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Altera Corporation (ALTR)

Q2 2007 Earnings Call

July 23, 2007 5:00 pm ET

Executives

Scott Wylie - VP of IR

Tim Morse - CFO and SVP

John Daane - President and CEO

Analysts

Glen Yeung - Citigroup

Tim Luke - Lehman Brothers

Chris Danley - J.P. Morgan

David Wu - Global Crown Capital

Amit Rao - Credit Suisse

Ruben Roy - Pacific Crest Securities

Tristan Gerra - Robert W. Baird

Seogju Lee - Goldman Sachs

Steve Elisku - UBS

Hans Mosesmann - Raymond James

Presentation

Operator

Good day, everyone, and welcome to the Altera Second Quarter 2007 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, 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 webpage where you will find complete instructions. The telephone replay will be available at 719-457-0820, 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 on 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 Tim Morse, CFO. Tim will open the call with a financial overview of the second quarter 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 Tim Morse.

Tim Morse

Thank you, Scott. My comments today will cover three topics: second quarter results, third quarter guidance, and the next step in the evolution of Altera's capital structure.

Beginning with second quarter results, revenue advanced by 5% from first quarter to $320 million slight above our guidance range of 1% to 4% sequential growth. Our largest 21 customers grew bit more strongly than the overall 5% rate, but the remaining customer base also expanded.

New products were particularly strong, registering 26% growth on a quarter-over-quarter basis, compared with the year earlier period, revenue was down 4%, despite 69% growth in new products. With respect to second quarter product family performance, FPGA has grew 3.5% versus 1Q, but declined 3% compared with the year earlier period, both Stratix II and Cyclone II registered strong double-digit improvements sequentially.

CPLD revenue was up nearly 3% sequentially, but down 16% year-over-year with MAX II registering strong double-digit growth versus both comparison periods. Consistent with our previous guidance HardCopy bounced back from 1Q decline with nearly 60% sequential improvement and a record number of Proto acceptances and tapeouts.

In end-market terms versus first quarter, both computer and storage and communications gained proportionately to our previous guidance, but consumer was considerably stronger and industrial considerably weaker than anticipated.

At 64.6% gross margin for the second quarter, this when compared to expectations impacted our GM rate by 6 times of a point versus guidance.

The remaining gap to the mid-point of our range is attributable to above-guidance strength and high volume communications customers. We see the mix of market segments and customers allowing us to hold gross margin rate steady in 3Q. However, we expect GM to turn upward again in the fourth quarter as more favorable market segment mix coupled with cost improvements will return margins to our long-term target operating model of 65%. At this point, we are comfortable reaffirming 65% for 2008 as well.

Returning to second quarter results, operating expenses were $131 million in total with the breakdown of $63 million for R&D and $68 million for SG&A. R&D increased by $5 million from first quarter as our 65 nanometer products continue to launch, but it fell short of guidance by $7 million primarily as a result of a few tapeouts that were scheduled for late 2Q, but actually shipped in the first few days of 3Q instead.

Full year implications of the 2Q R&D under run also lead us to update previous guidance from $275 million to what is now $270 million. Minor timing variations aside, we are foreseeing no change to the product rollouts scheduled for the remainder of the year. However, we do now expect slightly lower cost associated with our first 45 nanometer test chip as well as continued discretionary spending favorability.

With respect to SG&A, our cost out and simplification efforts remain on or slightly ahead of schedule resulting in sequential improvement of $4 million and an under run versus guidance of $2 million. We continue to see SG&A at the $275 million level for 2007. Today I would also like to reiterate our previous guidance for reduced OpEx dollar spending in 2008.

Other income was $18 million for the second quarter including a $3 million benefit from favorable returns in our nonqualified deferred compensation plan. As usual those gains have been offset in operating expense for accounting purposes, so they create no impact on our earnings in total.

Excluding NQDC, $15 million of other income was down $1 million for both the first quarter and guidance. That result is reflective of our previous announced commitment to repurchase $1 billion of our common stock over an 18 month period.

Year-to-date we have repurchased approximately $530 million or 24 million shares so we are well on our way to the goal both in terms of dollar magnitude and timing. Rounding up the income statement, second quarter net income was $80.5 million or $0.22 per diluted share up 4% from last year in dollar terms then up 6% in EPS.

Our 14% tax rate remained unchanged versus 1Q and versus the mid point of guidance.

At quarter-end, cash in investments were approximately $1.3 billion, a reduction of just over $220 million driven by our share repurchase activities. Elsewhere on the balance sheet, first quarter day sales outstanding of 54 days was up 15 days versus 1Q primarily driven by an accelerated shipment pattern to distributors related to the implementation of our new ERP system.

It's important to note, however, that this action had no impact on our income statement since we have recognized revenue on sales out of distribution basis. Distributor payment terms have not changed versus prior periods and we had no significant past due accounts at the end of either quarter. We expect third quarter DSO to return to normal levels.

Pipeline inventory ended second quarter at 3.2 months supply on hand toward the low-end of our stated 3 to 4 month model as well as a half month below 1Q. Distributor inventory dropped at tenth of the month to 1.2 months, while Altera inventory declined from 2.4 months to 2 months. Both Altera and distributor MSOH were oppositely impacted by the fore mentioned accelerated distributor shipment pattern with Altera inventory ending at an artificially low level. Distributor MSOH was nonetheless able to post a small reduction for the quarter.

