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Altera Corporation (NASDAQ:ALTR)

Q3 2007 Earnings Call

October 23, 2007 5:00 pm ET

Executives

Scott Wylie - VP of IR

Tim Morse - CFO and SVP

John Daane - President and CEO

Analysts

Peter Stournaras - Citigroup

Jim Schneider - Goldman Sachs

Tristan Gerra - Robert W. Baird

Venk Natirmani - JP Morgan

Steve Elisku - UBS

Gurinder Kalra - Bear Stearns

Arnab Chandra - Deutsche Bank

Tim Robinson - Buoyant Advisors

Mark Lipacis - Morgan Stanley

Operator

Please stand by, we are about tobegin. Good day, everyone, and welcome to the Altera Third Quarter 2007Earnings Results Conference Call. Today's call is being recorded.

At this time, for opening remarksand introductions, I would like to turn the call over to Mr. Scott Wylie, VicePresident of Investor Relations for Altera Corporation. Mr. Wylie, please goahead, sir.

Scott Wylie

Good afternoon. Thank you forjoining this conference call, which will be available for replay telephonicallyand on Altera's website shortly after we conclude this afternoon. To listen tothe webcast replay, please visit Altera's investor relations webpage where youwill find complete instructions. The telephone replay will be available at719-457-0820, use code 258712.

During today's call, we will bemaking some forward-looking statements and in light of the Private SecuritiesLitigation Reform Act, I would like to remind you that these statements must beconsidered in conjunction with the cautionary warnings that appear on our SECfilings. Investors are cautioned that all forward-looking statements in thiscall involve risks and uncertainty, and that future events may differ from thestatements made. For additional information, please refer to the company'sSecurities and Exchange Commission filings, which are posted on our website oravailable from the company without charge.

With me today are John Daane, ourCEO, and Tim Morse, CFO. Tim will open the call with a financial overviewbefore turning the call over to John. After John concludes his remarks, we willtake your questions.

Prior to the Q&A sessionoperator will be giving instructions on how you can access the conference callwith your questions.

I would now like to turn the callover to Tim Morse.

Tim Morse

Thanks Scott. My comments todaywill cover third quarter results and fourth quarter guidance. On December 11thin New York City,we will provide additional perspective on Altera's 2007 performance, as well asinsight into out 2008 financial model.

Beginning with third quarterresults, revenue declined by 1% from second quarter to $316 million. Thatresult was one percentage point below our guidance range of flat to 3% growth,driven largely by a weaker than anticipated second half of September. In totalfor 3Q our largest customers comprising just over 60% of our revenue grewmodestly, but the broad based declined 4%.

New products continued to gainmomentum registering 13% growth on a quarter-over-quarter basis, and 52% growthversus prior year. With respect to third quarter product family performance,FPGAs declined 1% versus 2Q; with Stratix II up 4% and Cyclone II up 34%. CPLDrevenue was up 1% sequentially, led by13% growth in MAX II. HardCopy declinedby 7% in the third quarter following a 58% sequentially jump in 2Q.

Transitioning to gross margincoming of 64.6% in 2Q, we had guided GM rates in the 64% to 65% range wereroughly flat based on expected market segment mix. Instead we experiencedstrong double-digit growth in consumer and weakness across all other segments.Consistent with the GM mix model we have been articulating, the effect of thatshift was a reduction of eight tenth of a point in 3Q. We finished at 63.8%fractionally below our guidance range.

Continuing down the incomestatement, operating expenses were $137 million in total with a breakdown of$71 million for R&D and $66 million for SG&A. R&D increased by $8million from second quarter as we continued our successful 65 nanometer productlaunch with $4 million of favorability versus guidance due to better than anticipatedyields and spending for both Stratix III and Cyclone III. SG&A declined $2million from second quarter and also under ran guidance by the same amount. Weremain slightly ahead of pace with regard to our cost out commitments for 2007and therefore are building better than plan momentum heading into 2008.

Other income was $16 million forthe third quarter including $2 million benefit from favorable returns in ournon-qualified deferred compensation plan. As usual those gains have been offsetin operating expense for accounting purposes so they create no impact on ourearnings in total. Excluding NQDC in both periods $14 million of other incomein 3Q was down $1 million from second quarter but slightly ahead of guidance.

