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Executives

Scott Wylie – VP, IR

Ron Pasek – SVP, Finance and CFO

John Daane – President, CEO and Chairman

Analysts

Srini Pajjuri – CLSA

John Pitzer – Credit Suisse

Adam Benjamin – Jefferies & Company

James Schneider – Goldman Sachs

Chris Danely – J.P. Morgan

Glen Yeung – Citi

Uche Orji – UBS

Tristan Gerra – Robert Baird

Shawn Webster – Macquarie

Sumit Dhanda – Bank of America/Merrill Lynch

Apurva Patel – Ticonderoga Securities

Ian Ing – Broadpoint

Mahesh Sanganeria – RBC Capital Markets

David Wu – GC Research Limited

Tim Luke – Barclays Capital

Altera Corporation (ALTR) Q1 2010 Earnings Call Transcript April 20, 2010 4:45 PM ET

Operator

Good day, everyone, and welcome to the Altera first quarter 2010 earnings results 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.

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 webpage 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 first quarter 2010 as well as guidance for Q2 and the full year. Revenue for the first quarter 2010 was a record $402 million, a sequential increase of 10% and at the high end of our guidance for the quarter.

Q1 sequential revenue growth was fairly broad. Both large and small customer categories grew; new and mainstream products were both up; and all geographies with the exception of Japan showed growth. Q1 turns were in the mid-40s range, which is in line with our guidance. Incoming orders were also strong throughout the quarter, which yielded a book-to-bill ratio well above 1 and drove a significant increase in Q1 ending backlog.

Q1 gross margin was 71.4%, a sequential increase of 3 points. The increase in gross margin Q4 to Q1 was largely due to cost reductions, specifically yield improvements, offset by slight price decreases. Operating expenses for the quarter ended at $126.5 million, a decrease of $3.8 million or 3% sequentially and essentially at the midpoint of our guidance.

R&D spending was below our guidance due to a change in the scheduling of the remaining few 40-nanometer tape-outs. SG&A spending was a bit higher than guidance, but does include higher than planned accruals for variable and incentive compensation, resulting in an adjustment to our revenue assumption for the year.

Operating margin dollars grew 211% year-over-year, and operating margin percent reached a remarkable 40%. This level of operating margin is 8 points higher than our target operating model of roughly 32%. The vast majority of this overachievement can be explained by the healthy gross margin rate, which is over 6 points higher than the 65% we used to plan the company. More on this later in my discussion.

Our Q1 effective tax rate was 4.3%, reflecting some favorable discrete items totaling roughly $15 million. The largest discrete item relates to a ninth Circuit Court ruling on March 22, 2010, holding that stock-based compensation was not required to be included in certain transfer pricing arrangements between a US company and its foreign subsidiary. We released nearly $12 million in income tax reserves as a result of this ruling, and this caused the current quarter decrease in our effective tax rate.

Net income for Q1 was $153.2 million or $0.50 per diluted share, an increase of $0.16 over Q4 2009 and an increase of $0.35 over Q1 a year ago. On the balance sheet, cash and investments increased to $1.7 billion. Cash flow from operating activity was $133 million for the quarter.

As I indicated last quarter, we will be using the cash conversion cycle metric as the key indicator of the quality of our cash management. Looking back several quarters, our CCC has fluctuated between 70 and 100 days. For comparable fabless semiconductor companies, medium CCC has been in the mid-80s.

Having said this, our CCC for Q1 was 97 days, or 20 days higher than the 77 days in Q4 ’09. All of this increase can be attributed to an increase in DSO. This increase was caused by an overall increase in business level, the increase in channel list price dollar inventories, and the timing of price concession credits. Although DSOs increased Q4 to Q1, the accounts receivable aging remains quite healthy.

Altera pipeline inventory increased by $24 million as planned, reflecting our desire to get back to a healthy inventory level. Total pipeline months supply on hand for Q1 was at a desirable 3.2 months for -- it was comprised of 2.3 months for Altera and 0.9 months for distributors.

Moving on to guidance for the second quarter, we expect to see revenue growth in the range of 8% to 12% sequentially. Second quarter turns look to be in the mid to low-30s, the result of a very strong backlog position. Keep in mind, as demand has strengthened in the past several quarters, our customers are giving us increased visibility to their needs by placing orders on our books in a more timely manner. This low turns number takes into account some of that change in behavior. In addition, you will notice the turns number in each of our last several quarters has moved progressively lower.

Second quarter gross margin rate will likely be in the range of 71% to 72%. We think R&D and SG&A spending will be largely consistent with the first quarter. R&D spending will be $64 million to $65 million, and SG&A between $63 million and $64 million. Our core tax rate will be 13% to 15%. As we saw this quarter, there can be discrete items, which may add or subtract to the core tax rate.

Given the recent increase to our share price, the fully diluted share count for Q2 will increase to approximately 311 million shares. With respect to inventory, we expect to end Q2 with pipeline months supply on hand in the low 3s or roughly flat to the metric for Q1.

Other than giving specific gross margin guidance for the full year, I want to reiterate what we have said in the past about our target operating model. We plan the company assuming 65% gross margins. While our first quarter and anticipated second quarter results are considerably higher than this, we don’t think this level is sustainable over the long-term. More importantly, we don’t think it is responsible to plan the company at this level. Having said this, we think that gross margins in the second half of 2010 will be closer to our anticipated first half results rather than our previous guidance.

Full year 2010 R&D spending will be approximately $265 million, slightly higher than our previous guidance, as we have decided to accelerate some 28-nanometer spending and absorb incremental incentive compensation costs. As we have indicated, our long-term target operating model assumes an R&D to revenue ratio of 18%.