Second quarter capital spending was $5 million substantially lower than the $10 million guidance with about half the favorability timed in the 3Q, and half falling through for the full year.

Turning to our outlook for the third quarter, we expect to see revenue growth in the 0 to 3% range that will require 3Q turns in the low 60s, which is up slightly from 2Q, but below our historical average of mid 60s. As previously commented given our current visibility of the segment mix, we see gross margin percent roughly flat from quarter-to-quarter.

Third quarter spending will be in the mid $70 million range for R&D, in the high $60 million range for SG&A. Below the operating margin line, our view of the GAAP basis tax rate continues to be in the 13% to 15% range, and we see other income at roughly $13 million.

Diluted share count will be in the low-to-mid $350 million range depending on share price. Pipeline inventory will remain within our 3 to 4 month desired level, and capital spending will be $7 million, a revised total year outlook of $32 million.

Finally, with respect to capital structure, we are currently negotiating the financing commitment letter to provide Altera with a long-term credit facility of up to $750 million. We intent to draw $500 million from this facility, and use the proceeds to repurchase common stock above and beyond our current $1 billion commitment, but still within the previously announced June 2008 timeframe. This action underscores our belief in the ongoing strength of the Altera business model, and it's an important step toward optimizing our capital structure for shareholder benefit.

With that I will hand it over to John.

John Daane

Thank you, Tim. Revenue in Q2 increased 5% sequentially, as a result of the success and growth of our new products, as well as the return of some of the communications business. Also some of our customer base that had been depleting inventory in Q4 and Q1 returned to purchase products in Q2. We are very pleased to have slightly exceeded the high end of our forecast range in a challenging semiconductor market.

By product classification, we expect the new product category to grow Mainstream to be flat to down, and mature products to decline. In Q2 new products grew 26% sequentially. Cyclone II was up 29% Stratix II and Stratix II GX up 19%, HardCopy up 58%, and MAX(R) II up 17%, while small Cyclone III and Arria GX both had revenue in the quarter.

Mainstream products increased 5% sequentially due to the ramp of new customer programs, and due to a portion of the customer base returning to consumption after inventory work downs. Stratix and Stratix GX were flat and Cyclone increased 11%. Mature products declined 7% sequentially.

By vertical market for Q2, we had forecasted networking to decline due to inventory rebalancing, but for telecom and wireless to grow resulting in sequential growth for the aggregate communication segment.

We expected computer to rise with both storage and server up for industrial to grow, and for consumer to be flattish with declines in broadcast offset by growth in the traditional consumer products area.

At final tally for Q2, communications rose 6% sequentially, and the sub-segments played out as expected with wireless up on CDMA, wideband CDMA and TDS forms, telecom rising on IP DSLAM, GPON and cable platforms, and networking decreasing due to inventory reductions. We have not yet seen all of our communications or customers return to their normalized consumption levels pre-carrier and equipment company consolidations.

Computer increased 12% sequentially with double-digit growth in each of the server, storage and office automation sub-segments. Industrial declined 1% with test and measurement down significantly, the broad industrial market flat, and medical and military up, consumer roses surprising 11% with strength in the set-top decoder box, audio and TV areas more than offsetting the sharp decline in broadcast. All in all the traditional consumer business was stronger than originally predicated, and the test and measurement market was weaker.

A few highlight for the quarter, first we introduced a new mid range FPGA series with integrated transceivers named Arria GX. The family is optimized to support PCI Express, Gigabit Ethernet and Serial RapidIO standards, speeds up to 2.5 Gigabit per second for applications in each of our four major markets.

We shipped software in May, and have already shipped production qualified units. We continue to release members of the low cost, low power Cyclone III family including its largest member that shipped in June one month ahead of schedule. And finally the first Stratix III family member is in testing characterization, and we expect to begin shipping engineering samples to customers in August one month ahead of customer commitment.

Moving to our Q3 forecast, we expect slight growth and what is a traditionally challenging quarter for Programmable Logic. We expect computer to decrease sequentially, and for industrial to be flat with recovery and test, and measurement offset by declines in medical.

We expect the consumer segment to grow in both traditional consumer applications, and in broadcast. Communication should grow even and what is our traditional weak communications quarter with networking and wireless up.

Overall, we expect turns in the low 60s%, lower than our typical mid 60s and only slightly higher than Q2's 59%. Q3 is typically a slightly more backend loaded quarter than our other three, where bookings today through July have been strong and fully support the turn's requirement. For Q3, we are forecasting revenues to be flat to up 3% sequentially.

In summary, we continue to execute on the fundamentals of new and differentiated product development, expansion of our current markets, and developments of new ones, operational excellence in cost, inventory, and quality, and then simplification of our business model to reduce operating expenses. We believe, we are well positioned for future revenue and profit growth.

Now, let me turn this call back to Scott.

Scott Wylie

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

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from Glen Yeung with Citi.

Glen Yeung - Citigroup

Thanks. I guess just two questions. First one is, a comment was made that you haven't seen your comps customers back at normalized levels, and that you're starting to see some growth emerge in the seasonally weak third quarter. So, question is when do you expect them to get to normalized levels?

And the second question is your guidance for the third quarter is better than your competitors and eminently they seem to have some issues in the European disti market. I wonder if you can address why you think there is a data, whether or not you saw any disti issues and may be if you are gaining shares as the other two reasons don't make any sense?