Rounding up the income statement,third quarter net income was $69 million or $0.20 per diluted share down 21%from last year in dollar terms and down 18% in EPS. Our 14% tax rate remainedunchanged versus 2Q and versus the midpoint of guidance.

At quarter end, cash andinvestments were approximately $1.2 billion a reduction of $93 million drivenby $255 million of share repurchase activity in the third quarter. 3Qyear-to-date we have repurchased $717 million or 32 million shares. That leavesus with a little less than $800 million to repurchase over the next threequarters in order to fulfill our previously announced repurchase plans of 1.5billion by June 2008. Elsewhere on the balance sheet 52 day sales outstandingin third quarter declined by two days from second quarter levels. Pipeline inventoryended third quarter at 3.3 month supply on hand, essentially unchanged versus2Q.

Distributor inventory dropped totenth of a month to 1.1 months, while Altera inventory increased as expectedfrom 2 months to 2.2 months.

Third quarter capital spendingwas just shy of $3 million roughly $4 million lower than the $7 millionguidance level. We are taking the same approach to optimizing capital spendingas we are reducing operating expenses. So, we anticipate these kinds ofefficiencies to be ongoing. Our total year outlook for capital spending is now$27 million.

Turning to our outlook for thefourth quarter, we expect to see revenue in the flat to down 4% range despite3Q book-to-bill ratio greater than one and despite 4Q being the high watermarkfor entering backlog this year. That growth range will require 4Q turns in themid-to-high 50s which is down from 61% in 3Q and below our historical averageof mid 60s. Assuming unchanged market segment mix GM rate should remainessentially flat on a sequential basis.

Third quarter spending will beapproximately $73 million for R&D, and $67 million for SG&A. Thosespending levels will bring total year R&D to 266 million up 7% from 2006and total year SG&A to 273 million down 11% from 2006.

In 2007, we continue to investstrongly in new products and technologies, while greatly improving our spendingefficiency. The resulting $539 million of operating expense will be down lowsingle digits from 2006, as well as 10% favorable to original 2007 guidance. Weare well positioned to leverage these initial cost out, simplification effortsfor the benefit of 2008 and beyond. Once again, more detail will be forthcomingin our December 11th event.

To wrap up 4Q guidance, we seeother income at roughly $12 million, our view of the GAAP basis tax rate isunchanged at 13% to 15%.

Diluted share count will be inthe mid $340 million share range depending on share price. Pipeline inventorywill remain within our 3 to 4 month desired band, and capital spending will beapproximately $5 million.

With that, I will hand it over toJohn.

John Daane

Thank you, Tim. Revenues in Q3decreased 1% sequentially, softening of our communications business late in thequarter was the primary reason for our shortfall to guidance, as I will detailon them.

By product classification, wetypically expect the new category to grow, Mainstream to be flat to down, andmature to decline. Our new products grew 13% sequentially and 52%year-over-year and continue to outpace our major competitor. Cyclone II was up34% Stratix II and Stratix II GX up 4%, MAX II up 13%, and HardCopy decrease 7%as expected after a 58% sequential increase in Q2.

Mainstream products declined alarger than normal 9% caused by Stratix and Stratix GX which combined were down21%. Cyclone increased 4%. Mature products declined 7% sequentially.

The shortfall in the original 130nanometer Stratix series was due to lower revenues in our industrial andcommunication segments and the conversion of some high volume devices to HardCopywhere customers bled off FPGA inventory before the HardCopy ramp.

Through approximately mid 2008,the HardCopy product line will be flattish as new product ramps particularly inthe Wireline Access and Wireless center cell applications offset slow declinesin older storage and communications areas.

By vertical market for Q3, we hadforecasted computer to be down, industrial to be flat with a rebound in testand measurement offsetting a decline in medical. For communications to be up ongrowth in wireless and networking and for consumer to grow in a traditionalstrong consumer quarter.

Computer declined 3% asforecasted with server revenue up and storage down. Industrial declined 8% withmedical down as expected but the test and measurement market decreasedsignificantly for the second straight quarter instead of the rebound we hadforecasted.

The declines here are bothindustry and account specific and we believe this sector has bottomed. Thecommunications segment declined 1% instead of growing as forecasted. Telecomdeclined, Wireless grew very slightly and Networking declined with overallcommunication shipments tailing-off in late September.