Our full year SG&A will be approximately $251 million. Our first quarter results and guidance for Q2 saw SG&A at 15% of revenue, which is our desired level. Therefore, over the next several quarters, you should expect to see minimal new investments in SG&A.

Now let me turn the call over to John.

John Daane

Thank you, Ron. Q1 revenues increased 10% sequentially with 65-nanometer and 40-nanometer FPGAs contributing to a majority of the growth. We continue to benefit from a combination of new program ramps, improved end market demand, and increase in customer take rate due to inventory depletion, and the tipping point where our newest products are several process generations ahead of mainstream ASICs, and the resulting FPGA cost advantage is accelerating ASIC replacement.

We have changed the product categorization. New products now contain 65-nanometer and 40-nanometer FPGAs and HardCopy ASIC and our latest CPLD family, all products which are in the design win and production ramp phase of their lifecycle. Mainstream includes 90-nanometer FPGAs and HardCopy ASICs, products which are no longer in the design-in phase and tend to grow or decline with the market. All other products are in the mature category, which we expect on average to slowly decline each quarter.

A history for both new and old categorization is on our IR website. Our new products increased 29% sequentially. Stratix IV was up 70%, Stratix III 31%, Cyclone III 22%, Arria II 66%, and MAX II 9%. 65-nanometer products were 22% of company revenue, and 40-nanometer, 7%. By market, telecom wireless increased 8% on strength of 3G wireless and wireless backhaul. Industrial, military, automotive grew 15% with each market up. Computer, storage, networking declined 1% with slight growth in networking, offset by a decline in computer. Other grew 18% with consumer broadcast, test and medical, all up.

Our customers continue to tell us that they are not building inventory. Once again to gauge this, I would like to compare Q1 2010 to a prior quarterly peak in Q2 2008. As a note, Q1 2010 revenues were 12% higher than Q2 2008. By market, six of our 11 end markets were higher in Q1 2010 than Q2 2008 and five were lower. As newer markets to Altera, both automotive and military have increased as prototype programs transitioned to production.

Broadcast is higher due to a high definition equipment upgrade cycle ahead of the World Cup this year. Industrial was up because of a broad-based recovery combined with new applications in security and factory automation that are ramping. Wireless and telecom also each grew because of the Asia communications infrastructure build. Networking, consumer, computer, storage, test, and medical are all still below Q2 2008 levels.

By product category, our new products increased 512% in Q1 2010 compared to Q2 2008. Mainstream products increased 2% and mature products declined 33%. Since the growth is almost entirely from new products, this speaks more to a new product success rather than inventory accumulation. Nevertheless, we do assume that there is a component of inventory accumulation and have taken this into account in our forecast even though it is not apparent in our product or market analysis.

For Q2, we are forecasting an 8% to 12% sequential increase. Telecom wireless should increase driven by wireless. Networking, computer, storage should increase across each of the sub-markets. Automotive, industrial and military should have growth in each sub-market. And the other segment should slightly increase.

Our book-to-bill was over 1 in Q1, and turns required to make the Q2 guidance are in the low-to-mid 30% range, well below our historical high 50% range and below the Q1 mid 40% figure. Due to the industry-wide supply constraints, customers of pipeline backlog further into the future than normal resulting in lower turns expectations in the near term. Our book-to-bill remains over 1 Q2 quarter-to-date.

Capacity is very tight in the industry, particularly in foundry. Nevertheless we were able to grow inventory as planned in Q1 to the low end of our 3.0 to 3.5 months supply on hand operating model, while also increasing revenue 10% sequentially. Altera product lead-times are generally short. But as with any quarter, there are point die-package combinations that have extended product lead-times due to high and forecasted demand.

On the product front, yesterday we introduced Stratix V, our first 28-nanometer FPGA family. Stratix V contains new FPGA DSP and memory architectures to improve performance, cost and power, while also increasing our industry-leading transceiver performance to 28 gigabits per second. Stratix V also enables the integration of blocks of ASIC and ASSP logic, creating cost-effective and flexible hybrid devices to open new markets and accelerate growth in existing ones.

In summary, we are very pleased with our Q1 revenue, gross margin, and operating margin results. The products introduced over the last several years are contributing the strong growth and profitability for the company, and we have a pipeline of 28-nanometer products that what we believe will continue this momentum.

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, would you please provide instructions and poll for questions?

Question-and-Answer Session

Operator

Thank you, Mr. Wylie. (Operator instructions) And we will take our first question from Srini Pajjuri with CLSA.

Srini Pajjuri – CLSA

Thank you. John, obviously, a very strong guidance year. And recently we’ve been hearing some talk about CapEx cuts in Asia, and I know you are guiding for a strong growth in the wireless business. I’m trying to understand what’s driving the telecom -- what drove telecom in Q1 and also what’s driving in Q2 to get there. Give us a bit more color, that would be great.

John Daane

Yes. The growth in Q1 is broad, but mainly attributable to 3G growth as well as wireless backhaul. So, as you deploy more base stations and there is an increase in data usage from a wireless perspective, there is a need to increase the bandwidth from the base stations to the core network. And that’s backhaul. Q3, likewise we expect 3G to be the main growth driver for Asia as well as for other markets -- other geographic markets.

Srini Pajjuri – CLSA

Okay. And then quickly on the inventory front just on the balance sheet, John, it’s up about 25%. It’s still within your target range, but what’s the risk that if things slow down in the second half that you may need to write down some of this inventory?

John Daane

We have had, I think, in the last 20 years one inventory write-down associated with the year 2000 going into 2001. The difference in that period of time is, between Altera and our distributors, we held about seven to nine months supply on hand. So you will note that our operating model really since the year 2002 has been for us and our distributors to hold between three to four months supply on hand, and right now, we are operating at the low end of that, roughly at 3.1. So we think the risk is low. Capacity is clearly tight in the industry.