John Daane

So, Glen let me take the order backwards. So in terms of the comparison to any of our competitors hard to do don't understand all of their business in great details I probably shy away from that. We've actually seen the smaller accounts doing okay in Europe. I characterize them as smaller accounts because we don't recognize revenue through when we ship to distributors. We recognize it when they ship it to end customers. So, don't necessarily want to refer to it is as disti and possibly confuse people.

But generally the smaller customers in Europe and for that matter worldwide did well last quarter. In terms of comps business getting back to normalize levels, I am not sure that we probably will see it get back to where it was before, but I do expect that there is going to be growth in the segment. And let me work through the various components there.

First of all, networking was down last quarter in calendar quarter Q2 because of the inventory reduction, we expect networking to start growing this quarter and probably return more normalized levels, if not in Q3 certainly by Q4.

Telecom and wireless have both been impacted by deployments that are happening on a worldwide basis as well as carrier integration and what we view is our end customers or equipment vendor consolidations. I would have expected that in our end customer consolidations where there would be some short-term impact as one works through and the inventory contract manufacture rebalancing, that ultimately there would been not be any short run impact on the product revenue side, because ultimately the operators wants to continue to purchase the existing qualified equipment for sometime and that ultimately the product rationalization would happen over longer period of time, R&D would be impacted earlier.

We have actually seen accounts where existing programs have been impacted and slowed down. We started to see in the quarter some of those customers start to return to more normalized order patterns. We would expect some of those customers to continue to pick up this quarter. Although at this point, it difficult to say exactly what the normalized levels are going to be on going.

All in all, we do expect communications to pickup again this quarter. Again, we expect networking to come back. We expect wireless to grow predominantly in the 3G standard areas. We expect our telecom area to be slightly down this quarter and then return to growth in calendar quarter Q4.

Glen Yeung - Citigroup

Are there any implications of that for margins, John? I think most of the time, like high margin business is regarding for kind of a flattish margins?

John Daane

Yeah. There is certainly a margin impact of the portfolio of business that can be in a larger area like communications. So for instance, if you have a CPE, Customer Premise Equipment, piece of equipment, which is shipping in the hundreds of thousands to millions of units per year, certainly the margin expectation is going to be lower than a fewer and add-drop multiplexer.

So, there can be swings in business. We did see from a margin profile a little of that in the quarter in the communications area as Tim pointed out. But ultimately longer term, we expect our margins will be fine at 65%. We've been talking about the 65% number for four or five years as our long-term target. There are pieces of business that we do look at, that we do turn down, because we don't think that they are profitable today or will ever be profitable pieces of business for us to entertain. As an example in Q1 we looked at two pieces of consumer business, where the pricing expectation and requirement for the customer was not something that we could support. And so, we told the customer, we were not interested in participating in the business going forward.

So, well, we will trade off some margin in order to grow the top-line, which is what we've been discussing for years, and using 65% as our targeted margin level that does not mean that we're going to grab all pieces of business out there in order to show top-line growth. There are some that we'll continue to pass on.

Glen Yeung - Citigroup

Okay. Thanks.

John Daane

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

Operator

We will take our next question from Tim Luke with Lehman Brothers.

Tim Luke - Lehman Brothers

Thanks. John, just to go back to the share thing, with respect to the computer and storage area you guys were up quite strong double-digit, and your largest competitor was lower, any commentary there on share positioning? And separately just within the networking segment, do you see any sort of adjustment in your general share positioning? And then separately you've talked about 45-nanometer, I was just wondering how the timeline was…

John Daane

Okay. So, I'm leaving the first part down. So, I'll start with the second part, well I remember it. At 45-naomenter, we do a series of test chips usually it's in the area of about 8 to 14 test chips that we'll run. We'll look at everything from a number of different process devices in order to fully flush out these spice models that come from TSMC. Usually those are jointly developed between the two of us all the way through actually implementing structures from PLLs, IOs, EST structures, some of the analog IOs that we've. The lookup table structures, the programmable power devices that we've. So, there are a lot of different functions that we want to see in silicon.

We've already done some several actually test chips with TSMC that are joint test chips. Some of the test chips that we do are more dedicated to Altera, and then we pay a much larger portion of the bill. The test chip that Tim was referring to is more of a one that's dedicated to Altera that is something that we plan to do in the quarter. And ultimately part of the reason, we're seeing the R&D cost reduction as now that we're into actually doing these devices. We're finding that the cost for the mask sets and the prototype wafers that we're running is actually lower than we had originally budgeted. So that's bringing down the cost.

From a schedule perspective, we'll be introducing one of our families next year both in terms of software as well as actually shipping devices to customers. We haven't given a more specific timeframe other than to say that we'll be shipping 45-nanometer software and actual devices to customers in the calendar year.

In terms of our sharing computer and networking, I think generally Altera has been over the last couple of years picking up market share, and what has been the traditional core markets programmable logic, this is things like computer, server most of the communications markets. We've seen some of our competitors much more aggressively go after and earlier by the way, and I give them credit for that the automotive consumer business as examples. We got out of the military market. I think as everybody knows, we've been concentrating and getting back in on that. So, we've been doing very low in the core markets and gaining share.