Consumer grew 14% far strongerthan forecasted with upsides in flat panel TVs and set-top decoder boxes. Theupside in consumer offset the decline in test and measurement and midst toguidance was the weakening of the communications business towards the tail-endof the quarter.

A few highlights for the quarter,we shipped our first member of the Stratix III series in August one month aheadof schedule. With our innovative programmable power technology, Stratix IIIFPGAs offer both 45% lower power consumption and 25% performance advantage overcompeting solutions and Cyclone III shipped over $600,000 in the quarter, astellar ramp for a low cost, low power series after only five months from firstprototype shipment.

Moving to our Q4 forecast, we areguarded with negative pre-announcements from several major communicationsequipment manufacturers and are forecasting revenues to be flat to down 4%. Weexpect Consumer, Industrial and Computer to each be flat to down and for theCommunications segment to decrease. Note that our Communications customers areforecasting our business with them to roughly flat and we are taking a cautiousposition.

Within the markets we expectbroadcast to be flat, digital entertainment flat to down as the holiday ramptails, storage to be flat, servers and office automation down, networking up,for wireless and telecomm to be down on industry weakness; and industrial,medical, military and test and measurement to be roughly flat.

Overall we expect turns to beapproximately 56% lower than our typical mid-60s and lower than Q2s 61%.

We will be hosting an analystmeeting in New Yorkin December and plan to detail our 2008 financial model and long term growthopportunities and strategy at that time. Based on our latest bottoms upanalysis by vertical market, we expect Altera to grow between 10% to 15%compound annual over the next five years.

With the maturing of thetechnology industry there are naturally changes that temper growth, such as theconsolidation of communications carriers and equipment vendors that reduce thenumber of R&D projects.

On the other side there are newopportunities within existing markets allowing continued PLD expansion such asin the communications wireless GPON and [center cell] applications. There arenew market opportunities such as automotive that offer greenfield growth and there are large marketsuch as military where Altera has low market share, strong design wins andmomentum.

Overall semiconductor designcontinues to become more expensive with each new process note making ASICs and ASSPsaffordable for only high volume applications. PLDs will continue to replaceASICs and ASSPs providing the industry with a strong future growth path.

At Altera we continue to focus oninnovation, execution and customer service, we are completing our 65 nanometerStratix III and Cyclone III rollout, where these products have significantlylower power consumption than competing devices. And we are well into design of45 nanometer products that will begin to ship next year putting Altera in astrong position to take maximum advantage of the ASIC and ASSP replacement cycle.

Let me now turn this call back toScott.

Scott Wylie

We would now like to takequestions. Please limit your questions to one at a time so we that we give asmany 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. I'll be happy to.(Operator Instructions). And our first question go to Glen Yeung at Citi.Please go ahead.

Peter Stournaras - Citigroup

Hi this is Peter Stournaras for GlenYeung. I wanted to ask about, you talked about large customers growing modestlyversus the broader base not growing. Could you give us some sense or can youalso help us understand that versus your longer term growth rate it looks likeyour year-on-year growth rates are inflecting pretty much though you are downquarter-on-quarter, is year-on-year growth rates inflecting? Can give us someview of '08 and how your large customer growing modestly now or may you being alittle bit stronger relative, would make you any more or less comfortable withthat longer-term growth rate?

John Daane

Peter this is John Daane. It'svery difficult for us to forecast much beyond the quarter and in an environmentthat we had for years where our customers don’t have clear direction themselveswhere they are headed. From a major customer category as Tim outlined inaggregate the category was up. In reality some of the customers were downparticularly you can imagine customers that are in the communications field, wehad several that were negative quarter-over-quarter.

We would expect actually allproduct categories or customer categories to go both big and small over thelong term. We would note that a lot of the small customers represent theindustrial sector. Bigger customers are aggregated more around consumercommunications; some of the computer and storage area medical, military asexamples. So, we would hope that all of our customer categories grow over thelong term, continue to believe as we talk about few moments ago that few ofthese will continue to replace ASICs and ASSPs for years to come, simplybecause it is becoming very expensive to design forward and newer processnotes.