As you have seen from us over many years, there may be a few quarters where we operate at the high end of the 3.0 -- 3 range, excuse me. I think one time I can remember in the last seven years, it’s been above 4 for one quarter. There has been one or two quarters that’s been below 3. But generally because we have very solid relationships with our supply base, we’ve been able to get what we need and manage this process very tightly. So I would not expect that there would be an inventory write-off. I think we are managing the inventory very carefully.

Srini Pajjuri – CLSA

If I may, one last one, for Ron. Ron, on the gross margin, you said most of the improvement is coming from the cost side. And my question is, why is this not structural if it is coming from cost savings? And why wouldn’t you sustain beyond the second half of this year? Thank you.

Ron Pasek

Well, I mean, we do control the cost to the extent we can. But again, the offset over time is pricing action. So as of late, we have been doing a better job and quickly reducing cost. At the same time, prices aren’t falling as quickly. Over time, the two do move in tandem.

John Daane

I think generally long-term we’ve said for many, many years that 65% is our long-term model. Different market segments that we target have different gross margin targets. We would like to participate and be able to grow in some of these new markets. So 65%, we think, is a good balance, representing success that we can have in our entire portfolio. Clearly in the interim, we will be operating well above that range.

Srini Pajjuri – CLSA

Thank you.

John Daane

Thank you. Next question, please.

Operator

And we will go to John Pitzer with Credit Suisse.

John Pitzer – Credit Suisse

Yes. John, can you hear me?

John Daane

Yes.

John Pitzer – Credit Suisse

Yes. John, real quick, you talked about three drivers on the top-line, just outright good demand, re-stocking and ASIC replacement. As you look into the June quarter, do you think inventory levels over the time kind of flattish? So when you look at the top-line growth given, how much of that do you think is coming from just growth in the end market versus really just ASIC replacement? And just can you help me understand relatively enough to allow that, where you think if you view had changed all that much around ASIC replacement and what type of trend in growth rate you guys can get to the semiconductor market?

John Daane

Yes. So just to reiterate, the growth that we are seeing for last several quarters, including Q2, we really think is a combination of new program ramps and a success that our new products are having really because of the tipping point. So this is now, as you see with our 40-nanometer devices and coming into our 28-nanometer devices were between four to five generations ahead of mainstream ASIC design, which gives us a cost advantage.

And I think increasingly people are moving away from using fixed function devices, either ASICs or ASSPs for a lot of the core infrastructure markets and instead using programmable logic, because we really -- we don’t have that upfront cost and we’ve been able to substantially lower our unit cost by aggressively adopting new process generations. And those two things together mean that were more cost-effective in many cases than ASICs the company has used in the past.

And if you look at Q1, what you saw is really most of the growth coming from 65-nanometer and 40-nanometer products. And again, most of that resulting from displacement of ASICs and many prototype programs starting to move into volume production. We also saw two other factors, obviously improved end market demand, as our customers are doing better themselves that we are growing more product.

And then finally, not that I say the people are stocking inventory as much as what’s happened is they depleted the inventory that they had on hand. As their business decreased, in many cases, they had extra inventory that they needed to work through before they return to what was a normal run rate based on the current business levels. As they have depleted that inventory, we are seeing more customers come back and place orders.

If we look at our business, we do not see customers building buffer stock itself. And this would be customers anticipating that lead-times are going to lengthen and supply is going to be tight in the semiconductor industry, and therefore trying to buy extra product to create a buffer. The reason we don’t see that is really three-fold. One is the customers who are telling us are not doing it. Number two, if you look at it from a product perspective, all of the growth is in the new products. And typically when you see customers putting a buffer stock in place, you see an increase across all of your products.

And finally by market segment, only six of the 11 end markets that we have are actually up from our prior peak. And so that generally tells us that there has not been broad inventory accumulation as much as it is just raw product success and success of PLDs displacing ASICs. Nevertheless, this is the semiconductor industry and we’ve all lived through these cycles. And if you learn anything from semiconductors is that customers in these times will try to accumulate buffer. So we are assuming, therefore, that there is that going on and have taken that into account in some of our guidance.

John Pitzer – Credit Suisse

And John, as a follow-up, as you are able to build inventory despite a good top-line growth, and as you mentioned, you’ve been running well below normal turns, do you think customers’ attitudes have changed (inaudible) June is going to be the last sort of below normal turns level? And as you move into the back half of the calendar year, we could see turns that come to more normalized levels. Thanks.

John Daane

I have no ability to really forecast that at this point. It will really depend on what happens from, I would say, an overall industry perspective and even what happens with Altera specifically. But again, very difficult for us to project that at this point. Thank you very much. Next question, please.

Operator

We will go to Adam Benjamin with Jefferies & Company.

Adam Benjamin – Jefferies & Company

Thanks, guys. You mentioned that you’re booking out lot further than you typically do. I was wondering if you can give us some view into how far out you are booking to right now and your visibility. Thanks.

John Daane

I think we can answer that simply by saying, we’ve historically had turns in the -- on average over the last several years, high-50s. Turns this quarter are going to be in the low to mid-30s. And that sort of gives you an indication as to how much more backlog we are carrying this quarter than we have in our prior historical quarters. Our book-to-bill has been over 1 for several quarters straight so far and, as I mentioned earlier, also over 1 quarter-to-date for Q2.

Ron Pasek

Let me just add a little to -- if you look at our turns number that we are guiding too for Q2, it’s in the low to mid-30s. Q1 was in the low-40s. Q4 was in the low-50s, and before that, it was in the high-50s. So it really has progressively come down.

Adam Benjamin – Jefferies & Company

Great. And then just on the book-to-bill, can you give a little bit more color in terms of by segment or certain areas just that may be stronger than others?