Generally I would expect pretty much across the board. We'd be gaining market share in most markets going forward. We think, we are very well positioned. We've a good set of products that are aimed at both cost sensitive areas as well as high performance. We've a lot of features that differentiate us particularly today on power reduction capabilities whether the Cyclone III that's made on a low power process are used for cell phones or it's the Stratix III, which has the programmable power capability to dramatically lower the power consumption of the devices. We have in the last several generations of products, a very strong market share, much higher than our overall market share for the FPGA industry. And as those products continue to ramp, we should continue to take market share.

I would caution you that on one quarter, we may take market share on one market, another quarter competitor may take market share back. We are kind of looking at it on a long term trend that we should continue to see Altera take market share. So, yeah, we did well in computer. I haven't analyzed it could very well be that they did well in a particularly sub-segment in a quarter as well. And as some of our other competitors announced, we will just have to see what they are going do.

Tim Luke - Lehman Brothers

Can I just squeeze in one clarification gentlemen, just on the R&D. It look like the R&D was a little below what you guided this quarter and then next quarter is guided up a little bit more than one might have modeled previously. What's the financing there?

Tim Morse

This is, Tim. Hi, Tim. These two tapeouts that were in the last couple of weeks of June that shipped in the first week or so of July instead. So you've got the lower affect in 2Q and a little bit higher affect in 3Q. 3Q though, I've guided previously that the second half would be fairly even then it will get into 275s. That would have implied about 74 for 3Q. We are just on the mid 70s range. So, it's not dramatically up and what's brining down is as I referenced and John references, the 45-nanometer test chip favorability and discretionary spending controls.

Tim Luke - Lehman Brothers

Sure. Congratulations on the quarter.

Tim Morse

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

Operator

We will take our next question from Chris Danley with J.P. Morgan.

Chris Danley - J.P. Morgan

Thanks guys. Hey, was HardCopy really starting to gain some traction here? Are there any thoughts to Altera maybe getting into the ASIC or standard-cell business?

John Daane

We will continue to look at variations off of the HardCopy strategy, for some applications continue to reduce costs. For instance, as you probably are aware Chris, the FPGA packages have lot of pins on them because sometimes in prototyping applications people like to pin out large portion of the design during debug, but they have no intention of using all of those pins as they move in their production. So, one way we can deal with also lowering the cost is to redesign packages to make them smaller, have fewer pins and therefore take some of the cost out of the application not just focus on, so what can silicon die size reduction.

And so we are continuing to look at HardCopy, in the HardCopy strategy for ways to reduce cost to incrementally take on business that they couldn't otherwise participating before. And we would do it only for very high revenue base design, so whenever we get into these further modifications of HardCopy whether it's on package or anything else that we do on a silicon design. We do look for very, very high volume designs, high revenue designs, which had significantly to the top line.

And so we will continue to look to expand that family, we do think there is a good business there. We do think it differentiate us. We do think we capture a lot of high-end FPGA business because of HardCopy and we will explore other opportunities over time. I would say though that the entire HardCopy business, I would only expect to still get to 10 to 15% of revenues, really no matter, what we do in the next few years. So, that's still our target, my target is to operate it with margins that are similar to the rest of our business based in those market segments.

Chris Danley - J.P. Morgan

And that the follow-up is, let me see the bigger buyback, what are the plans for dividends. Do you think you'll keep it at the current level or do you have like a payout ratio in mind or something like that?

Tim Morse

These are issues, as I've said before the Board looks at on a continuing basis. You can see the first announcement of the dividend in the company's history, and the original buyback in the first quarter, now the debt announcement, and the bigger buyback in the second quarter. So, those are both products of the process we've going with the Board and that will continue. These are really the only announcements we're in a position to make at this point. Again other than to say we'll definitely continue to look at it, and in a general sense, we want to be able to grow our dividend in mind.

Chris Danley - J.P. Morgan

Got, it. Thanks guys.

John Daane

Thank you. Next question please.

Operator

We'll go next to David Wu with Global Crown Capital.

David Wu - Global Crown Capital

Tom, John can you elaborate a little bit on the product mix swing. Q3 you mentioned about product mix getting a little bit lean, and it will be richer in Q4. What account would add other than the thing that you mentioned in the Com segment between the CPE and the central office?

John Daane

We didn't talk about Q4 really in detail. One thing, I could show you to David is this will be, I think the precoder for some of our traditional consumer applications like televisions we would expect it to ramp down in Q4 which is traditional consumer cycle. We look to see some of the infrastructure size of the business continuing to increase into Q4.

So, I think things like broadcast equipment or its broadcast, if you go back has been down two straight quarters. We do expect it to start growing in Q3. We would expect it to continue into Q4. So, I think, and broadcast certainly is more like a communications or computer segment in terms of its margins. So, we see, I'd say the traditional consumer business decreasing, and we see some of the other businesses continuing to increase.

And as Tim pointed out we also have material cost reductions built into calendar quarter Q4, and so both of those things should bring margins backup to the 65 level.

David Wu - Global Crown Capital

Yeah. John one more question on the continuation of subtitle gross margins. Obviously 45-nanometer is next year, and it's not even in your tele product line, do you see any difference between what 45-nanometer can afford to you in terms of gross margin and then very successful 90 and 65?

John Daane

I'd say that at this point David it probably is more or the same.

David Wu - Global Crown Capital

More the same. Okay.