For those companies that aretrying to use existing older generations of process technology, because theyare cheaper to design with. I think their fundamental problem is as we moveforward and write Moore'sLaw we can make our programmable devices even now they are slightly bigger thanASIC, because they incorporate technology to allow them to be programmable. Wewill be able to under cut the costs.

So for those that want to stand0.13 micron as we move in the 65 nanometer and 45 nanometer, we will have amore cost effective solution, and therefore can continue to replace ASIC andASSP solutions. We had also outlined that the servable market in both the ASICand ASSP fields are several times larger each than the PLD industry is today.So, we have a very long runway of replacing existing technologies before weneed to look at something else to continue strong growth.

Operator

And we'll go next to Seogju Leeat Goldman Sachs.

Jim Schneider - Goldman Sachs

Hi, this is actually JimSchneider for Seogju. Just first question, can you talk a little bit aboutspecifically in the industrial sector you called out test and measurement as anarea of weakness. Did you see any other kind of bookings weakness in Septemberat an industrial sector? And what have you seen so far in Q4?

John Daane

The weakness that we saw in theback half of September, just to clarify that. Generally in Q3, if you take astep back Altera is a very linear company in any quarter with the exception ofQ3 which is a little bit more backend loaded. We said in the past, itapproximate about an extra 4%ish. So, it's not that much more backend loaded.

The back half of September wasweak for a typical September, but it was also weak for any quarter, much weakerthan we have seen in the past and I think that had to deal with in particularthe communications industry where some customers decided to cut that on orders,because they were seeing softness themselves and ultimately had inventory.

Overall, within the industrialsector as we said, we expect this quarter that most of the sub-segments withinindustrial will be flat to slightly down. So, we are not necessarily seeing anyfurther change in our industrial sector from what we saw in Q3.

Operator

Our next question goes to TristanGerra at Robert W. Baird.

Tristan Gerra - Robert W. Baird

Hi, good afternoon. It looks likeyou benefit from cost advantage with Stratix II, but this products family seemsto be still lagging a little bit? And how should we look at the revenue rampfor that line irrationally next year, we pass an inflection point or are we stillat the stage where there is so much prototyping that there is basically a bigvolume ramp ahead of us?

John Daane

Thank you, Tristan. So, we'vetypically seen that our products peak about 4 to 5 years from their date ofinitial introduction. We would expect that Stratix II will still continue togrow. And in fact, if you look at our new product area, it is dominated inrevenues by Stratix II as an example, so has Cyclone II and MAX II in it. Andwe've outperformed the competition in that new product segment. So, I thinkwe've done extremely well with the Stratix II family. It's got some runwaystill to go before its peak and we would still expect that to grow andnaturally, we're adding to that 65 nanometer 3 series both Stratix III andCyclone III. So, we expect that new product category to grow for quite a longtime.

Operator

Next question goes to ChrisDanley of JP Morgan.

Venk Natirmani - JP Morgan

Hi, good afternoon this is [VenkNatirmani] sitting in for Chris Danley. John, I have a question for you. Youtalked about the various applications that could lead to sustained growth inthe PLD end market. But on flip side do you see anything that could perhapsslow down to growth, perhaps in terms by their complexity or cost?

John Daane

Thank you [Venkat].Fundamentally, if you look at the technology, we talked about this as a companyabout five or six years ago and I think its fairly well accepted now, aroundthe industry, our comment at the time was really only programmable types oftechnologies can take advantage of Moore's Law. Naturally, if the cost to do adesign increases with each node, that means you have to achieve a higherrevenue source or flow for each product that you introduce. The advantage ofprogrammable products as we can take one ship and sell it to lots of customersin lots of different markets and through the aggregation of volume justify thecontinued investment moving forward. So, we would see that as we write Moore's Law, we can makeour devices more cost effective, move them into higher volume applications, sothat we can take more market share that way. Increase the density so that wecan also play more in the higher end of the ASIC industry, where we were notable to compete previously and therefore take market share based on those twovectors.