John Daane

Sorry, I don’t have that data. I think if you go back to some of our opening comments, we talked about which markets we expected to be up, and in particular, the markets we expected to grow in Q2 were the military, industrial business. Wireless, we expected to be up, going from memory, and I’ll go back and look at my notes here. We expect computer, networking and storage to also be up and automotive as well. So basically most of the markets we would expect to grow this quarter cannot provide the specific breakdown of book-to-bill. Thank you very much. Next question, please.

Operator

And we will go to James Schneider with Goldman Sachs.

James Schneider – Goldman Sachs

Good afternoon, and thanks for taking my question. Congratulations on the strong results. I guess on the -- first, could you talk about the communications business specifically for a minute? What are your customers telling you about their profile of orders and shipment sales throughout this year? I’m really thinking about the Asian customers specifically. But any other color you can give on sustainability of just kind of rough revenue run rate, any other deals [ph] as well would be great.

John Daane

It’s very difficult, Jim, for us to project revenues really for any market segment beyond the current quarter that we are in. So I really cannot accurately project that at this point. In general, what I would say over the long-term is we do expect communications to have really a solid three to five-year growth cycle. You have China obviously spending for both second and third generation wireless as well as the wireline core network. You have India has been spending on 2G, but is moving through the 3G auctions right now. And then we have both Japan and North America that are going to be in the next few years starting to deploy the fourth generation equipment.

So we think that that’s a positive for us, as well as the fact that many of the frequencies being auctioned today are much higher frequency than prior generations. Higher frequencies require more sell-side coverage. More sell-side coverage equals more equipment. That benefits us. And additionally, as we’ve mentioned before, moving from 2G to 3G to 4G, we have increasing dollar content in many of these systems. So, very difficult for us to project really any market segment beyond the quarter. But I do think in the next three to five years, communications does present for programmable logic and particularly Altera very, very solid growth.

James Schneider – Goldman Sachs

And then maybe as a follow-up, within the statements -- within the communications from that, what are you seeing from your US and European customer base at this point? And is that relatively weak or strong compared to what you are seeing in Asia? And if you could comment on wireline specifically, that would be great.

John Daane

Wireline was actually down in Q1 just slightly. It had had a really, really strong Q4 and really was a growth driver for communications growth in Q4. So it was not surprising it was down. And in fact, we’ve projected that. This quarter we expect telecom to do okay, but again wireless to drive the communications growth. In general, we are seeing growth out of all of our customers in communications across all geographies right now. So it’s not just one market specific area. There have been announcements out of various operators that they are increasing some spend, particularly for wireless networks, which is benefiting us as well.

James Schneider – Goldman Sachs

Thanks very much.

John Daane

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

Operator

We will go next to Chris Danely with J.P. Morgan.

Chris Danely – J.P. Morgan

Hey, thanks, guys. Quick question on the gross margins, I think we are in all-time peak now. So if you could just go through what -- I guess, what the differences are as to why you are hitting this peak. It sounds like it might be pricing. If you could maybe detail why pricing is so much better now than it has been.

John Daane

So what I said earlier -- I’d just reiterate what I said earlier for prior questions. So we are doing a better job of getting our cost down than we are -- we are ahead of that than what prices are doing. Over time, prices do decrease except on older products. So right now, we are ahead of the curve on the cost, and we are not seeing the price erosion that we’ve seen historically. It’s as simple as that.

Chris Danely – J.P. Morgan

Why do you think that’s happening?

John Daane

It could be just the strengthening demand. It’s hard to say. In general, I think from a cost perspective, we’ve been very focused on product substitution and yield enhancements, in particular. I think as those who follow programmable logic know yield is critical to our devices because our chips are larger than the average industry device. And we’ve had great success, particularly in things like 65-nanometer and 40-nanometer, which are really growing. And those two families combined are closing on 30% of our overall revenue. So, significant yield improvements those families have a dramatic impact also on our overall gross margin profile.

Chris Danely – J.P. Morgan

Okay, great. And as a follow-up, it sounds like you guys are getting plenty of wafers from TSMC now. Do you anticipate any difficulty with wafer supply throughout the rest of the year?

John Daane

As I mentioned, Chris, capacity is very tight in foundry. It’s also increasingly becoming tighter in the back end package assembly as well. So far, we have been able to get what we need. And so far, we’ve generally been able to keep our inventory at the right levels that are targeted and have been on targeted levels for a long time. And generally, our lead-times are short, although there are some package-die combinations where our lead-times are extended. It is difficult to say at this point exactly what will happen next quarter to quarter after. But so far, we are doing okay. As those are the few that followed us for a long time, we’ve generally been able to manage our vendor relationships such that we do get what we need during these sorts of times.

Chris Danely – J.P. Morgan

Yes. Do your lead-times -- I don’t mean your product lead-times, but do you wafer lead-times ever stretch out?

John Daane

Yes, lead-times can stretch out on products and materials. Generally in the past, our vendors have maintained normalized lead-times for Altera. So there may be other products that stretch out. Generally, they have again given us what we need in terms of our normal lead-times. So I would say generally how it’s operated. During these times, obviously it just takes a lot more work and a lot more communication with your supply base, making sure that your forecasts are accurate, you are ordering the product on time, and you are working very closely with them to see if they can schedule what you need when you want.

Chris Danely – J.P. Morgan

Got it, thanks.

John Daane

Thank you very much. Appreciate it, Chris. Next question, please.

Operator

We will go next to Glen Yeung with Citi.

Glen Yeung – Citi

Thanks, John, just on that capacity issue, in thinking about the competitive position that you are in, I know you guys don’t like to forecast. On a quarterly basis, you think you’re gaining share. But given that a lot of what’s benefiting your new product is your general sense that part of your growth there is a share gain element. And within that -- if it is true, within that, do you think that your relationship with your suppliers in a market that is kind of disruptive as this one is helping you in terms of market share.