John Daane

Yeah. What it could do is they do allow us to certainly reduce the cost of what we manufacture before, which allows us to extend the same number of logic elements into higher volume applications. It also allows us to target more the high end. In other words, we can make devices with higher capacity, higher performance, and take on more of the traditional WYSIWYG business both of are those are an increase in revenue play. But also currently from a margin perspective, I don't think it should change our perspective at all. Ultimately, it would be probably sum it up there.

David Wu - Global Crown Capital

Okay. Thank you very much.

John Daane

Thank you very much David. Next question, please.

Operator

We'll take our next question from Michael Masdea with Credit Suisse.

Amit Rao - Credit Suisse

Yes, thanks. This is [Amit Rao] calling in for Michael Masdea. Can you just talk about programmable logic and what is the change in content for programmable logic as a whole in some of your core markets, like wireless infrastructure et cetera? So, I know, it increases as you go to 3G. But relatively speaking compared to DSPs and other silicon, or types of silicon that have you seen more share for programmable logic or can you just talk about the dynamic there?

Tim Morse

Yes, certainly. So, if you look at the 2G systems, which I think are best characterized by GSM versus the 3G systems like wideband the dollar content for the programmable logic in wideband is over two times that for the content that we had in the GSM systems. There are differences in architectures by customer some will use more DSPs, some of will use more FPGAs. Ultimately since FPGA is today widely included multiply-accumulate structures, we can very cost effectively and to be honest more cost effectively implement the DSP functions in the base station than traditional DSP can. And so we've seen a dramatic increase in our functionality and therefore dollar content in the third generation systems.

Generally, if you can go back or take a step back we've been able to grow our communications business on a 16% compound annual rate from the year 2002. Well, we measure those accounts only at their revenue level growing at about 8%. So part of the reason that Altera in a market that we were traditionally strong and being the communications industry have been able to grow at a two [ex-rate] of our customer base is because we continue to displace other functionality predominately ASICs and we would be expect that to continue to going forward.

Amit Rao - Credit Suisse

Okay, great. And just a quick question, you had commented earlier Q4 that gross margins would go higher. Did you say that's going to be driven by revenue growth, mix shift or lower cost or is it combo of all three of those?

Tim Morse

Yeah. It's really. This is Tim. Its really reverting of the current mix trend, remember the mix trend right now was heavier consumer later in industrial and that carry through remains fairly steady and proportion in 3Q than in fourth quarter as John mentioned, you lose a steam out of the consumer, we do see industrial growing. So you get a pickup effect there and you'll also see our cost improvement kicking as well. They will start to kicking here in 3Q, but the accounting of it pushes most of the favorability in to 4Q.

Amit Rao - Credit Suisse

Okay, sounds great. Thanks.

Operator

We'll take a next question from Ruben Roy with Pacific Crest Securities.

Ruben Roy - Pacific Crest Securities

I think you had a one liner on APEX for 2008. Did you provide guidance for APEX for 2008?

Tim Morse

Not in dollar terms. In the last conference call, we had we announced the reduction here for APEX in 2007. We also said at that point, that the dollars would be down for APEX in 2008 as well. As we see our cost out sophistication initiatives taking holding and keeping the dollars down, in a little bit lower on the one side and a lot of that thing and I think plus the natural kind of sine wave pattern of R&D causing it to be down in lower on the other side.

John Daane

I think it's actually quite significant because this would be the second year that you will for instances SG&A down on a dollars basis. Also I think if you look at it this, this year we have already reduced our operating expense forecast from the prior quarters forecast for the entire year. So we are continuing to set the bar lower and we are continuing to find ways to reduce our overall cost structure. So that we can it can deliver on and obviously reducing the expenses and increasing the profits for the company.

Ruben Roy - Pacific Crest Securities

Right, thank you. John, in terms of geography, can you give us some commentary on the outlook for Q3? Europe is typically down in the Q3 for instance just a kind of how things are shaping up thus far?

John Daane

So we would expect typically in this sort of quarter that Japan, North America and Europe would all be impacted typically you'll see a lot of vacations in Japan in August. Obviously you've got some holidays as well as people taking vacation in North America, and then a lot of vacation time, and if it July or August depending on where you're in Europe. This quarter I'd note that some of the geographic stuff is starting to not play out exactly as it used to anymore because there is a lot of contract manufacturing that's US based or European based companies are moving their manufacturing to Asia.

And therefore you're more susceptible to the Asian holidays and perhaps the US ones. This quarter on a gut level, we'd expect Japan to be flat to slightly up, Europe to flat to slightly down, North America and Asia, the both the up. Generally, we're far less accurate on forecasting the geographies. We're far more accurate forecasting on a vertical basis. And the reason is you can see one company that could manufacture the same base station in three separate markets North America, Europe or Asia depending on where their business is.

And so business will move around pretty quickly, but it still counted for instance, in the latter case is communications business. So, that's my gut take it with the grant or so. I'd say, we're far more accurate in forecasting the actual verticals, and I think at the end of the day they are probably more important.

Ruben Roy - Pacific Crest Securities

Thanks John. I just had a quick product question in terms of the Arria family that you came out with, can you just discuss what the thinking was behind introducing a product like that, is that something that your customers are asking for or more of perhaps something that your competitors have that you might not have had that you're trying to get into the market with? And also, how that product, kind of lines up, when you're outselling it versus something like the Stratix II GX, which has a lot of I think common features?