I think that will continue forquite a few years to come. I think when I join the company, the PLD industrywas probably able to do an ASIC accounts something around 100,000 gigs. Todayin 65-nanometer we're shipping product that are in the 4 million to 5 milliongig range. So, we have substantially upped an increase the density that we canplay, that's allowed us to take on more the ASIC business and obviously morethe revenue. There are headwinds as I mention, certainly with the consolidationof the communications industry there is going to be fewer programs available,fewer R&D platforms that naturally creates some damper. But overall, if youlook at the opportunity, again the ASIC and ASSP market is each several timeslarger than the PLD industry today and that is the servable industry. So, weare taking out parts that we cannot service either because of power, forinstance in handsets because of volume more in ASIC will still be far more costeffective or because some designs include analog technology that we can'tservice.

The other thing is we have newopportunities to move in the new marketplaces and automotive is a great exampleof that, there are new applications that are being developed and deliveredtoday that we can now plan. So, overall, we would still expect this industry tocontinue strong growth, certainly much stronger than the overall semiconductorindustry. And again, I still believe this sector will grow at least two timesthe overall semiconductor industry rate.

Operator

We go next to Steve Elisku at UBS.

Steve Elisku - UBS

Yes. This is Steve Elisku for UcheOrji. Given you've been below your target gross margin here for three quarters.How are you going to get back to your 65% target without at the same time sacrificingyour long-term growth targets?

Tim Morse

Yeah. Thanks for the question,this is Tim. As we've articulated, we are in a little bit of a low in terms ofthe mix right now. The GM, the only good thing I could say about gross marginrates right now it is behaving very, very consistently with how we've beenarticulating it, and therefore it's fairly a simple message on how it will getback into that round. We are as we said before actively managing our businessto that 65% target. Right now we are a little bit light on industrial, which isabove the corporate strike zone of 65%. We see terrific growth opportunities inthose segments to get us back in the range. We see a lot of the key dynamics inthe other segments playing in our favor as well.

We will continue to evaluate manyof the consumer opportunities and as John had mentioned in the last call, we'vewalked from a couple of those that haven't had satisfactory margins. So I thinkwhen you couple the mix that will rebound, we've had a couple of quarters herein a row that's been week, but it will rebound with the opportunities we see.Couple that with the cost reductions that come along with Moore's Law and additionally a lot of thework that we are doing in our cost out simplification initiatives will actuallyhave a nice impact on cost to goods sold as well. We are evaluating a widerange of fairly big projects that will help our gross margin rate. So we areactually pretty optimistic in that regard.

John Daane

Yeah. Steve I'll just throw inone other comment, this is John. I see as much or more growth opportunity inthe industrial space than I do in the consumer space. As we've talked aboutthose represent the two extremes in terms of margins. Military, I think aseverybody knows we are a very small player in growing and doing very well indesign wins. As we continue to grow that we continue to even grow industrialcontrol, medical some of the other areas within the industrial sector. We seethose growing faster than consumer and therefore that would allow us to bringour gross margins back up in line with where our long term target is.

Operator

And we'll go next to GurinderKalra at Bear Stearns.

Gurinder Kalra - Bear Stearns

Thanks just a couple ofquestions; firstly, on your operating expenses, now its three quarters were youhave done better as far as those are concerned. What makes I guess forecastingthem a little bit difficult in that you managed to save in the last threequarters?

Tim Morse

This is Tim. I don't knowGurinder if there is a difficulty in forecasting. We have ranges, we try to runour teams to something a little bit more aggressive certainly in terms oftiming then we will commit to externally, we'll always attempt to do that. Ithink in this particular case, we've been talking about a cost out plan in amodel to gets R&D and SG&A to target percentages of revenue for sixmonths now. And that plan is unquestionably evolving. It evolves every singlestep along the way and it's a multiyear kind of journey if you will.

So I think this year, startingthat cultural shift to the productivity mindset to innovating as much on yourcost structure as you historically have innovated on your top line. That's abig thing to get a companies head around and get that the elephant moving if youwill. So I think particularly in these few quarters I have seen a betterreceptivity and better execution on that plan, such that we're ahead ofschedule.

So we're being aggressive. We areunquestionably driving the message throughout the entire organization. I thinkthe entire organization is grasping it well, and again we feel good about wherewe're going with this. So, I wouldn’t call it a problem forecasting, I amdelighted with the progress and I just want to continue to build on thatmomentum.

Operator

And we go next to Arnab Chandraat Deutsche Bank.