John Daane

Glen, it’s very difficult for us to know exactly what’s going on in any given quarter in terms of market share. I think we are the first PLD company to announce. So we will just have to wait a couple of weeks to see what the others do. What I would say in general is our strategy has been to really manage to a small supply base. And we’ve always felt that that gives us an advantage in a couple of different areas. One is, we require a lot of yield improvement work, working with fewer foundries allows us to -- from an engineering perspective, work much more closely.

And we think that that’s helped Altera have the highest gross margins in the overall PLD industry. We also think at times like this where capacity is tight because we have a much higher dollar spend with the new companies; we are trying to get higher priority and higher service. So I would -- I tend to believe that during times of tight capacity, our strategy really is a strategy that runs out. And so I would believe that we are in a much better position than our competitors, but again very difficult for us --.

Glen Yeung – Citi

(inaudible)

John Daane

Yes. I would say going forward, really 65-nanometer is going to start to peak and 40-nanometer is going to be the growth driver for the PLD industry over the next several years. And I do think in 40-nanometer we have a much higher position in terms of market share, and that should mean that Altera should gain market share at a higher pace than we have historically. Now, note that our overall market share in FPGAs is, I think, about 33%, 34%. However, in the 130-nanometer, 90, 65-nanometer nodes, our market share in each of those families has been well above that, which is why we generally continue to take market share every year. 40-nanometer was a node where we were just well out in front of the competition and has served up a lot of business, and we think this is a node that can accelerate market share gains as 40 really becomes the driving growth driver for the PLD industry over the next several years.

Glen Yeung – Citi

Thanks. As a follow-up, I think this quarter you said there are five sub-categories where you are not above your past because I think last quarter you said six. Is this the scenario that we think will persist, i.e., you’re going to be setting record revenues across all of these areas as the economy improves?

John Daane

It’s a good question, Glen. I think actually this is probably the last quarter that we can do that comparison. The reason I say that is, if you look at Q1 2010, it was up 12% over Q2 2008. So even though we grew 12%, the growth was really driven by six of the 11 sub-markets. The other five are still below. But as that figure gets higher and higher above, that comparison becomes less meaningful. In general, we are seeing a pretty solid growth across most of our market segments. And so I think that’s healthy. I think our growth generally has tracked what our end customers are doing or indeed reflects the fact that programmable logic is replacing ASICs or that Altera is being very successful in gaining market share against ASICs or other PLD products.

Glen Yeung – Citi

Okay. That’s helpful. Thank you.

John Daane

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

Operator

We will go next to Uche Orji with UBS.

Uche Orji – UBS

Thank you very much. John, let me just go back to your answer to the previous question on 40, when you talk about 40 being the big good driver. Can you talk about the mix of 40-nanometer? And is there any way you can calibrate any unique customers you are winning as a result of 40 that you didn’t’ have, say, 90 or 65?

John Daane

Yes, there -- Uche, this is John. There are definitely customers that we have -- if you look at the business, as we talked about going back in I think was the November meeting that we had, a majority of the design wins are either from ASIC replacement or from other PLD suppliers. And that’s healthy, because if a majority was just Altera’s existing customer base, we would not see growth. And that trend continues in all of the design win data.

So we are continuing to see that a majority of the design wins are new customers replacing other types of products and that should allow us to continue to grow very strongly. There are definitely cases in many markets where this has opened us up to customers that we have not participated in the past. There are also applications that we’ve never participated in in the past. And I think all of that is exactly what you should expect, as programmable logic becomes more cost-effective and ASICs increasingly in the infrastructure do not make economic sense, and we are definitely seeing that play out.

Uche Orji – UBS

So you -- is that like a mix data you can tell us like more telecoms or more industrial just for us to kind of calibrate (inaudible) including 40?

John Daane

I’m sorry, Uche. I don’t have a breakdown to provide. What I could say, though, is we are seeing success again in communications across wireless, wireline, military, industrial bases going very strongly for us. I think we’ve done well in broadcast, in medical, in test and measurement. And computer is a market we are seeing a lot of growth. Networking is a space that we’ve been taking market share. So I think it’s pretty broad. And we are very happy with that. We’d like to be able to manage our business with a strong broad portfolio of end markets.

Uche Orji – UBS

Yes. Just one follow-up, quick follow-up. Why are you announcing Stratix V so early and why are you confident that your foundry partners can begin to sample in 1Q? And those days in anyway still indicates the growth of 40 if 28 is available so quickly?

John Daane

I think the advantage of moving to the next generation process node as aggressively as possible for programmable logic is that it again accelerates the ASIC replacement. We are 3.5 generations ahead of mainstream ASIC usage going to 28-nanometer is 4.5. It just allows us to more quickly replace ASICs and grow faster as an industry and as a company. And that’s what we are focused on and that’s what we are doing. TSMC had their annual symposium last week. They did announce that the HP process technology was Stratix V is developed on is the first process variant that will be available for risk starts in Q4.

If you then look at the time it takes to manufacture test and put the product out, Q1 is the initial shipment date for that product line. And the reason that we announced the high end products a little bit earlier than the lower end products is, for customers, the design-in phase for the higher end products is longer. The complexity of these, we can now integrate many millions of ASIC gates takes customers in many cases a few years to actually implement the design. So we announced it early so that they can start working with the technology. Ultimately, they won’t need the devices or prototype devices for a while, yes.

Uche Orji – UBS

Right.

John Daane

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

Operator

We will go to Tristan Gerra with Robert Baird.

Tristan Gerra – Robert Baird

Hi, good afternoon. Given the tightness in wafer supply, are you considering or are you already looking at a decent pricing strategy near-term to kind of control the volumes with respect to supply you have at hand?