John Daane

Okay. So Ruben, the reason is we've offered transceiver based products, and we were the first company to introduce those going back three series ago, I believe the Mercury. And the reason that we did that is some customers were using high-speed serial transceivers to interface on the backplane between cards or PC boards within a system or a chassis. And we've the ability to integrate the transceivers, and therefore, win those backplane delights. And that was originally why we did that, and then followed on with the Stratix and Stratix II GX family.

Ultimately now with some of the high-speed serial protocols that are being introduced to replace some of the past parallel buses things like Serial RapidIO or PCI Express, you're now seeing that the transceivers are going to be used more for chip-to-chip interconnect on a PC board as sort of a standard going forward rather than just in some specialized backplane applications.

There is a series of customer designs that we'd like and use the transceiver at lower speeds in order to implement that. So, we introduced a separate family. Now the reason that it's got a new name, as we do not do view it as a low cost family. If we view this as a low cost family, we'd have used the Cyclone brand name. We also did view this as another high end family, where you're using the transceivers for backplane interconnect. We really view this is as a new space requiring both a midrange performance fabric and midrange performance transceiver, and so the transceivers themselves go up to 2.5 gigabits per second.

As we're establishing a new brand, we'd expect to continue to introduce new transceiver families around the Arria brand name. The Stratix brand name is again for high end. So, if you look at Stratix II GX it supports about 20 something protocols instead of the three that I mentioned for Arria, and the transceiver speeds go up to 6.5 gigabyte per second. So certainly, if you look at it the Stratix II GX sort of product line is a much higher end much more fully featured product line much higher performance both in the transceivers as well as the fabric down the Altera family. So they are meant for two different series of applications. We find ourselves really I think out with a better product today is much more robust than our competitors better software. And we really feel in this new chip-to-chip interconnect world we are doing very well and locking up lot of sockets today. I would expect longer term that there will be competitors, who will introduce products in this space.

Ruben Roy - Pacific Crest Securities

And that's it. Thanks a lot, John.

John Daane

Thank you very much, Ruben. Next question please.

Operator

We'll go next to Tristan Gerra with Robert W. Baird.

Tristan Gerra - Robert W. Baird

Good afternoon. It looks like Stratix II GX was pretty strong in quarter. Do you feel the market share gain relative to vertex for ASIC so must be realized and we recall that time your competitor had done some execution issue with Vertex for ASIC, a few quarters ago. Do you think that they would still elect to go in terms of Stratix II GX to further gain market share over the next year as more customer is ramping volume.

John Daane

Hi Tristan. This is John Daane. I am trying really hard, I mean really hard to stay out of the direct comparison world and talk more about either Altera specific or PLD industry trends. So I need to get into trying to do in us versus them at this point. I do think that we have done very well from a market share perspective. If you look at us in the last couple of years we have gained market share in FPGAs. A lot of that gain has come at the higher end FPGA series, which is the Stratix and the Stratix II series. We would expect based on our design win success to continue to see market share gains, that would drive market share gains overall for your company. Because again our share of market within both the first generation and 0.13 micron and the second generation 90-nanometer are higher than our overall FPGA market share. And so we do expect to continue that. The reason that I don't want to get into a head-to-head comparison and something like that I commonly talk about an Altera is just not about trading market share between the two companies. The bigger opportunity is to continue to replace ASICs, DSPs, microcontrollers, ASSPs and we need to continue as a company to focus on that bigger market opportunity and execute that. And if we do well with that, certainly we would expect to continue to take market share both against those other areas as well as within the PLD segments itself. So we think, we are very well positioned, if we got a good product set, if we got a really good sales force, marketing organization. Operationally, we think we are very good stead, so for us is it's more of continuing to execute and hopefully the results will continue to flow through for us.

Tristan Gerra - Robert W. Baird

Great and a quick follow up, in communication is to be down pretty much across the board or there is specific geographies, where communication is picking up faster than elsewhere?

John Daane

I would not say it's necessarily geographic based. I would say its just more account based. So in the quarter, we saw some of our communications customers up. We saw some of them down in the quarter, some are continuing to do rebalancing of inventory, some are starting to consume our product after going through rebalancing, some customers we've got new programs that are starting to ramp, some customers are seeing ramps of products where they've once a new contracts. So it's really more on the later side, I would say in generally we haven't seen the entire communication segment really come back. And so in general, I'd say there is still on the inventory rebalancing face. And we still see that across some of the other segments that we've. In other words, we still see some customers that are trying to work down inventories that they captured last year and in some cases where we saw customer's comeback, they came back later in the quarter or mid quarter. So, we'd expect to capture those customers for a full quarter this quarter, and obviously that will help drive some revenue gain.

Tristan Gerra - Robert W. Baird

Great. Thank you.

John Daane

Thank you very much Tristan. Next question please.

Operator

We will take our next question from Uche Orji with UBS. Mr. Orji your line is open. Please check your mute button. Hearing, no response. We'll go on to Sumit Dhanda with Banc of America Securities.

Unidentified Analyst

Hi, this is (inaudible) for Sumit. Can you hear me?

John Daane

Yes.