Arnab Chandra - Deutsche Bank

Yeah, thank you. Couple ofquestions, first of all John, I think you've talked a lot about, clearly therehas been different opinion for you or your competitor about the launch andgrowth that appeal to the industry and you've consistently spoken about theopportunities, industry et cetera. It just seems though that given how long ittakes in some of these sort of great markets that are under penetrated versusconsumer where things are faster. You had to make judgment between growth andmargin, because this year at least you are not getting both, you either goingto get one or the other. Can you tell us why that’s going to change?

And then the other question aboutexpenses, it seems like maybe you are a little bit slower and kind of movingyour tapeouts or your sort of process transition, so you are cutting SG&Ahowever you are increasing R&D. Where you a little over optimist on whatyou can get to if you want you want to be a growth company in terms of youroperating margin versus revenue growth? Thank you.

John Daane

So I guess there is multiplecomponents within that question and so I'll try to break it down. In terms ofprocess generations we are as aggressive as we've ever been, perhaps moreaggressive in adopting process generations, as we mentioned we'll shipping45-nanometer products next year. I think but you have to take a step back andappreciate is the fact that what we heard from customers and feedback couple ofyears ago as power was starting to become a major issue for them, particularlyin the infrastructure equipment area, you’ve now heard that out of companieslike Intel and AMD for servers. It is very much so if not a bigger issue withinthe communications industry. And so we wanted to do something different onpower.

We could make our devices biggerto lower power that would have impacted the cost; we didn’t want to do that. Wecould make our devices slower to lower power we didn’t want to do that, becausethat then would limit our ability to reach some of the market. So we came upwith an innovative programmable power technology, it required a lot of toolsdevelopment and a lot of architectural development, which was different thanwhat our competitors decided to do. Ultimately we have a much better productline, which we can not only deploy in 65-nanometer, which answers the powerissue, but also take that forward into 45-nanometer.

So we've solved what we think isa fundamental difficult point that our competitors are going to have toaddress. There is a natural balance between our top line growth and grossmargins. We could go sell programmable logic into just about any application inthe world including some of the game sectors if we wanted to. It’s just theprice and the profit and there are certain sectors that we do not want topursue, because we know we are not the right vehicle, that something else maybe more cost effective even with a really expensive NRE. And so there arecertain sectors or certain pieces of business that we just decide we may notparticipate in.

Now I would also tell you to goback and look at last years numbers. So if you look at last years numbers theindustrial sector actually had double digit growth and the consumer sector wasflattish. So this year it’s a little bit the opposite, I would expect going inthe next year the industrial sector is going to have strong growth and theconsumer area is going to be weaker. So I think what you are seeing is consumeris taking a little or consumer is building strong this year, I think it’s goingto pause a little bit next year. But in fact a lot of the industrial businesswe are doing is set to resume growth after a very strong growth last year.

And I think if you go back overthe last five years, we have seen close to which is about 18% compound annualgrowth out of our industrial sector. Certainly 2002 through 2006 that wascorrect, we will have to go play 2007 and to see that. So, the industrialsector has shown strong growth in the past and we believe we will continue toshow strong growth in the future.

And again, it’s a portfolio ofbusiness. We plan to manage this as a portfolio. We will try to grow thetop-line as quickly as possible. We are also cognizant that at the end of theday we want to grow earnings. And so if a piece of business has strong top-linegrowth that actually hurts our earnings that's something that we're just flatnot going to pursue.

Operator

And we will go next to MarkLipacis of Morgan Stanley.

Unidentified Analyst

Hi, this is John, on for Mark. Iam wondering if you could add a little color in terms of geographical wise. Iam particularly curious about Japanthat has been particularly strong area for you but it has been on the declineas a percentage of revenues for the past several quarters. And also howeverything is going in Europe, traditionallypretty backended loaded quarter. I am wondering if that had anything to do withthat weakness in the second half of September as well? Thank you.

John Daane

Certainly John. I'd cautionpeople probably for about 6 or 7 years that the geographic splits are not thataccurate. The reason is, we can have one customer take a GSM base station andmanufacture it in Mexico, inthe UK or manufacture it in China,depending on where they're going to ship the business. And it’s the same pieceof equipment. So, business moves around quite literally on a regular basis inour customer base. So, the geographic splits are really not as meaningful asthe verticals.