John Daane

Tristan, this is John. Our pricing strategies tend not to change over a short period of time. By that, what I mean is when we sell a product, we tend to give the customer multi-year pricing. And so therefore they have regular price down progressions that we provided a year ago, six months ago, two years ago, which we have committed to and they are naturally taking advantage of today. Additionally, for new design starts that you are bidding on or the design win phase, those designs may not go into production for a year or two years, three years from now. And so you don’t know what the capacity of the industry is likely to be then. So therefore we tend not to change our overall strategy for the short run.

Tristan Gerra – Robert Baird

Okay. And would that apply as well to any orders that would be more last minute. So expedite orders as well?

John Daane

We tend not to change pricing to not to -- we don’t change pricing based on short-term availability or allocation. Again, customers have had quotes, and that’s the price that they pay. And we try to get them the product as quickly as possible. So there is not -- I mean, if you’re sort of reading into the gross margin, are we raising prices, are we charging higher amounts to customers to get product, are we doing things like that, the answer is no.

Tristan Gerra – Robert Baird

Okay, great. And last quick one, what was the percentage of wireless infrastructure as a percent of your total communication? And I don’t know if you are able to give how big Huawei was in the quarter as a percent.

John Daane

No customer was over 10%. And wireless is just slightly larger than wireline.

Tristan Gerra – Robert Baird

Great, thank you

John Daane

Maybe in the area of 10% larger or less. Thank you very much, Tristan. Next question, please.

Operator

We will go to Shawn Webster with Macquarie.

Shawn Webster – Macquarie

Yes, thank you. And congratulations on the great results, guys. In terms of the capacity situation, given things are tightening up, have you started to put your customers on allocation at all yet?

John Daane

No, we have not. Generally, in times like these, our busier customers do provide us forecasts. We do try to manage the inventory well. We do have some products, which the lead-times have moved out simply because we’ve had high end forecasted demand and that may have drawn down the inventory that we had in that particular spot. And then we have to go back and start from scratch.

Shawn Webster – Macquarie

In certain end markets in particular that are tighter or certain process nodes that are the tightest for you right now?

John Daane

It’s not any one particular process node as much as I’d say it’s particular die-package combinations. And so you can be -- you can have one family and even one chip in the family everything is okay except one package type. You can have couple members in a family. It’s not just your latest generation. It’s really across a couple different families. I would say it’s probably six to ten particular die-package combinations probably that have extended lead-times right now.

Shawn Webster – Macquarie

And are those still going out now or is it getting better at this point?

John Daane

I would say, if you look at the results in the quarter, we actually were able to grow our revenue 10% sequentially. That was after a quarter where we have 27% sequential growth. And we were also able to increase our inventory back into our targeted range. So we’d say if you look at it from an inventory perspective, we actually ended Q1 in better shape than we ended Q4. And so I think that’s what our customers would like to see, and hopefully that gives us a competitive advantage in terms of relationships with the customer base.

Shawn Webster – Macquarie

Okay. And then so just one last one if I could squeeze it in, on the cost -- the lower cost upside you guys had in the quarter, what was that changed versus your initial expectations in January on the unit cost side that drove this roughly three points of upside?

Ron Pasek

So there were a lot of cost elements, but the largest single item was yield -- yield improvement.

John Daane

And that combined with existing Q4, low inventory meant that the yield improvements flowed through very quickly.

Shawn Webster – Macquarie

Okay, thank you very much.

John Daane

Thank you very much. Next question, please.

Operator

We will go to Sumit Dhanda with Bank of America/Merrill Lynch.

Sumit Dhanda – Bank of America/Merrill Lynch

Yes. Hi. Couple of questions. Ron, one housekeeping question for you. In your 10-Q, you usually break out the cash advance to distributors. I was wondering if you have that number handy.

Ron Pasek

I don’t, but over time, we’ve really decreased the advance that we are giving to distributors. So it’s getting to be a fairly small number.

Sumit Dhanda – Bank of America/Merrill Lynch

So would you think it’s down sequentially quarter-over-quarter or flat or --?

Ron Pasek

It’s directionally down, yes.

Sumit Dhanda – Bank of America/Merrill Lynch

Directionally down, okay. John, couple of questions I had for you, one, you talked about the comparison versus the end markets which were above, which were below the prior peak. On your networking and computing and storage segment, I noticed that you are still below the prior peak that you registered in Q1 of ’08. What’s been the drag there? Is that the computing and storage segment can structurally would think that that category as such is a better grower than most that you sell into?

John Daane

I would say in general if you look at those, it’s actually computer, storage and networking that are all down from their prior peak in Q2 ’08. I would say probably in the networking space, we should see that -- because we anticipate that is going to grow this quarter, it also grew last quarter that it will be one of the ones that’s in a healthier space. I would say long-term, we also think computer is a good solid growth space for the PLD industry because you’re hearing a lot more discussion about using FPGAs for acceleration of algorithms or as a co-processor within computer appliances for specific vertical markets. And more of the computer manufacturers are talking about using those types of devices going forward. And that presents a new growth opportunity that really had not participated in in the past. In general, I would expect computer to grow this quarter, I would expect networking to grow this quarter. And I think we are in general seeing company start to spend again on infrastructure equipment, our corporation spend on infrastructure equipment, which should certainly help networking.

Sumit Dhanda – Bank of America/Merrill Lynch

Okay. One last quick one. Europe seemed to be the strongest geography. Anything in particular that drove that?

John Daane

Nothing to -- nothing to carve out. Specifically no.

Sumit Dhanda – Bank of America/Merrill Lynch

Okay. Thank you very much.

John Daane

All right. Thank you. Next question, please.

