?

John Daane

Yes. It’s the ones I mentioned. So it’s five of the six. So it’s military – again, think of us as newer in the military space, that makes sense. Telecom and wireless, both, simply because you are going through large worldwide infrastructure builds, but a lot of them [ph] in Asia today. The automotive market, again, new market for PLDs, transitioning from prototype to production, and then the broadcast industry because you are going through a high-definition upgrade cycle, and also with that, digital cinema is another – as a lot of the movie theaters are upgrading to digital format, that’s another great cycle for us in programmable logic as well. So those five markets are up. The other six markets compared to Q2 of 2008 are down. And a majority of those markets are down double-digit percentage. So – and that, to some degree, may make sense; to some degree, may say that we’ve got some room for those markets to continue to come back and grow.

Chris Danely – JP Morgan

Great. And then last quick question. In other words, through the black hole [ph] of the end demand and things at least look like they are somewhat normal. I think you guys have held your $5 per share in cash. What are the plans to turn that cash to shareholders?

Ron Pasek

So we are looking at a number of things. As you know, we still – we currently have a dividend. We are looking at that over the next several years. We are looking at continuing buybacks as well. And we are looking at and continue to look at acquisition targets. All those things are part of the strategy.

John Daane

I think in general, Chris, it is no different from a strategy that we’ve had over many years. I mean, obviously we generated tremendous amount of cash within our business model. Our intent at this point is both to return the cash to the shareholders through dividends and through share repurchase. We did take from a repurchase perspective, the year of 2009 off, really because we weren't sure what was happening to the banking industry and we wanted to preserve cash. But over the next few years, I think what you will see out of us is a return to that process. What I would tell you though is we’ve tended not to signal what we are going to do ahead of time; we just report after we’ve done it. And so again, look for us to continue the dividend obviously and then return to share repurchases as we move forward.

Chris Danely – JP Morgan

Thanks.

Scott Wylie

Operator, I believe we have time for one more question, please.

Operator

Okay. And we’ll take that question from Auguste Richard with Piper Jaffray.

Auguste Richard – Piper Jaffray

Thanks for taking my question. John, I appreciate your stamina here. Just real quick on the 28-nanometer, I know that the transistor performance has been quite good. That’s what I hear. However, the yields haven’t been so hard. I was just wondering if you could comment relative to a launch how those yields look relative to prior generations.

John Daane

Is the question on 40-nanometer or 28?

Auguste Richard – Piper Jaffray

28, 28.

John Daane

Okay. So 28-nanometer is a process generation, which is still in development qualifications, will be from the various foundries and companies later this year. So yields will continue to improve. We expect that, as we ramp that products, yields should be exactly where we – from what we’ve seen, should be good. And again, when we ramp new products, Altera has not had a negative impact from new product ramps associated with gross margins because we tend to do a lot of yield work and a lot of design rule work ahead of time. 40-nanometer, I think, has been an issue for the industry, with the exception really of Altera.

Generally our yields are good, but a lot of that has to do not with necessarily the foundry as much as it is the technology group. We use our own design rules. We use our own design for manufacturing techniques. We do our own yield enhancement work and have done that for a long, long time and it has resulted in us getting pretty good yields. In general, Stratix IV yields are quite good. Arria II yields are quite good. We have had, of the 12 chips we are shipping total, one chip where we had a couple lots that zeroed at the end of the quarter, was nothing common to the entire family as much as it was a processing misstep unfortunately on those lots. So if you look at the 12 devices we are shipping in 40-nanometer, one is on allocation, the other have ample product available today.

Auguste Richard – Piper Jaffray

Okay. And then just a quick follow-on. Historically your gross margins have been able to get up to 70%. Could you just talk a little bit about the possibility of that and what might drive that either higher volumes or favorable mix?

John Daane

Well, certainly, the components that drive this are costs and cost reduction capability, which we are always working on in the company in order to – because cost reduction does allow elasticity. It allows us to enter into some higher volume markets at times and grow our business, new markets for us. When I started here, if we did something that was 10,000 units a year, that was a big deal. Today we are able to extend those products into applications that are in the 1 million to 2 million units a year. So there is certainly elasticity in the business there.

I think in terms of – the other component is the market segments. There is variability around our margins by market. You would expect that in some of the lower volume markets like industrial and military, which are more fractured in one case, very low volume that the prices are going to be higher, and then in the consumer side of the business when the volumes are very high that the prices are going to be lower for the same component. And so obviously then customer mix and market segment mix has a play as well. Very difficult, as Ron mentioned earlier, for us to know exactly where that are going to trend over the next couple of quarters. We do feel comfortable with the guidance that Ron has provided for the entire year, long-term our model of 65%. We’ve consistently said that for seven or eight years. That’s where we are trying to manage our business. There will be times where it might be a little higher and times where it might be a little lower, but on average we think over the next several years, we can manage it to roughly that number.

Auguste Richard – Piper Jaffray

Great.

John Daane

Thank you very much.

Scott Wylie

Thanks, Auguste. A final note, as we bring this call to a close this afternoon, with respect to our conference scheduled this quarter. We will attend the Goldman Sachs Technology & Internet Conference 2010 in San Francisco and we will be speaking on February 24th. This concludes Altera’s earnings conference call. Thanks for your interest and participation.

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Source: Altera Corporation Q4 2009 Earnings Call Transcript
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