Now, overall, Japan the reasonthat it’s declined this year, we had a really strong growth in Japanthe prior two years because both NTT as well as KDDI were going through a verylarge build-out of 3G wireless technology. That is obviously gone through apause this year. We expect that our Japanese revenues are again going to grow,going forward as NTT starts to deploy the NGN network. And so, we are extremelywell positioned there both in terms of high end FPGAs, as well as, HardCopy atthe two major suppliers into that segment and we would expect that our Japaneserevenues will grow probably sometime beginning next calendar year as thatdeployments starts to take-off.

Now within Japan, we also have a bigindustrial-based businesses, as well as, medical and computer and storage.Those areas have been going through some ups and downs. But overall, we thinkwe are doing extremely well from our market share position and but again wewould expect Japanto start growing for us again next year.

Operator

And we will go next to TimRobinson at [Buoyant Advisors].

Tim Robinson - Buoyant Advisors

Hi guys. Thanks for taking mycall. I apologize if I miss this, but what was your quarterly cash fromoperations?

John Daane

CFOA for the quarter was $116million.

Tim Robinson - Buoyant Advisors

Okay. Thank you very much. Andjust the other question I had was relating to the R&D expenses. Does forthe past couple of quarters they've just been lower than previous quartersguidance, is it a question of being conservative? Was it or are there increasedefficiencies going out?

Tim Morse

Yeah. We've characterized in eachof these last couple of quarters as increased efficiencies. Last quarter too wehad couple of paypal's that just missed the cutoff in 2Q and we ship instead inthe first 10 days or so of 3Q. So, there was a little bit of timing lastquarter. This quarter, undoubtedly, better lower spending on both Stratix IIIand Cyclone III as I said in my script better yield. So, the rollouts have justbeen very, very smooth, we are happy with them.

John Daane

Yeah. Typically, we build into anassumption that we are going to have to potentially respend some of the earlydevices that we prototype. Mask sets are running around $3 million and so asyou can imagine, if you have to respend a device that can be very expensive andagain if you have to respend here for several devices, you can multiply thatup.

This year, we are doing both theCyclone and Stratix family, so you can imagine that you have quite a few.Altera has executed really almost flawlessly, since 0.13 micron 90-nanometerand 65, I can't think of a chip that we've actually had a full mask respend on,that we've had to go back and do this. I think that's why Altera has such astellar record of bringing the products out on schedule, as well as, being ableto achieve volume. So, we certainly have that going in our favor this year. Andas Tim mentioned, we usually plan wafer purchases and yield work to improveyields and 65-nanometer yields that are well ahead of schedule, so we aresaving money also within that side of the business.

And of course, there are otherefficiencies that we've been able to realize as well overtime in R&D. Ithas not changed our product strategy, it has not changed our product rolloutand we continue to execute, bring everything out to market on schedule.

So, it is nothing to do with ourproduct schedules, a number of products that we are doing as much as it justhave been. We've executed much better than I think any other company normallydoes, PLD or semiconductor period and that efficiency has led the lower overallR&D cost.

Operator

(Operator Instructions). And wewill go to Tim Luke of Lehman Brothers. Please go ahead. Mr. Luke your line isopen, we are not hearing you. Mr. Luke are you there sir. (OperatorInstructions). And we do have a question that's come up, this is a follow-up.This is Mark Lipacis from Morgan Stanley. Please go ahead.

Mark Lipacis - Morgan Stanley

Hi, great. Thanks for takinganother question. Could you view in the past you have mentioned a desire torefocus on the military business. Can you give us an update of what you aredoing there? Thank you.

John Daane

Unfortunately, I think Alterahave decided to get out, I don’t know whether it was 10, 12 exactly when thatnumber of years ago it was, we exited the military space. Military is perfectfor programmable logic because of two reasons, one is the military generally isgoing through a very significant upgrade to electronics or everything.Everything is becoming smart, communications is being push down to theindividual solider, obviously the amount of purchase that they have onelectronics is increasing. Generally, the volume is low, and so it's reallyperfect for our space.