Unidentified Analyst

Great. Couple of items, the first on the tapeouts that slipped into Q3, could you maybe quantify the extent of the dollar push out associated with the tapeout, and then maybe how many? Second with respect to HardCopy, can you talk a little bit more about the 60% increase and what's maybe a more sustainable rate going forward? And then finally, on consumer, can you talk a little bit more about really where the strength was and maybe what caught you by surprise was it just seasonality or was there something more to it? Thanks.

Tim Morse

Let me start…

John Daane

Sure.

Tim Morse

All right. I will handle the first one. This is Tim. On the R&D, we won't talk about how tapeouts, but as I referenced in my commentary, it was the majority of the $7 million under run is what ended up kind of miss in the fiscal week 26 cut off.

Unidentified Analyst

Okay.

John Daane

Just kind of frame that in 65-nanometer eight chips for masks and wafers runs in the millions. So, it's not like and when I started in the industry, where an asset cost you $5,000 and you could afford respense. Today the costs will just run that first chip are very expensive and particularly, if you make a mistake.

In terms of the consumer business strength was really across the board in our audio area and TVs, and also set top decoder boxes. It's a combination of both existing business continuing to ramp as well as, and in particular I'd underscore as well as a series of new programs, which ramped in the quarter. And we're doing a lot of expedite of us to get the products because they were all in excess of their original forecast. And so, we saw really broad base strength in the consumer world. We'd expect that the TV and the set top area will be applicant this quarter, and again will fall going into the calendar quarter Q4.

In terms of HardCopy don't really have today what I'd expect that of HardCopy next year. We're going to be going into our planning cycle over the next couple of months probably you could get a better indication also that in the future. We'd expected to grow as a percentage of the business overtime it however has been running at roughly about 4% rate, and I note there has been some fluctuations between quarters, but generally it still about 4%. We'd expect better results out of it overtime.

I don't expect it to grow 68% this quarter certainly but to some extent remember, we had a soft calendar quarter Q2. We did say at the end of the Q2, we expected a strong quarter this quarter, and we certainly saw that.

Unidentified Analyst

Okay, thanks.

John Daane

Thank you very much. Next question please.

Operator

We will take our next question from Seogju Lee from Goldman Sachs.

Seogju Lee - Goldman Sachs

Thank you, John and Tim. At the start of the call you mentioned you've taken sort of a fundamental change in your approach to share repurchasing, you are looking to enter into a credit facility. Just can you talk about, just sort of the long term fundamental thinking and if you have any sort targets or what metrics you look at in terms of the cash and how you returning share holders?

Tim Morse

Yeah, I think, consistent with how we've always talk about this; first, we knew we had too much cash on the balance sheet especially at the end of 06. The problem really ballooned during the year 2006 while we were out of the buyback market and that's it we knew we had to take it down it's a matter of then how you return it to share holders. We have a target level -- formulated target level of what we think we need for operating cash and we are going to kind of systematically work this balance down toward the target.

So, from that standpoint -- our intensions are pretty pure and pretty straightforward. On the debt side, again, we kind of look at this thing and these are things we review with the Board on a almost monthly basis. We look at the capital structure of the business and the cost of capital of the business and the opportunity to use that kind of leveraged to create a little bit more value for share holders, and we felt that was the right time in the company's history.

It's a very solid operating model, great cash flow. So, I think you couple that with the fact that really it's just a terrific environment right now from a variety of forms of debt but we think it especially bank debt, and you come to answer fairly quickly. I wouldn't say fairly quickly and easily. I wouldn't say we are necessarily targeting any specific metrics at this point. We feel comfortable with where we are but we will continue review at future.

John Daane

At a high level, Seogju, this is John Daane, we have Board which has made up a people from hi-tech, and generally in hi-tech since we had very strong cycles in the past the mantra has been to try to hold as much cash as you can, hard cash, cash is good. And if you have a hi-tech Board and you really need to start thinking about different structures from a capital perspective, you really need think to hard about the industry maybe different going forward than what we experienced in the past in the 70s, 80s and even in 90s.

And that's I think the inflection point is for the Board to really do a lot of study about business model both for the semiconductor industry as well as Altera itself, and to start thinking about things little bit differently. And I think we've gone through that over a period of time and feel very comfortable with business model that we have that we can incur debt and that we will continued to have a very strong cash flow within the corporation going forward.

Seogju Lee - Goldman Sachs

Okay. Just a follow-up on that, in terms of the credit facility that you are looking at, can you talk about that all or it's just a little too early?

John Daane

Well, I mean, it's early in some sense, but again, our intentions are we are in negotiations right now, it's coming along. We wouldn't anticipate the closure of this being too far out. We are negotiating 750 we intend to use 500. It will all go to repurchase and we really like banking market environment right now, it's great in terms of attractive rates. It's great in terms of structural flexibility, and in timing flexibility in terms of how we how and when we drawdown the facility. So, we think this is a good way for us to go. You want to comment on that versus bonds are.

Tim Morse

Yeah, that's great. The climate just doesn't feel quite as advantageous for bonds at this point, and what we've seen and the people we've talked to it converts obviously there has been a lot of activity on that front. And we philosophically just don't believe that issuing equity link debt is the best way to retire equity, and retiring equity and getting that cash back in the shareholder's hands is definitely our main objective here. So, what we're trying to do is something that's very straightforward and very consistent all of the dot should lineup, and connect pretty well here.