Operator

We will go to Apurva Patel with Ticonderoga Securities.

Apurva Patel – Ticonderoga Securities

Thank you. Going back to the inventory, I mean, are you seeing any -- are there any pockets of inventory that may be adequate or (inaudible) safety level?

John Daane

Can you maybe phrase that? I’m not sure I understand.

Apurva Patel – Ticonderoga Securities

Sure, John. I’m trying -- going back to the inventory, I’m just trying to understand -- given the inventory balance is up and your customer is telling that inventory balance is healthy, are you seeing any pockets of inventory that may be adequate today, at least a safe level compared to maybe two, three quarters ago?

John Daane

Well, we are projecting again the revenues are going to be up again this quarter. As Ron mentioned, based on our projection, we are expecting that our inventory itself will be roughly about where it is in terms of months supply on hand, which is at the low end of our band. We think what we match the inventory that we have to the growing side of the business. It matches fairly well. In other words, a bulk of the inventory that we have is really in new products and also in some of the mainstream product areas, which tend to be the growing areas. So I think we’ve been managing the inventory very well.

I mean, again, if we go back and -- I'm guessing at this, but I would guess the last 20 years of the company’s history, there has only been one inventory write-off, and that really was because I think the company came out of the bubble operating with a model that didn’t make sense. We, few years later, significantly decreased the amount of inventory that both ourselves and our distributors carry to spend a model that we’ve operated, I think, since at least 2002, which has been the three to four-month supply on hand band. And that served us well, both in strong up markets as well as down markets. So -- and we’ve done that without having to have any inventory write-offs even in the sharp declines. So at this point, if your question is does the inventory that we have match well with what the customers are demanding, I think the answer is yes.

Apurva Patel – Ticonderoga Securities

Great. And a follow-up, in terms of the different nodes, I’m trying to understand like when you are at 65 versus 40, maybe when you go to 28, does the peak to trough, does that accelerate in terms of the PLDs growth rates?

John Daane

Typically the peak of a product is about four to five years after introduction. And so what you will see with 40-nanometer devices were roughly -- we started to ship about a year ago. They were introduced about a year-and-a-half ago. You will see 40-nanometer peak three years from now and grow fairly strongly during this period of time. So I don’t think that overall metric is changing a lot.

Apurva Patel – Ticonderoga Securities

Great. Thank you.

John Daane

All right. Thank you. Next question, please.

Operator

We will go next to Ian Ing with Broadpoint.

Ian Ing – Broadpoint

Yes. Thank you, and congratulations. When I look at your gross margin and yield improvements versus historical, how much can we attribute to things like redundancy in your PLD architecture or some other unique impacts? Or is it just working closely with your foundry this quarter?

John Daane

I think it is more in the latter category, which is in this particular case we are seeing some very strong yield improvements from working on individual process modules. I would say 40-nanometer and 65-nanometer in particular. So the yields have really substantially improved in both of those product categories and are running at this point ahead of our models, which is what’s driving that much higher gross margins.

Ian Ing – Broadpoint

I understand, thank you. And I saw your Stratix V announcement. Your main competitors talks about a unified architecture to help them launch high density and low density families at the same time in each node, including 30s [ph]. So for Altera, are there some similar goals or needs to launch simultaneously? And if so, how would you get there?

John Daane

I do not know exactly what our main competitor is doing and for that matter, the other competitors are doing specifically within 28 because there has been really very little released. What I can tell you is, we do believe for each of the markets, they have different requirements in terms of things like transceivers, density, cost points, package types, power requirements, performance requirements. And we think it’s very difficult to cover all of these segments successfully with one process or with one particular architecture. I think if you do that, you will create a very good mid-range product.

I think what you would end up doing is sacrificing the density and performance for the high end, and then likewise, you would end up sacrificing the cost points for the low end. So we do believe that you need to develop different architectures, at times use different process technologies, and certainly have different features for all of these families. We also, starting about two generations ago, instead of having two products, divided the market into three. So we created a mid-range product portfolio. This is again just to segment our products a little bit more to provide different features and cost points to better optimize the business and better target some of the end markets that we are pursuing. So our strategy is going to be very similar to what we’ve done in the past. Exactly what our competitors do? I’m not sure.

Ian Ing – Broadpoint

Okay, thanks. That color is helpful.

John Daane

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

Operator

We will go next to Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria – RBC Capital Markets

Yes, thank you. I wonder if you can provide on the -- for the June quarter’s growth, which segments are growing faster than the 10%, which lower, or if you can say which order with communication, industrial and data processing and that terms of growth.

John Daane

I’m sorry; I don’t have that specific breakout data available.

Mahesh Sanganeria – RBC Capital Markets

But you said some segments you know that wireless is a bigger driver. Is communication the biggest driver?

John Daane

Again, we don’t have that data to provide from a breakout perspective. I did not provide any specific breakout as to which market segment I said would grow any faster than others. Again, what I did say, if you look at Q2, that we expected wireless to really be the driver behind telecom and wireless growths. In other words, telecom and wireless should be up this quarter. Wireless would be the main contributor to that. We said that networking, computer and storage, each of those segments should grow. Automotive, industrial and military, each of those sub-segments should grow. And then portions of the other maybe grow, some portions of the other maybe decreased. Overall, the other segment slightly up, but I didn’t break out which market would do better than the others or ranked them or said which would be higher than our guidance. Typically don’t provide that and don’t have the data here.

Mahesh Sanganeria – RBC Capital Markets

Okay. So within the communication, you did say that wireless was slightly higher this quarter than the telecom. That will indicate that wireless is definitely at, say, a good peak here. Is that fair to say?