Altera has two advantages for thisfield, number one as we have HardCopy. So, there are some programs particularlyin Avionics, where they would like to achieve power reduction. And so, HardCopybecomes a wonderful play for first prototyping in FPGAs and then moving to thestructured ASIC for the cost reduction.

Number two is power consumption.Most military applications are space constraint, they are power constraint andby having lower power consumption within our devices, I think we have a greatadvantage over our competition. I guess the last thing I would throw out, it'sjust a very conservative customer base and on-time execution is key and as acompany we have the best quality, the best reliability we bring out productsout on time which matches from a cultural perspective what the military wouldexpect of suppliers.

In area that we have done quitewell is for instance in SDR. And the reason that we have done well within thesenew communication systems is because the government has mandated programmabletechnology for radios in order to upgrade algorithms to be able to change theequipment. So that they can ultimately upgrade the crypto algorithms to stayone step ahead of either the enemy or the terrorist and that has been mandatedto be done on programmable logic devices, because we have both the logic fabricas well as the DSP capability.

In this field after talking tocustomers for a concerted amount of time, they were looking for a Cyclone likedevice with low power. A Cyclone III fits that perfectly, we’re able to offer aspecific device within the Cyclone III family that had the density, the memory,the DSP features, the IO features that these military customers were lookingfor. Our power consumption is considerably lower than the competitions and wereally have the only product in the town.

So almost every one of the STRplatforms is now Altera based and this is a market that we had very littleparticipation in previous generations. And as you can imagine they are tryingto again push communications down to be individual soldier, so the volumes herecan be quite substantial. It's an area, as an example Altera has done extremelywell from a design win standpoint and we would expect to ramp for us over time.

Operator

And we do have a follow upquestion in the queue this is from Steve Elisku at UBS. Your line is openplease go ahead.

Steve Elisku - UBS

Yeah, this is a follow up to yourcomments on being optimistic regarding a rebound especially in industrial. Canyou give us a sense what you are seeing in terms of the overall macro economy.There has been obviously a lot of concern out there specially related to the United States.And if you could give us your take on what you are seeing globally, that wouldbe very helpful? Thank you.

John Daane

Steve, as I think I went throughthe test to measure when market has gone down for two quarters. I think therehave been some challenges there both from -- as the communications industry isan example has gone through some consolidation. That has led to either delaysor cancellations of additional R&D tester acquisition. Companies likeAltera as we continue to look for ways to differ or eliminate capital purchaseshave been very creative to keep existing equipment like testers alive that wehave by introducing new algorithms or new test capabilities.

I really have to applaud our testR&D as well as PEN manufacturing group for being very creative to find waysto extend our current equipment and delay purchases. I think those two effectshave definitely impacted that market, but we do feel that market has flattenedat this point. I think the input from medical customers is generally the marketis somewhat flattish, they don't expect it to get worse though. I think thebroad industrial base is probably doing okay, because there is a lot ofequipment expansion in Asia right now and so if the U.S. economy is slow, if you thinkof actual companies building factories a lot of that is going into lower costgeographies, which is overseas and so a lot of that effort continues.

So we haven't overall seen Iwould say, a slow down in the smaller customer industrial segment, although wewill continue to watch it. It is an area of concern if the overall economy on aworldwide basis were to downturn certainly capital equipment would be impactedand therefore Altera would be impacted.

We are trying to keep is as Ithink you are aware a conservative view on every quarter. We do hope thisquarter we have taken into account as many things that we can for instance thepotential for a significant communication slow down in the wireless sector andby the way that slow down at wireless does effect both our wireless as well aswireline or telecom areas, because some of the backhaul equipment that is soldwith the wireless network falls into our telecom segment. So we think we'rebeing guarded there and cautious in doing the right thing, so we are hopingthat we are conservative enough this quarter.

Operator

Gentlemen we have no otherquestions in the queue at this time. So I'd like to turn the call back over toMr. Wylie for any closing comments.

Scott Wylie

Thank you, operator. I have a fewfinal items. First a reminder, on December 11th at 3:00 PM in New York, Altera will host a meeting forinterested members of the investment community and we'll be sending out thefull details shortly. And on November 28th, we will present at the CreditSuisse Annual Technology Conference in Phoenix.This concludes Altera's conference call. Thank you for your participation andinterest.

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Source: Altera Q3 2007 Earnings Call Transcript

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