Seogju Lee - Goldman Sachs

Okay. Great, thanks. It's very helpful. And just one last question Tim you talked about some cost down that will restrict the flow three products that were said to flow through your P&L a little bit in Q3, but more so in Q4. Just how should, I think about it, is it across the board, is it simply just wafer pricing or if anything on that front will be helpful? Thanks and good luck.

Tim Morse

It's our ongoing cost-out efforts. We work wonderfully with our supplier. There is an ongoing effort between us to take our material prices down, and this is nothing out of the ordinary, it just it kind of comes on a half year kind of schedule. And when it comes in because of our [price flow] accounting starts to kick in the second half you get most of it in the fourth quarter.

John Daane

Yeah again realized that any yield announcement we do today, it takes about three to four months to actually show up on the P&L because we've between us on and our distributors usually between three to four months supply on hand. So, well you can get instantly better yields on your advanced process technologies today.

They're not going to flow through on your P&L for at least a quarter and sometimes a quarter and a half. But for us, it's ongoing yield enhancement, it's a cost reductions that we're doing test time reductions, materials reductions, it's also items that we feel very strong were going to possibly impact us in the fourth calendar quarter.

Seogju Lee - Goldman Sachs

Great. Thank you. Good luck.

John Daane

Thank you.

Tim Morse

Thanks

Operator

We go next to Steve Elisku with UBS.

Steve Elisku - UBS

Yes. This is Steve Elisku for Uche Orji. A question on Japan you had some nice growth this quarter talking about flat up next quarter, how should we think about Japan going into 2008 talk about that picking up in the prior conference call?

John Daane

Yeah. I'd expect Japan to pickup in '08 because of several things; one is the carriers, they will be deploying next generation networks, which on the telecom side will enhance or increase bandwidth to user homes. So, while we expect that deployment for instance from NTT to start flowing in towards the end of this year, and pickup through next year. They will continue to build out some of the wideband capability as well as CDMA, and in order to enhance data capabilities. We also see that the broad industrial base, the medical base and even some of the computer and storage area should increase for us next year.

Japan is one of those countries that for us they've one of everything that matters, what we do, consumer, the broad industrial base, test and measurement, medical. They have military business it's just one of everything that we've. And again because of success, we'll have again in our existing markets, new applications ramping up and then further penetration to replace ASICs and lot of markets in growth in new areas we expect Japan should grow for us.

Steve Elisku - UBS

And as a follow-up question I have on 45-nanometer, if my data is right TSMC typically prioritizes there low power process ahead of the high speed process, which seems to be what you did with your Cyclone III product. Should we think about being the same cadence where you start with your 45-nanometer Cyclone followed by a Stratix device?

John Daane

Steve, we haven't announced the product. As you probably are aware we've typically never use this conference call to announce products. So I'm not prepare today to give you any specific dates or information on what product that we will release, other than to say we are very far long in 45-nanometer development and we will have software and shipments in calendar year 2008.

Steve Elisku - UBS

Okay. One last question on long-term growth of the FPGA market, you have talked about mid-teens it seems like if I look at this year and look at the overall FPGA industry relatively flat. What is your current view on how the FPGA industry as a whole growth and your ability to grow faster within that?

John Daane

I think we will continue to grow faster. If you look at us since 2002, when I use that is the year that the post communications period of time, more PLD industry really sought new markets to grow in the year 2000 communications as two pairs of our business. We introduced a new series of products, which included a low end FPGAs, low cost FPGAs to get into volume. We ourselves through the end of last year grew 16% compound annual in total in PLDs. I think the industry grew twelvish.

So, we certainly outperformed the industry. This is the tough year. I don't know exactly where will end up. But its through the first half is down than an overly strong year for programmable logic. I would expect this year again that we would increase market share going forward if you had this year and it certainly is going to bring the mix down a little bit, you probably looking at sort of it in the low teens to mid teens area. I would say for our business, which incorporates both CPLDs, FPGAs as well as the HardCopy structured ASICs.

Steve Elisku - UBS

Great, thank you.

John Daane

Thank you very much Steve.

Scott Wylie

Operator, I think we have time for one more question.

Operator

And it comes from Hans Mosesmann with Raymond James.

Hans Mosesmann - Raymond James

Thanks. How you sort HardCopy John, can you tell us what vertical market was part of the 58% sequential growth?

John Daane

Yes certainly Hans. The HardCopy growth came from communications, it came from storage and that probably could have come from some other things that I am after top of my head, thinking of. We did have the ramp of some new programs in the quarter. We have been having a record number of tapeouts, so the NRE side is also up significantly. So and I think if you look at the NRE side, there is probably a lot of customers and lot of different markets consumer communications, computer storage. So its probably a mixture of lot of different markets, but certainly the two bigger ones were in the communication side and then the storage side.

Hans Mosesmann - Raymond James

Great. Thanks a lot and congratulations.

John Daane

Thank you very much Hans.

Scott Wylie

Thanks, Hans. Listen as we wrap up today. Let me conclude with a save the date announcement. On December of 11th at 3 PM in New York, Altera will host a meeting for interested members of the investment community. We will send out a remainder email shortly, and more details will follow as we get closer to the date. During the current quarter, we will be present at two conferences. On August 6th, we'll be present at the Pacific Crest Technology Leadership Forum in Vail and in September on the 6th we will present at Citigroup's 14th Annual Global Technology Conference in New York.

This concludes Altera's conference call. Thank you for your participation and interest.

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