John Daane

No, because I also said that wireless would be up this quarter. And we are only taking a quarter at a time. So at this point, don’t know exactly what Q3 will do. So again, getting into trying to call peaks on particular products or which product -- excuse me, peaks on segments or which of the markets are doing better than others is something we are not prepared to do today.

Mahesh Sanganeria – RBC Capital Markets

Okay. I guess I misspoke. What I meant was not peak, but wireless was a record revenue quarter in March.

John Daane

I didn’t even give that indication. To be honest, I haven’t gone back and looked at prior years. So it’s higher than it was in Q4. Wireless grew in Q4. Again, wireline was a bigger growth driver in Q4 than wireless. I couldn’t tell you whether this is the peak of wireless or not. But again, I think if you go back to our projections, we had fairly broad-based growth in our -- and markets in first calendar quarter, and we are again expecting most of our end markets to grow again this quarter based on some solid new product growth. Thank you very much. Next question, please.

Operator

We will go next to David Wu with GC Research Limited.

David Wu – GC Research Limited

Yes. Thanks for setting me in. I have just a very quick question. When I look at your numbers as I looked at the full year, it looks like the growth rate of Altera in calendar 2010 is going to be roughly 2X the growth rate of the semi industry. How much do you think this is really would be replacing ASIC phenomenon as opposed to the telco and wireless markets getting better than normal strength coming out of recession?

John Daane

I think it’s a combination of multiple events. I think some of the end markets that we are serving are doing well. I think what we are seeing is a lot of ASIC replacement within the infrastructure equipment, which means that with every new product generation we have higher dollar content. I think in many cases, we are seeing ourselves move into higher volume segments of the industry as we are becoming more cost-effective than ASICs. I think it’s relative success that we are having from a product perspective and therefore market share perspective.

And so I really think it’s a combination of a number of things. But a lot of it, as you point out, driven by the product success and the fact that we as an industry are increasingly replacing ASICs, ASICs being much larger industry than the PLD industry and really in pretty strong decline. I think if you look at the ASIC combined with PLD rankings for last year, we moved up a slot and we significantly outperformed, I would say, probably eight of the top ten ASIC companies that would be the second year running. And we would expect to probably significantly outperform the ASIC industry again this year.

Scott Wylie

Thanks, David. Operator, we have time for one more question, please.

Operator

We will take our last question from Tim Luke with Barclays Capital.

Tim Luke – Barclays Capital

(inaudible) Strong results to you, John. Quick questions. Can you just go over again why was the accounts receivable up like $140 million? And I think you said that they are more normalized now, but can you just go over that? Can you also just give us some color on what happened with respect to the slight income on sales statistic [ph], which was also up around $100 million? And what does that (inaudible) maybe just a very strong book-to-bill? And just to be clear, in the cost of goods -- the revenue was up a lot, but the cost of goods is actually kind of flat to down. That’s just yield as whether some other material things that really brought the cost of goods slightly down without revenue. Thanks.

Ron Pasek

So Tim, this is Ron. So with respect to AR, what I tried to describe was the fact that the business grew in gross billings $0.5 billion Q4 to Q1. At that time, we also were increasing inventory. As you know, we have a sell-out model which determines the price at the time that product is sold out. So if there is a slight timing difference between the growth in the sell-out, you get a temporary increase in AR. And that’s what we saw this quarter.

Tim Luke – Barclays Capital

So what happens next quarter do you think? I mean, you said that the inventory is going to be flat, but so the AR next quarter will be more normalized in this environment or what should we think?

Ron Pasek

Hard to tell. I didn’t give guidance on that, but it was somewhat of a lag phenomena this quarter. So we tend to see that correct itself in Q2. With respect to COGS, what I’ve tried to articulate was, most of that cost reduction was yield improvements. There is other elements to cost that we see as well, and there is some slight offset, but most of that this quarter was due to yield improvement.

Tim Luke – Barclays Capital

And the deferred income going up $100 million?

Ron Pasek

Again, that’s the channel inventory.

John Daane

So that’s -- as we shipped inventory into a distribution, we book that within the deferred space. And then when they ship it to the customer and the price is known, that’s where the transaction actually happens. We take revenues. We decrement it out of that category. So if you have an increase in distributor inventory, that will cause both the -- and particularly at the end of the quarter, that will cause both the DSO as well as the deferred revenue to go back.

Ron Pasek

So Tim, when I referred to pipeline inventory, that’s both our inventory and our balance sheet plus the distributor’s, which is on our balance sheet and deferred income.

Tim Luke – Barclays Capital

Is that also in the backlog, John, the deferred income on sales adjusting [ph] or not?

John Daane

No.

Tim Luke – Barclays Capital

Okay. Lastly then if I may, just would the new OpEx guidance, R&D is up some. Is it up similarly in the third and the fourth quarters, as you ramp it towards 265 or is it like making fourth quarter loaded? Then similarly the SG&A is down in the third and fourth quarter, it looks like, why is it down if the revenue is like probably growing?

Ron Pasek

You should see R&D ramp equally in Q3 and Q4.

Tim Luke – Barclays Capital

Thank you.

Ron Pasek

And with respect to SG&A, it’s attracted to how we book our accruals for compensation through the year.

Tim Luke – Barclays Capital

Thanks so much, guys.

John Daane

I think most of the increase that you are seeing is (inaudible) the original November guidance is really because of the variable side, which is our revenue is obviously much higher than we originally projected coming into the year. There is a variable component of sales and incentives and commissions, as well as the internal bonus and as our revenue is pulled up. So it has some of the accrual for the variable side, which has really driven most of those numbers.

Scott Wylie

And finally, as to conferences this quarter, on June 9, we will attend the UBS Global Technology and Services Conference in New York. This concludes Altera’s earnings conference call. Thanks for your interest and participation.

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Source: Altera Corporation Q1 2010 Earnings Call Transcript
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